“Steep decline” in reinsurance operating results in H1 2016: Fitch

Reinsurance company operating results suffered a “steep decline” in the first-half of 2016, according to Fitch Ratings, as return on average common equity (ROAE) plummeted by 36% compared to the same period in the prior year.

Reinsurers remain under pressure and, as ever at this time of year with the key industry meetings of the Monte Carlo Reinsurance Rendezvous and Baden-Baden approaching, analysis of how they are coping with the soft market and heightened competitive environment by the rating agencies is ramping up.

Fitch Ratings looks at reinsurance company performance in its latest look at the U.S. property & casualty re/insurance market and finds that performance has declined sharply as reinsurers struggle through the soft market and deal with rising catastrophe losses.

Returns on equity have been waning for a number of years now, but Fitch highlights a sharp drop in the first-half of 2016.

“After years of outperforming the other four primary insurance subsegments, Fitch’s universe of reinsurers reported a steep decline in operating results through first-half 2016 as operating ROAE decreased to 7.0%, a 36% decline over first-half 2015,” the rating agency explains.

Fitch notes that there have been some bright points, with the effects of consolidation and a less appetite to keep decreasing pricing evident, as too was solid growth in premiums underwritten over the prior first-half.

But catastrophe losses hit reinsurers the hardest in P&C, “with losses as a percentage of earned premiums more than doubling and adding 6.2 points to the combined ratio.”

All reinsurers in the group reported on suffered higher catastrophe losses in the first-half of 2016, apart from RenaissanceRe and Allied World Fitch says.

Reserve releases continue to be vital to reinsurers profitability, with the group covered in Fitch’s report releasing 7.3 points worth in H1 2016. Excluding the impact of reserve releases the group’s combined ratio would have been verging on unprofitable, at 99.6% which is up considerably on the same metric in H1 2015 at 95.5%.

And that is not simply due to catastrophe losses, the combined ratio minus catastrophe losses and reserve development is also up, from 93% in H1 2015 to 93.4% in H1 2016, which Fitch says shows that “run-rate results continue to decline.”

Interestingly, despite all this pressure on profitability reinsurance firms continue to spend more as well, with a 33.2% expense ratio in H1 2016, compared to 32.1% a year earlier.

Part of this expense increase will be due to the expansion into different lines of business that is being seen among reinsurers, as well as the growing insurance underwriting trend. As we’ve written before, spending their way out of a soft market comes with its own risks for reinsurers.

For reinsurers the risk remains that ILS markets will continue to apply rate pressure, meaning that price rises cannot be enforced as easily as in the past and the reinsurance cycle is not the same going forwards. With profitability declining and operating results suffering as a result, reinsurers will need to focus on expenses with increasing urgency.

Reinsurers will also need to focus on cost-of-capital, as reducing this is one way to increase their returns on equity. Leveraging third-party capital and welcoming more ILS investors into their business models is one way to achieve this, but making the fundamental shift to a business model which is also focused on managing other people’s money will not be an easy one for every reinsurer.

As the conference season approaches, expect reinsurers to focus on underwriting while continuing to be open to innovation, new business lines, leveraging third-party capital in certain parts of their business and reducing their costs through technology and insurtech.

Whether these initiatives can help all reinsurers to turn around their returns remains to be seen. Increasingly it feels like not every company will be successful and hence we could see a return to consolidation in the market, after a quieter few months in M&A terms.

“Maintaining or improving underwriting performance will be the key to generating adequate returns on capital going forward but may prove challenging as competitive forces are promoting flat to declining insurance pricing in many market segments,” commented Christopher Grimes, a Director at Fitch Ratings.

Fitch remains negative on the reinsurance sector, as “intense market competition and sluggish cedent demand have resulted in a soft reinsurance market.” Currently the rating outlook remains stable, but as the softness persists there is a good chance that some reinsurers individual prospects may turn more negative in months to come, especially if there is not market turn at the next major renewals.