Credit Suisse: Reinsurance Earning Estimates

May 24, 2013

Following discussions with nine reinsurers in Bermuda earlier this week, analysts at Credit Suisse find no reason to believe the growth trajectory of insurance-linked-securities reinsurance structures and the subsequent pressure it puts on pricing will dissipate for the foreseeable future.

In a research not issued to investors on Friday, Credit Suisse analyst Michael Zaremski said “more specifically, while we believe 10 percent to 15 percent pricing declines in Florida on June 1 will become less negative [i.e., down five percent to 10 percent] in the latter half of 2013 as both insurance-linked securities [ILS] market growth estimated at $5 billion year-to-date and traditional competition is less pronounced in non-Florida and non-US geographies, we see no indication — outside of a wider-than $25 billion loss — for overall property-catastrophe reinsurance rate levels to stabilize in 2014.

“We point out that our published earnings-per-share estimate declines are more pronounced, as we foresee a majority of the margin pressure being exhibited in business lines that are currently earning a higher margin than each insurer’s respective consolidated portfolio [e.g., Florida business offers a few points more margin than a line on a program for a national insurer].”

Accordingly, Credit Suisse is adjusting its prospective reinsurance EPS estimates downward by an average of five percent [with a range of one percent loss for Ace to a 10 percent loss for RenaissanceRe Holdings].

Mr. Zaremski continued: “In the event of a large loss during the current wind season, we are also doubtful the ‘payback period’ for most reinsurers would be attractive given our view that 1) ILS providers have access to ample capital, which can be more quickly deployed than start-up reinsurers [KKR's relationship with ILS market-share leader and closely held Nephila of London, for example]; 2) well-capitalized Berkshire Hathaway is still largely on the sidelines in the U.S. property-catastrophe space; and 3) a majority of the largest global reinsurers [Munich of Germany, Swiss Re of Switzerland, ACE, PartnerRe, etc.] are sitting on ample excess capital positions.”

“We also have come to the conclusion that some of the downward pressure on property-catastrophe reinsurance rates [perhaps as much as 50 percent of it] is being self-inflicted by the wave of start-up ILS platforms from traditional reinsurers.”

Mr. Zaremski said while this pressure will ease in the long run, it’s unlikely to let up in the next 12 months given: 1) the small absolute size of existing ILS platforms relative to insurers’ desires to grow their ILS platforms; and 2) the number of insurers who will be rolling out new ILS platforms [including Bermuda's XL Group and Aspen Insurance Holdings] through January 2014.

“We’re also still grappling as to the extent ILS solutions will be successful moving into other reinsurance asset classes,” he said. “For example, reinsurers such as Lancashire discussed including nonproperty catastrophe shorter-tail risks within its upcoming $300 million to $500 million targeted third-party capital vehicle.”

The Credit Suisse analyst saod with reinsurance stocks trading near book value relative to still high-single-digit return-on-equity profiles, while sitting on healthy excess positions and having underperformed the Standard & Poor’s 500 and primary insurers by six percent and four percent, respectively, since investors started catching wind of poor pricing conditions last week, the Zurich-based financial services group believes a majority of the near-term negative news has been priced in.

“For example, Outperform-rated Aspen has less than 25 percent of its portfolio exposed to property-reinsurance headwinds, while we expect a combination of capital management and operating leverage to ultimately raise its ROE profile,” said Mr. Zaremski.

“We also view Outperform-rated Validus Holdings’ near tangible book valuation being unwarranted relative to over 50 percent of its revenue being derived from nonproperty catastrophe reinsurance lines and relative to its 13.7 percent ROE profile [its growing ILS platform also offsets some of the aforementioned pricing pressure].

“On the other hand, a large excess-capital position — estimated at over $500 million — is the key variable keeping us from becoming more bearish on Neutral-rated RenaissanceRe given its more-pronounced estimated exposure to property-catastrophic reinsurance-rate pressures, including its apparent unwillingness to grow its third-party capital platform in order to take in new Florida (not existing) reinsurance demand, which has for the most part gone to ILS platforms, such as Nephila.”

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