Global reinsurance industry returns will continue to weaken: S&P

The softening reinsurance market cycle has persisted for longer than many market players and observers had anticipated, suggesting that global reinsurance industry returns will likely weaken further, according to analysis from Standard & Poor’s (S&P).

International financial services ratings agency, S&P, has commented on the ongoing softening reinsurance market cycle, in its latest reinsurance market report released in time for the 2016 Monte Carlo Rendez-vous.

In the report S&P suggests that reinsurance market players are running out of ways to navigate the “softer for longer” scenario.

“The soft cycle is proving to be deeper and longer than many market participants anticipated in 2013, with falling premiums, increased competition putting pressure on reinsurers’ top and bottom lines.

“We forecast that the global reinsurance industry’s returns will continue to weaken, with a combined ratio of 97%-102% and return on equity of 7%-9% for 2016,” says S&P, in a recent report on the global reinsurance landscape.

It’s been discussed previously by a number of market analysts, observers, executives and experts that the current softening reinsurance market cycle has been exacerbated by the inflow of alternative reinsurance capital and the benign loss experience.

In the current market environment S&P feels that the reinsurance industry’s combined ratio could creep above the 100% mark, meaning that the series of sector headwinds could turn the marketplace unprofitable by the end of the year.

Add to this a return to more normalised losses, or even an above average volume of losses in the final months of 2016, and reinsurers’ risk seeing their profits diminish rapidly.

“Longer term, we believe that reinsurers’ financial flexibility could diminish as investors look to other insurance sectors for larger returns. Additionally, assuming a return to normalized catastrophe losses and reserve releases, reinsurers’ weaker earnings profiles could slowly erode their capital and undermine their competitive advantage,” said S&P.

The ratings agency notes that reinsurance rate declines have slowed relative to recent years, and expects overall average price reductions of 0%-5% for 2016.

The pricing environment, along with the relaxation of terms and conditions (T&Cs), merger and acquisition (M&A) activity, the presence of insurance-linked securities (ILS) capacity, a lack of demand for protection from cedants, continued low investment returns, and limited organic growth opportunities, are all potential drivers of the market conditions for global reinsurers, says S&P.

In spite of this, and for the time being at least, S&P feels that the strong capitalization of reinsurers should be enough to withstand further price declines and a substantial catastrophe loss event, and as a result feels that there will be limited rate changes over the next 12 months.

“On the other hand, we foresee the gulf between the largest reinsurers and the rest of the market continuing to widen, pressuring the business models, and potentially the ratings, of the smallest firms over the medium term,” continued S&P.

The profitability of the global reinsurance industry is clearly under threat, and should losses return to more normalised levels, reserves continue to fall, and other headwinds persist, unprofitability might not be too far away for some in the sector.

The need for efficiency, discipline and resilience is as important as ever in the global reinsurance industry, as is the need for innovation in order to increase profits and limit the impacts of the ongoing softening landscape.

With pressure set to continue and profitability on the wane, efficient business models are more important than ever, as too is the use of third-party capital and ILS structures to lower reinsurers overall cost-of-capital.

A continuation of the gradual evolution of the reinsurance business model that we’ve been tracking for nearly twenty years seems increasingly likely, as the capital markets take a larger slice of the pie due to reinsurers need for efficiency and desire for enhanced product offerings.

Read all of Artemis’ Monte Carlo Rendez-vous coverage here.