Reinsurers’ management of catastrophe exposures diverges: S&P

by Artemis on September 3, 2015

Global reinsurers are adopting divergent approaches to managing catastrophe exposures as market challenges, driven in part by ample capacity and a lack of significant losses persist, according to insurance and reinsurance ratings agency Standard & Poor’s (S&P).

As the softening reinsurance market persists many reinsurers have been forced to adapt their management approach to catastrophe risks, reducing their exposures to catastrophe threats and redeploying capital into differing business lines, such as U.S. casualty.

However, not all firms are adopting this method to navigate the softening market landscape, as international ratings agency S&P explains: “In analysing reinsurers’ catastrophe exposures, we have identified a divergence in reinsurers’ strategic reaction to the softening markets. While most reinsurers allowed their exposure relative to capital to contract, a few took on more exposure this year.”

24 months of benign loss activity coupled with the constant flow of alternative and traditional sources of reinsurance capacity has resulted in a market with record volumes of capital, which in turn has driven and helped to sustain the recent downward trend in catastrophe risk pricing.

Unsurprisingly, and in response to this, many global reinsurers have pulled back on their catastrophe risk exposures in recent times, reallocating capital into other business lines where perhaps the impact of a softening reinsurance market is yet to have as much of a negative impact on rates, for the time being at least.

But as highlighted by S&P in its recent industry report, ‘Discipline Is Necessary As Reinsurers Adjust Their Exposure To Catastrophe Risk,’ some reinsurers have actually increased, or managed their catastrophe risk exposure to remain flat.

The result of which, particularly for companies that are less diversified, is the risk of increasing the volatility of their balance sheets.

“Where less-diversified reinsurers have adopted such strategies, the additional volatility to both their balance sheet and earnings position may weaken our view of their risk positions, even though any score change in the short term is unlikely,” said S&P.

S&P continued to stress that in its view, “an increased focus on catastrophe risk weakens a reinsurers’ risk position by increasing volatility in earnings and on the balance sheet. We consider underwriting profitability in the sector likely to become more vulnerable to natural catastrophes; therefore, we anticipate that operating performance could deteriorate at reinsurers that are more exposed.”

Typically, and again unsurprisingly, the majority of reinsurers that reported an increase or flat exposure to catastrophe risks are the well-diversified firms, which are more capable of supporting the “incremental capital cost of additional catastrophe risk exposure and thus benefit from lower technical price constraints,” notes S&P.

Expectedly then, S&P advises that the less diversified players are the ones that typically represent the largest reductions in catastrophe exposures and are increasingly looking to other business lines, primary included, to redeploy capital in an effort to achieve more desirable returns.

With the influx of alternative and traditional sources of reinsurance capacity and intense competition predicted to continue, coupled with the possibility of a continuation of the benign loss activity witnessed in recent times, S&P expects the divergence trend among reinsurers’ management of catastrophe exposures to “widen as rates soften further.”

Furthermore, management of catastrophe exposures is also a vital piece of the risk landscape puzzle for insurance-linked securities (ILS) fund managers, including catastrophe bond market participants. It is perhaps particularly vital for those ILS managers writing increasing quantities of collateralized reinsurance.

The S&P report suggests, based on its own analysis, that for most reinsurers’ exposure to extreme catastrophe events has reduced, and the majority of firms show little appetite for taking on increasing levels of catastrophe exposed risk.

In fact, the report notes that “a third of rated reinsurers have seen a reduction of 3 percentage points or more” in their balance-sheet exposure to catastrophe risk.

As the softening rate environment across the global reinsurance sector persists divergence with firms’ catastrophe risk exposures is predicted to continue, signalling a need for reinsurers to adequately adjust and manage their catastrophe exposures.

Whether a well diversified entity seeking to increase catastrophe risk exposure as others flee in search of more desirable yields, or one of the fleeting many, perhaps less diversified organisations pulling back on catastrophe exposed lines in an attempt to reduce its capital-at-risk, the challenges and opportunities are apparent.

But the message from S&P is clear; “Those that misjudge their exposure could be left isolated after the next large event. This reinforces our view that discipline is necessary as reinsurers face difficult strategic decisions when adjusting their exposure to falling catastrophe rates.”

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