Back in March we suggested that the supposed structural link between low investment returns and poor profitability for reinsurers was a myth.
Our view in essence (http://litmusanalysisblog.wordpress.com/2013/03/06/reinsurer-profitability-and-the-interest-rate-myth/) was – and is – that expected investment yields are a generic given, and that reinsurance pricing therefore reflects these. Disappointing results in reinsurance are not logically a function of low investment income but rather the degree of competition in the industry reflected in reinsurance pricing.
The caveat to that being that, since the industry’s basic ‘productive capacity’ is risk capital, the extent to which a lack of attractive investment opportunities in global financial markets sucks in too much capital ‘supply’ is in itself a cause of pricing pressure.
But let’s be clear: that does not mean reinsurers have to under-price. It means they chose to do so in the face of severe competition; of which some of the newer flavours might have lower return on capital hurdles than ‘traditional’ reinsurers (a subject for another day).
Far from being a problem, low interest rate environments are (or should be) the perfect environment for reinsurers, negating the temptation for irrational ‘cash-flow’ driven competition.
Half yearly numbers have provided an ironic twist to this. The US Fed’s hints at ‘tapering’ (the running down of its programme of purchasing US government debt) led to a spike in yields – falling prices – for Treasuries (and other ultra-low yielding sovereign debt such as German Bunds and British Gilts). Hence the losses (even if only paper losses) for the holders of these was triggered by the bond market ‘pricing in’ a return to exactly the more normal interest rate environments many reinsurer leaderships claim they want to see.
This was a ‘known unknown’; it was going to happen we just didn’t know exactly when. Like an unusually heavy ‘cat ‘ year there is not much reinsurer leaderships could do about it without making the kind of investment ‘bets’ that, frankly, they really shouldn’t be.
So reinsurers can very reasonably argue that this was out of their control (although it is, of-course, just the flip side of the bond portfolio gains many of them made as governments slashed rates in 2008/09).
However this simply serves to highlight the point. The vagaries of investment markets are what they are.
Reinsurer performance is fundamentally not about interest rates; the true quality of a reinsurer is seen in its underwriting results.
Stuart Shipperlee, Analytical MD, Litmus Analysis