Reinsurers “well-equipped” to weather the storm, for now at least: S&P

International ratings agency Standard & Poor’s (S&P) has highlighted the strong enterprise risk management (ERM) practices of global reinsurers as key to success in the current market. But as market headwinds persist and margins continue to thin, the harder it will be for firms to weather the storm.

The profitability of global insurers and reinsurers continues to wane under pressures from an array of market challenges that includes an abundance of capacity from alternative and traditional sources, heightened competition and ultimately reduced rates.

With continued low interest rates making profits on the investment side of the balance sheet a challenge, the threat of more frequent and severe extreme weather events and evolving regulatory environments, disciplined and prudent risk management has become key to survival, says S&P.

“However, the reinsurance sector as a whole is differentiating itself from other sectors through its stronger enterprise risk management (ERM) frameworks, which have led to an increased focus on disciplined risk selection.

“S&P Global Ratings believes this has likely resulted in conservative underwriting and investment asset allocation, despite lower returns. We thus view reinsurers as well-equipped to weather the headwinds they face, as reflected in our broadly stable outlook on the sector,” said S&P in a recent report.

The ratings agency explains that its ERM assessments reflect the view that the reinsurance industry’s ERM practices are very favourable when compared to those of primary players, aided by reinsurers’ strong investment in risk modelling and increased understanding of complex risks.

S&P’s analysis shows that when compared to insurers across the world, reinsurance companies’ ERM practices are far stronger and as a result S&P feels reinsurers are “well-equipped” to manage current market headwinds.

One thing reinsurers have benefitted from in recent times, says S&P, is with their increased understanding and utilisation of catastrophe risk models, with the confidence and experience in using models acting as a key differentiator for reinsurers.

“A robust understanding of catastrophe model components gives reinsurers with strong ERM frameworks a competitive advantage over traditional insurers in risk selection and pricing as well,” explains S&P.

However, while reinsurers might be in a more favourable position to mitigate the current market headwinds, owing to strong ERM practices, the longer negative aspects of the marketplace persist the harder it will be for reinsurers to successfully navigate the soft market.

“While we view the developments in ERM favourably, we are aware that these frameworks and new techniques have not been tested in recent years by historically stressful events, the likes of Hurricane Katrina, Rita, and Wilma in 2005, the reserve strengthening in the late 1990s, or periods of high inflation.

“It remains to be seen how well these frameworks have prepared the industry for the hurdles that are sure to come,” said S&P.

While there’s been a notable slowdown in the entry of alternative reinsurance capital in the overall re/insurance marketplace, it does continue to enter the market and contribute to the current supply/demand imbalance, and this shows no sign of waning in the future.

At the same time expenses continue to rise for reinsurers and the benign catastrophe loss environment at a time of lower returns has also driven some aggressive reserve releases, and ultimately reserves across the board appear to diminishing.

All of this contributes to continued profit deterioration for global reinsurers. So while prudent ERM strategies might well be assisting international reinsurers in navigating the current market, absent a dramatic uptick in pricing it’s likely the soft market will persist further into 2016 and into the start of 2017.

Essentially, the longer the softening landscape remains and margins continue to be thin, the harder it will be for reinsurers to weather the storm, regardless of their ERM approaches.

Furthermore, S&P highlights the potential impact of the evolving risk landscape, saying that as “uncertainty and volatility become the norm, we expect reinsurers’ ERM practices to adapt.”

“Some risks are accelerating, such as the potential for extreme weather events related to climate change; cyber risk and the ability of controls to keep pace with technology; capital market volatility; and evolving regulations reflecting various interests and differences among jurisdictions,” said S&P.

It’s promising to hear that reinsurers are remaining disciplined in the challenging market and that S&P underlines the strong ERM practices of the industry as vital to its ability to navigate the testing reinsurance environment.

But the reality is that the longer the soft market cycle remains and the wealth of headwinds persists and even intensifies, the harder reinsurers will find it to remain profitable and relevant, regardless of their ERM strategies.