If tested re/insurance fundamentals could deteriorate: A.M. Best

The potential for risk accumulation has never been greater for global insurers and reinsurers, and with reserves diminishing further and broader market pressures expected to persist, A.M. Best warns that industry fundamentals could start to weaken.

The international insurance and reinsurance industry remains significantly challenging for all industry players, with low interest rates driving down investment returns and stiff competition, ample capacity, and the benign loss experience testing the underwriting side of the balance sheet for many.

As a result, and as noted a number of times by Artemis during the softening market cycle, re/insurers have been utilising reserves to bolster returns and essentially mask true profitability.

A.M. Best, in a recent report, highlights that re/insurers across the world have become increasingly reliant on reserves to improve profitability and, combined with the benign loss experience in recent years, the ratings agency feels “it will become increasingly difficult to sustain the current level of reserve releases that are being used to support earnings.”

“More worryingly, there are signs companies may need to guard against possible reserve deficiencies in order to avoid a material depletion of capital,” says A.M. Best.

The high volume of reserve releases throughout the softening reinsurance market cycle has seen the trend come under the spotlight, and it’s been reported by a number of industry analysts that companies’ ability to call on reserves will likely diminish.

Interestingly, and underlining just how impactful ill-disciplined reserve releases can be during a time of reduced pricing across the sector, A.M. Best reveals that from 2000 to 2015, roughly 73.3% of U.S. property/casualty impairments were caused by “General Business Failure (deficient loss reserve/inadequate pricing).”

“Weak pricing dynamics, the potential for above-average catastrophe losses and reserve shrinkage together pose a significant threat to companies’ financial strength, a factor that A.M. Best is monitoring closely,” explained A.M. Best.

Adding to market pressures, the increased interconnectedness and complexity of the world, the continued transition to a truly digital world, combined with the expansion of risk transfer, means that the potential for risk accumulation and unexpected correlations is greater than ever, warns A.M. Best.

Globalization and advances with technology are reshaping the world and subsequently the risk transfer landscape, and the ratings agency feels that this creates both challenges and opportunities for insurers and reinsurers in relation to their management of potentially increased risk accumulation.

As a result of the myriad of market challenges, A.M. Best says that there’s “no doubt that the re/insurance industry is entering a highly challenging period in its history.”

“It is a time when margins are coming under increasing pressure at all levels of the industry and return on equities are now in high single digits. If tested by a major event or series of events, and with diminishing reserve releases to fall back on, industry fundamentals could begin to deteriorate,” continued A.M. Best.

Despite returns in the reinsurance market continuing to fall, a trend that has been apparent for quite some time, the benign loss experience and abundance of capacity from traditional and alternative sources, along with reserves, has helped players and the industry remain profitable in testing times.

However, combined ratios are beginning to move closer to 100% as insurers and reinsurers find it increasingly difficult to meet cost-of-capital requirements, a trend that is expected to accelerate should losses normalise.

Furthermore, should a truly market changing event, or series of events take place that removes a substantial amount of industry capital and drives a turn in the pricing cycle, then some in the space could find themselves in a very unfavourable position, fairly quickly.

With the key January 1^st 2017 renewal season on the horizon and the series of market headwinds expected to persist, discipline and efficiency will remain vital for those hoping to navigate the testing market landscape.

“Faced with these substantial pressures it is unlikely that all companies will be in a position to prosper. Those best-placed to ride out the storm are taking steps to reduce their cost-of-capital, maximise underwriting returns without taking on additional risk, underwrite with discipline and better manage portfolio accumulations by leveraging data and sophisticated exposure management tools.

“Strong players are also investing in technology, maximising digital channels, differentiating their offerings and getting closer to the original risk where they can,” said A.M. Best.

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