The impact of excess capacity, benign losses, low interest rates, and heightened competition, combined with further rate declines at the upcoming renewal season will be evident in next year’s reinsurance company results, according to Moody’s Investors Service.
During the last 24 months the profitability of global reinsurance entities have been masked by a lack of catastrophe loss events, reserve releases, and growth in earned premiums, explains Moody’s.
All of which has resulted in companies, and the sector as a whole reporting solid return on equity (ROE), and underwriting margin figures, which perhaps, aren’t a true representation of the reinsurance industry’s current state.
Ample capacity continues to flood the sector from both traditional and alternative reinsurance capital providers and, its influence on rates has been exacerbated by the low loss environment, which has seen primary players retain more risk and therefore require less reinsurance, a driver of the current supply/demand imbalance that’s discussed so much in the space.
Yet while the market has continued to soften as many of the challenges have persisted, reinsurers have continued to report healthy combined ratios of below 100%, and as a whole, ROEs have also been healthier than the challenging, competitive, and overcapitalised market landscape would suggest.
To achieve the ‘artificial’ profitability figures throughout the year, something highlighted by Willis Re back in May of this year, and noted by Moody’s, reinsurers have relied on positive prior year reserve releases, and have benefited from below average catastrophe loss events.
However, commentary from Moody’s suggests this approach won’t last for much longer, as the firm expects “the combination of stalled organic growth and a further potential 5%-10% decline in 2016 catastrophe rates will expose the real impact of cyclical and secular headwinds in next year’s results.”
Utilising prior years reserves to bolster underwriting profitability certainly isn’t anything new, however, when industry loss events remain low for a prolonged period it limits the opportunity to refill reserves as much as is likely required, which will eventually lead to reserves diminishing until obsolete.
It’s important to note that the above expectation from Moody’s is with catastrophe losses remaining benign, and the other determining factors, so excess capacity, competition and so on, following the trend of 2015 also.
Meaning that should catastrophe losses, natural or man-made, return to more average levels in the coming months, reinsurance company results during 2016 could take a significant turn for the worse.
In fact, according to Moody’s, were catastrophe losses to normalise then ROEs would be two to five percentage points lower than what’s reported, and “adjusted returns would only moderately exceed cost of equity.”
“We reiterate our view that 2016 will be the year when adjusted returns of some companies will fall below their cost of equity,” confirmed Moody’s.
Add to this the expectation from some industry analysts, experts, and market participants that terms and conditions (T&C) will likely loosen at the upcoming January 1st 2016 renewals, and it’s unsurprising that Moody’s expects reinsurer underwriting margins to seriously wane throughout 2016.
Should a large, or unexpected loss event occur during 2016, at a time when multi-year deals have locked in pricing at lower levels than seen before, and relaxations of certain T&Cs are expected, plus the dwindling of reserves, some companies could find themselves extremely exposed when disaster strikes.
Underwriting and investor discipline will likely remain key at January renewals, but as stated by Moody’s, with or without a large loss event reinsurers are going to face further challenges in 2016, pressures that will become increasingly apparent when results are reported.
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