Realistic reinsurance RoE’s down to 3.4%, expenses up: Willis Re

Based on a more typical catastrophe loss year reinsurers aggregate RoE for the full-year 2015 would decline to 3.4%, says Willis Re. Suggesting reduced profitability that leaves little room for firms’ to outmanoeuvre the persistent headwinds challenging the reinsurance sector.

Companies within the Willis Reinsurance Index that provided catastrophe loss and reserve release information (subset) reported an aggregate RoE for the end of 2015 of 10.2% (11.5% FY 2014), while for the entire index the full-year 2015 aggregate RoE was 9.3% (11.3% FY 2014), says Willis Re.

For those in the subset the aggregate RoE declined by 1.3% during the year, so not as steep as the aggregate 2% decline reported for the entire Index.

This suggests that some reinsurers within the Index saw RoEs decline by more than 2% during 2015; underlining just how challenging the sector remains and how important discipline and efficiency are in today’s market landscape.

Willis Re explains that based on a more typical catastrophe loss year and with the exclusion of prior year reserve releases, the subset of reinsurers’ aggregate RoE would decline to just 3.4%, so a fairly significant dip from the 5.8% reported at full-year 2014.

Full-year aggregate RoEs for reinsurers continue to diminish, driven by increased expenses, an oversupply of capacity from both traditional and alternative sources, and broader re/insurance market headwinds.

As a result of the benign loss environment and reserve releases many reinsurance companies continue to post what appear as healthy, profitable quarterly results, although true underwriting profitability might be far less attractive than what’s been reported in recent quarters.

“Reinsurers continue to face a myriad of headwinds placing downward pressure on underlying results. However, headline figures remain robust and capital positions are strong – the dual saviours of reserve releases and low severity loss experience continue to underpin reported results,” said Global Willis Re Chief Executive Officer (CEO), John Cavanagh.

Artemis has discussed numerous times that in the current market environment of diminished investment returns and low profitability on the underwriting side of the balance sheet, reinsurers have been masking true underwriting gains via the release of reserves.

However, as reported by industry analysts reserves are beginning to wane for reinsurers, owing to facts that include aggressive deployment to strengthen poor returns in previous quarters, and the fact that a lack of large loss events has mitigated the opportunity for reserves to be bolstered.

Cavanagh explains that despite the combined impacts of the benign loss landscape and reserve releasing, “underlying RoEs are now beginning to breach minimum target thresholds. The pressure persists with capital remaining at record levels amidst the continued influx of capital from non-traditional sources.”

“Given the current climate, the broadening of reinsurer business models is providing a successful strategy for many and increasing relevance to clients, despite the impact on expense ratios. But ultimately, reinsurers will yet again be looking to another below average loss year to maintain acceptable results,” continued Cavanagh.

The mention of expense ratios is an important one, as this is another area that is becoming increasingly costly for reinsurers and as a result is also serving to diminish RoEs, along with rate declines and heightened competition.

Willis Re explains that the expense ratios for the subset of reinsurers have increased by roughly 4% between 2007 and 2015, ending last year at 33.1%.

In fact, during last year alone the expense ratios of the subset increased by 1% as companies looked to diversify their business mix, alongside increased regulation and governance costs, says Willis Re.

This is actually the fastest annual expense ratio increase of the last decade, notes Willis Re.

All of the above challenges and market forces witnessed in recent times and that are expected to remain in the coming months, has resulted in a higher combined ratio for reinsurers, which is edging ever nearer the 100% mark.

The reported combined ratio for the entire Index and the subset came in at 91.4% and 89.3%, both declining from the 90.6% and 88.5% reported a year earlier.

However, Willis Re explains that excluding natural catastrophe losses and prior year reserve releases for the full-year 2015, the underlying combined ratio for the subset would be approximately 94.5%, “a full percentage point relates to increase in the expense ratio,” explains Willis Re.

Reinsurers’ RoEs are declining as the host of market pressures persist and intensify.

But the real danger for some is a return to more normalised catastrophe losses, or perhaps a year that sees cat losses roughly 3% higher than a more normal year, meaning that aggregate RoEs for the subset would be extremely close to turning negative.

Add to this the potential for expenses to continue to rise at the same time as a large loss event, continued pressures from alternative and traditional capital sources, and waning reserves, and reinsurers could find themselves with little room to manoeuvre, and results could start to turn sour fairly fast for some.

Discipline really is vital at this point in the softening market, and when losses start to normalise somewhat, which they undoubtedly will, and reserves aren’t available to boost returns those reinsurers that lacked discipline at times of market turmoil will likely become exposed.

As highlighted by Willis Re, some reinsurers are embracing new strategies and techniques in an effort to increase efficiency and improve the potential for returns, and in the coming months it will be interesting to see those that have failed and those that have managed to navigate the testing reinsurance landscape.

Also read:

– Reinsurers average return on equity tumbles in 2015: Fitch.

– “Probably impossible” for industry to achieve 10% ROE in 2016: Catlin.

– Reinsurer returns on equity more realistic at 5.9%: Willis Re.

– Reinsurance price pressure to persist, ROE’s to struggle: A.M. Best.

– Expense efficiency becoming vital as re/insurance ROE targets drop.

– Soft reinsurance market to show who takes ROE seriously: Munich Re.

– Reinsurer valuations too high, even at lower cost of equity: Deutsche Bank.

– Stand-alone reinsurance model may be unsustainable: Goldman Sachs.

– Managing the cycle & risks key, but reinsurance ROE’s set to decline: A.M. Best.

– What happens when the music stops (reserve releases run dry)?