Rate rises may not relieve underwriting result pressure: Fitch

by Artemis on November 28, 2017

Rate rises across the insurance and reinsurance industry following the major catastrophe losses of recent months may not be sufficient to relieve the pressure on London market re/insurers underwriting results, according to Fitch Ratings.

While the insurance and reinsurance market is focused on how much prices may rise, the question of whether it will actually help them much hasn’t really been addressed.

Rating agency Fitch believes that, for London re/insurers at least, the increased pricing that may be available at the January reinsurance renewals and beyond may not be enough to relieve the pressure on their results from high levels of expenses and lower reserve releases.

As a result, Fitch is maintaining a negative outlook on the London market re/insurers and doesn’t see dramatically improved prospects for them at this time.

However the agency does predict, “a significant increase in pricing for loss-affected insurance lines, particularly US property and catastrophe reinsurance” which may provide some solace that there will be an opportunity to increase returns at least in the near-term.

Fitch believes that for some London re/insurance players the recent losses will be a capital event, meaning that companies will need to rebuild their capital buffers and will likely look to increase pricing more broadly to help this happen.

However, Fitch warns that any rate increases may be short-lived, due to the “Strong level of capital available in the market and intense competition.”

For companies that have been struggling to turn an adequate result in recent years anyway and for whom expense pressure and dwindling reserve releases have been an issue already this could be an issue.

Erosion of capital without the ability to earn it back, while expenses remain high and reserve releases low, could mean very little in the way of results improvement for re/insurers hit hard by recent losses.

If the price increases do only last a renewal or two then these companies could very quickly find themselves back under pressure and may also be exposed to competition from new, more efficient entrants, including those backed by alternative reinsurance capital and ILS funds.

Fitch notes the market’s much stronger capital position, than was seen following heavy loss years in 2005 and 2011, which may act as a dampener of rate increases in 2018.

This has been evidenced by re/insurers ability to continue to return capital, despite recent losses, with no sign of capital management coming to a halt so money can be put to work in underwriting, suggesting the market remains over-capitalised on the traditional side.

While the ILS market has suffered a significant capital hit itself, with the twin pronged impact of losses and also trapped collateral, the ILS fund managers are largely preparing for the renewal with freshly raised capital injections to bolster their underwriting and many expect to reach 1/1 with a similar level of available capacity to before the recent hurricanes.

Additionally there are start-ups targeting the renewals and the first-half of 2018 (such as yesterday’s announcement of the $1 billion Ascot Re), and a range of NewCo’s readying their strategies, that could bring significant capacity to bear on the market in the coming months.

So while there has been a capital hit to the sector, as well as an earnings hit, the prospects of recouping that capital looks likely to be a tough task, especially while so much of future earnings is likely to disappear on expenses, commissions and the costly task of modernisation.

Exacerbating things further is the fact that Fitch says it expects, “Reserve releases will contribute less to underwriting results than in recent years.”

A lot could hinge on how substantially re/insurers have reserved following the recent loss events, as they may have provided an opportunity to replenish reserves to a degree.

But with profits under pressure there may have been a temptation not to put as much in reserve as before, to improve the capital position to take advantage of expected higher rates. But if those rate rises aren’t sufficient to relieve the pressure, would setting much higher reserves have been a more prudent strategy for the future?

However, Fitch does think that London re/insurers will be able to manage the capital hit from these events, but the question remains as to whether they can experience better profitability going forwards thanks to price increases.

Even if catastrophe losses in 2018 are around the long-term average, Fitch believes that the combined ratio in the London market could be 100% anyway.

This all suggests that reinsurance capital is going to play an increasingly important role in helping London market insurers and reinsurers to better manage their books of business, with an increasing emphasis on leveraging efficient capital to augment underwriting capacity, while reducing volatility of losses, a likely outcome.

That, alongside a focus on efficiency, could help London companies improve their results outlook, perhaps. But it won’t be an easy journey if they cannot get back to the pricing marks experienced a decade ago, something that seems increasingly unlikely to happen.

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