“Negative trends have become increasingly evident” when looking at Bermudian insurance and reinsurance company results, according to A.M. Best, as the Bermuda market increasingly struggles to generate a profit that covers its cost-of-capital.
In its latest analysis of the A.M. Best Bermuda Market Composite, the rating agency highlights that the pressure continues to be applied, and that even as Bermuda’s insurers and reinsurers try to adapt to persistent challenges, the returns they are generating continue to slide.
“Margin compression continues” the rating agency explains, as the softened reinsurance market means that profit is gradually being eroded out of the underwriting side of the Bermuda market’s business.
At the same time the investment side of the insurance and reinsurance business remains challenging and has not yet been seen to improve to a level that is benefiting re/insurers, despite their being a little more stability there.
The Bermuda re/insurance market saw a steady decline in return on equity (ROE) and the combined ratio in recent years. A.M. Best notes that return on revenue has seen a similar decline and that “the Bermuda market is struggling to generate profits sufficient to cover the cost of capital.”
As you can see above, Bermuda re/insurance market returns on equity are at a five-year low now, with A.M. Best’s average suggesting a return of just 7% for 2016, down half a point from 2015.
Perhaps signalling the potential for further worsening of returns and profits, A.M. Best explains that the long predicted drying up of reserve releases is now being seen, with the effects noticeable in year-end 2016 results.
Favourable reserve development dropped below 6% for the first time in the current five-year period analysed, and has been steadily declining since 2013, Best said, which serves to eat away another point of profit for the majority of the marketplace.
All this despite 2016 being a relatively modest year, with just an average level of catastrophe losses. Throw in the impacts of issues such as the Ogden Rate change and it’s easy to see how for some reinsurers in Bermuda the pressure is reaching a point where sustainability will increasingly be questioned.
The pressures facing global reinsurers are “perhaps even magnified” in Bermuda, A.M. Best says, however their balance sheets remain “strong on an absolute and risk-adjusted basis.”
Use of reinsurance capital is one key factor that helps Bermudian’s to manage exposures, safeguard capital and optimise their returns, and A.M. Best said that; “Generally speaking, most Bermudian companies have reduced their overall exposures year over year with an uptick in retrocession through excess-of-loss coverage or de-risking of their books of business.”
Additionally Bermuda’s reinsurance firms are increasingly working with third-party reinsurance capital, both as sources of retrocession and also as capital in insurance-linked securities (ILS) structures through which additional fees for underwriting can be earned.
Where underwriting is no longer meeting return requirements and adding anything to a reinsurers ability to meet cost-of-capital it is perhaps becoming advisable for greater use of third-party capital to be used, so at least some returns can be generated from that business.
As well as utilising third-party capital, Bermuda’s re/insurers are increasingly shifting their strategies to try to develop a more total-return type model, seeking to add valuable returns through their large investment portfolios.
This means a shift into alternative investments have been seen, which has the potential to add some volatility when the financial markets have down years.
So what is going to turn this trend on its head for Bermuda’s re/insurers?
Perhaps nothing, at least not in the way the market has become used to, as the prospects of a hard market akin to those seen in the past look increasingly slim.
“Questions as to how the market will turn linger, with participants largely conceding that hardening across most lines of business is unlikely and most are now hoping for at least some pockets of hardening,” A.M. Best notes.
The hope for hardening is perhaps a distraction for the Bermuda re/insurance market and it’s encouraging to note from our conversations with companies there that the majority are ploughing ahead with plans to evolve their businesses, embrace innovation, use third-party capital where it is more efficient and take whatever steps are necessary to more sustainably navigate the soft reinsurance marketplace.
Will it be enough?
It’s very hard to say and it remains likely that mergers and acquisitions will continue to occur sporadically in Bermuda, as companies find they can gain some performance enhancements (perhaps solace) through scale and synergies.
Companies are being forced to “manage shareholder expectations while exhibiting underwriting discipline and remaining relevant to cedants,” A.M. Best says.
While the market remains soft and the kind of cataclysmic market-changing events required to cause any turn in it remain absent, “the Bermuda market will need to balance innovation and discipline for the foreseeable future,” A.M. Best concludes.