Long-term viability at risk in reinsurance, outlook still negative: A.M. Best

by Artemis on December 13, 2016

The outlook for the global reinsurance market remains negative at rating agency A.M. Best as the firm cites the “continued market challenges” and an expectation that the longer the outlook persists, the more likely to is that we see negative rating pressure emerge.

A.M. Best logoA.M. Best analysts highlight the risk to reinsurers long-term viability, as longer-term challenges begin to emerge due to the sustained and persistent pressure the sector faces.

A.M. Best has been negative on the reinsurance market’s prospects since 2014. The situation since then has not changed and in fact in some ways the pressure has got worse, while increasing competition has risen from traditional and alternative sources of capacity.

Additionally reinsurers are going to face pressure further down the line from insurance technology (insurtech) start-ups, which taking a similar approach to insurance-linked securities (ILS) players will seek to leverage alternative capital and efficient ways to deploy capital into insurance and reinsurance risks.

The rating agency agrees with most observers that the reinsurance market is beginning to find a floor in pricing, but they remain negative overall as the strain on reinsurers profitability is becoming evident through lower risk adjusted returns.

“Recent indications of a market bottoming are slowly emerging, but the overall operating environment remains negative, which is concerning,” explained Robert DeRose, senior director, A.M. Best.

The headwinds that the reinsurance market is facing are now beginning to present “significant longer-term challenges” to sector profitability, according to the rating agency.

At this stage in the cycle, knowing what we do about the appetite of ILS investors and the likelihood that third-party capital is only going to become an increasingly permanent fixture in reinsurance, while innovation and insurtech start-ups are also going to drive risk more directly to capital sources, it seems likely these challenges are never going to go away for companies following a fully traditional business model and who fail to move with the times.

A.M. Best cites “low rates, broader terms and conditions, the unsustainable flow of net favorable loss development and anemic investment yields” as factors that are going to impact reinsurers risk-adjusted returns over the longer term.

Alternative capital is set to continue growing as well, so this threat is not going away and the need to adapt to it and find ways to leverage it within their underwriting is becoming increasingly key for reinsurers.

But still, rated reinsurance balance sheets remain well-capitalised and are capable of withstanding a variety of stress scenarios, A.M. Best says. However, this strength could erode over time for as pressure on earnings increases, loss reserve development becomes increasingly less favourable, volatility in earnings grows, and at the same time the cycle does not provide the same ability to earn back losses following major catastrophe loss events, due to alternative capital inflows.

“These issues have placed unrelenting pressure on underwriting discipline, forcing insurers to exercise restraint or risk long-term viability,” DeRose stated.

A.M. Best continues to believe that reinsurance companies with broad diversification, global scope and mature distribution networks are the best-positioned to withstand the market pressures, providing them a greater ability to make the most of profitable underwriting opportunities as they come up.

Pressure on the long-term viability of the traditional reinsurance business model, unless it’s at globally diverse scale, looks set to increase. The ultimate effect of this could be a narrowing of the playing field, as some smaller companies struggle and M&A speeds up, as well as an increasing need for third-party capital to be used in order to increase underwriting efficiency.

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