Rating agency A.M. Best changed its outlook on the reinsurance sector to negative recently, becoming the fourth of the major rating agencies to do so. In a video published this week senior A.M. Best rating executives explained the rational behind the shift.
Robert DeRose, Vice President at A.M. Best, said that the negative outlook has been an issue which was highly debated among the reinsurance team at the rating agency since April when it first put a warning out to the market that a change in rating outlook to negative was a possibility.
Earnings among reinsurers have been relatively favourable in recent years and balance sheets are strong, but what tipped A.M. Best’s view of the market to negative was the fundamental market dynamics. Returns have really been supported by benign catastrophe years and favourable reserve development but this has been masking the reality of what core earnings are today, explained DeRose.
When you go beyond this and reality does set in, continued DeRose, earnings are going to start to wane. “So really what it came down to is the fact that companies are getting paid less to take more risk and ultimately over time we think that is going to put a negative bias on earnings and translate into weaker financial strength over the longer term,” he explained.
A.M. Best looked at company performance, the actions they have been taking to ride market conditions and elements of influence such as convergence capital. Reinsurers are running out of these levers to pull in terms of managing the cycle in these challenging times, commented Senior Financial Analyst Greg Reisner.
DeRose also commented on the expansion of terms and conditions and cited concerns about the way reinsurers are providing more cover by adding risks such as cyber into the programme without being sufficiently compensated for it. This creep in terms and conditions can result in losses that are outside of expectations, DeRose explained.
The path back to a stable sector rating outlook could be a long one. The industry can turn on a dime, but in this case DeRose said that the view today is probably longer than the 12 to 18 months that A.M. Best typically maintains an outlook for. “We think that it’s going to take a considerable amount of time for the true operating fundamentals to manifest their true impact on the financial strength of the industry,” DeRose said.
DeRose also said that even after a very large catastrophe event, which had the potential to change pricing direction, the influence of alternative capital could be to shorten any hardening of the market therefore shrinking the time horizon that reinsurers have the opportunity to earn back the losses that they sustain from an event.
To change the outlook back to stable A.M. Best is going to want to see, among other things, is a fundamental shift in favour of driving operating performance to help drive and sustain reinsurers financial strength, explained Reisner.
In terms of alternative reinsurance capital DeRose said that the inflow was a major consideration in A.M. Best’s change to a negative sector outlook for reinsurance. This capital continues to come into the market as competition for many reinsurers at a rate perhaps faster than anyone expected, the analysts explained, which as a result means it has to be taken very seriously.
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You can view the A.M. Best TV video segment discussing the rating agencies negative sector outlook for reinsurance below: