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Rise of structured deals fuels reinsurance titans' growing dominance

The largest reinsurers are increasingly solidifying their position as industry leaders, according to analysts, as only those with the broadest underwriting expertise look able to meet clients' rapidly changing needs.

New European insurance regulations known as Solvency II — which were rolled out at the beginning of 2016 and stipulate that insurers hold capital sufficient to guard against a "1-in-200-year" loss event — drove demand for "structured" transactions, with many insurers asking their reinsurance partners for complex solutions to take risks off their books to improve their capital positions.

Such deals often involve reinsuring — assuming all or a portion of the risk — across a range of lines of business for a given insurer, which requires broad underwriting expertise on the part of a single reinsurer to understand and accurately price the risk being passed on. By contrast, many traditional reinsurance deals involve a syndicate of reinsurers taking on a single risk, making it easier for smaller companies to compete.

Based on premiums written, the top seven global reinsurers were the same in 2016 as in 2015, according to S&P Global Market Intelligence data. The big four European reinsurers — Munich Re, Swiss Re Ltd., Hannover Re and SCOR SE — remain firmly atop the pile and are also best-placed to take advantage of demand for complex, bespoke transactions, according to Daniel Bischof, a re/insurance analyst at Baader Helvea Equity Research.

Smaller reinsurers 'become irrelevant'

In one deal cited as an example by Swiss Re, the world's second-largest reinsurer, a Latin American insurer wanted to return more capital to shareholders while also increasing its return on equity. So, Swiss Re struck a deal to take on a loss-making book of business and a share of the company's lower-ROE business in exchange for a fee, enabling the cedent to achieve both goals.

In another example, Swiss Re reinsured a book of business belonging to a life insurer to allow its parent, a large bank, to refocus on core business. A quota share deal, whereby Swiss Re agreed in advance to take on a share of the risk to be written by the insurer, combined with a full transfer of existing deals, achieved the objective.

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The larger reinsurers do not break out exactly how much of their business comes from such large, bespoke deals, but they say it is an area of rapid growth.

A flurry of deals booked in 2016 was the primary reason behind a sharp year-over-year upswing in Swiss Re's premiums, Bischof noted in an interview. Yet a steady trickle of such transactions cannot be expected, CFO David Cole told analysts at the presentation of first-quarter results.

"[It's] not the kind of thing that just very neatly falls in a linear fashion, either in conjunction with the renewal schedule or even, for that matter, along a quarterly basis," he said.

Overall, Swiss Re and SCOR SE reported year-over-year premium rises in 2016, while Munich Re and Hannover Re booked decreases, driven by a retreat in mainstream lines of business. Individual underwriting decisions and foreign-exchange movements also played a part in moving premium figures year over year.

For Munich Re, big structured deals promise good margins as the company hones the focus of its core reinsurance operations to concentrate on the most valuable lines of business, outgoing CEO Nikolaus von Bomhard said at the company's full-year 2016 earnings presentation.

"These business opportunities arose worldwide and in all lines of business, especially in casualty and property reinsurance," the firm wrote in its annual report.

Big one-off deals occasionally allow minnows to leapfrog their rivals. Rothesay Holdco UK Ltd. vaulted into eighth place from 28th on S&P Global Market Intelligence's list by buying a £6 billion book of annuities from AEGON NV U.K. unit Scottish Equitable Plc.

Yet, in the main, the trend toward big deals has put intense pressure on smaller reinsurers that can't afford to invest in the underwriting expertise that these deals require. That leaves them to fight over the more easily underwritten types of risks — such as U.S. natural catastrophe — that have seen the fastest and sharpest price declines, according to Bankhaus Lampe analyst Andreas Schäfer.

"There are only a few companies able to make this sort of structured transaction," he said in an interview.

This echoes Bischof's assessment. "The smaller players aren't in a position to play this cycle any longer," he said. "You become irrelevant in the market if you lose too much scale. ... You don't want to lose scale and size, and that's why I think a lot of these mid-sized and small players are … holding on to business [despite] significant price reductions."

How low can it go?

For several years, the three annual rounds of reinsurance contract renewals have resulted in marked declines in the prices charged to clients, and industry brokers are warning that reinsurers will need to cut their prices again in the June/July renewals to hold on to existing business. JLT Re, an insurance broker, said the June 1 renewal round produced a 5.1% year-over-year fall in its index of Florida hurricane reinsurance prices.

"If nothing untoward happens in the next couple of weeks, why should the situation change?" Willis Re International Chairman James Vickers said April 20. "Reinsurers have [cut prices] at [the Jan. 1 renewals], they've done it at [the April 1 renewals]. Buyers will automatically expect at a minimum the same treatment."

Several years of below-average losses — JLT Re noted that it has been 11 years since an Atlantic hurricane made U.S. landfall — and the growing role of insurance-linked securities have led to an oversupply of capital, giving clients a free hand to negotiate better deals.

Aggregate net income for a sample of top reinsurers compiled by Willis Re fell to $26.6 billion in 2016 from $30.3 billion in 2015, figures released April 20 showed. Their return on equity fell to 8.0% from 9.3% year over year.

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