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Monte Carlo 2015: The analysts’ view

With the curtain drawn on another Monte Carlo Rendez-Vous, the sector's P&C equities analysts have issued their key takeaways from the conference.

While it's clear that reinsurance headwinds are likely to persist in the coming year, there were glimmers of hope, with indications of slowing rate reductions and ongoing reserve strength.

Furthermore, reinsurers are taking different paths across the soft market terrain, with some still expanding their reinsurance books while others are cutting back.

Meanwhile, M&A became the buzzword across the Principality as analysts anticipate that the recent industry consolidation will continue as reinsurers review their strategies in light of current market conditions.

Rates

Analysts generally agreed that although reinsurance rate cuts would continue at the upcoming 1 January 2016 renewal season, there would be a "softening of a softening", with overall rate decreases limited to the low- to mid-single-digit range. They pointed to early signs of pricing stabilisation, particularly for property cat.

"Clearly, absent a market changing event - a very large surprising cat, a liability crisis or a rapid rise in inflation - the market will be soft for some years to come," remarked analysts at Bernstein. They added that they expect broad pricing declines for another two to three years amid ample capital and pressure to produce.

"However, the freefall in pricing for property cat appears to have stabilised, as major cat bond managers have begun to demand higher cat bond yields," the analysts continued.

Despite prevailing rate declines, analysts at JP Morgan said they believed that on an underlying basis, the industry is still currently achieving a return on equity close to its cost of capital, which they peg at around 7 percent.

"Should rates stabilise in 2016 (as Swiss Re estimates), then it may be that a floor in industry profitability is reached at an underwriting level marginally positive, which is different to previous cycles. This may warrant higher valuations in our view," they said.

Analysts at Keefe, Bruyette & Woods (KBW) agreed, saying: "Most underwriters recite a mantra that cost of capital returns [...] are being challenged but not terribly breached, and so if the market is going to give up some margin then so be it."

They found that the European property catastrophe market was generally said to be the most competitively priced, while US business still offers better margins despite including much higher peak risk.

Bernstein also noted a divergence in soft market growth strategies. A few companies are using more defence and opting to "play the cycle" and shrink their books, while others are choosing to expand their top line even though this might not be the most prudent strategy.

Furthermore, they found that many carriers were "doubling down" on primary business to protect against reinsurance headwinds. In turn, this is likely to compress returns for commercial lines insurers as reinsurers increasingly shift capital to the larger, more syndicated wholesale primary lines.

Losses

KBW highlighted the ongoing favourable impact of a benign loss environment on reinsurers' underwriting results, adding that it was hard to judge when the current confidence in earnings among carriers would be contradicted.

Furthermore, they said that one reinsurer believed that many reinsurers were tweaking models to achieve a desired outcome.

Indeed, the recent Tianjin explosions are something of a warning. Earlier this month, Guy Carpenter estimated insured losses from the event at $1.6bn to $3.3bn, although exact ranges are still uncertain.

Nonetheless, analysts at Morgan Stanley said that despite being a large non-modelled loss, most considered the event too small and local to influence global pricing.

Reserves

Meanwhile, there was general consensus among analysts that industry reserves were still holding up despite constant predictions of depletion.

"Overall, we see little evidence of reserving adequacy having declined, and in fact the benign loss environment may have enabled further strengthening," remarked analysts at JP Morgan.

"This suggests the industry has scope to continue delivering good headline results in the coming years we believe, even if the loss environment becomes more challenging. Longer term this may be difficult to sustain, as consecutive low cat years leave reserves in absolute terms lower," they added.

Analysts at KBW said that most executives concurred with their predictions that reserving cycles could now become compressed at a higher level and potentially remain on positive ground instead of entering negative territory.

"We still think there is a long way to go before this view is proven, but it is worth highlighting that ours is not a lone voice in this regard and we are certainly not the most aggressive proponent of this point in the industry," they stressed.

M&A

Analysts also agreed that the recent spike in M&A activity would probably continue amid a deteriorating market environment, with consolidation being a focal point at this year's Rendez-Vous.

"We believe that the current environment is ripe for more willing sellers and buyers. In the past, periods with low profitability (rising combined ratios) tend to correspond with higher volume of M&A," said analysts at Morgan Stanley, highlighting that M&A activity grew by circa 5x in the most recent two cycles.

Analysts at KBW said that large European reinsurers continue to seek bolt-on M&A opportunities in a bid to strengthen their US presence, add innovative businesses or grow into strategic areas such as corporate solutions or casualty, while capital management is expected to persist.

Meanwhile, Bernstein analysts believe that now that M&A activity has picked up many growth-oriented firms will pay up to drive expansion and capture scarce platforms.

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