Bermuda reinsurance profits rise, alternative capital helping on cat exposure: Fitch

Reinsurance companies in Bermuda have been more profitable over the last couple of years, with a return to underwriting profit in 2018 while net income improved moderately, despite above average catastrophe losses.

This is currently set to continue in 2019 as well, according to a report from Fitch Ratings, who sees the effects of improved pricing starting to feed through into better earnings over the rest of this year and beyond.

However, while more profitable, the results are far from stunning.

Fitch Ratings reports that the group of Bermuda reinsurance firms it tracks together achieved a return on equity of just 3.4% in 2018. Profitable, but still-below-average and the improved underwriting performance was hurt by significant realised investment losses caused by weaker equity market performance in 2018, the rating agency explained.

Things do look better for 2019, helped by an improving reinsurance pricing environment.

“Earnings are poised to improve in 2019 as pricing trends shift across the market and catastrophe losses through the third quarter revert toward historical norms,” explained Ryan Ostrowski, Analyst at Fitch Ratings.

In addition, Fitch is forecasting that premium rate increases are likely to be sustained into 2020, which will assist the Bermudian reinsurance firms in delivering better results for their shareholders again.

Catastrophe loss activity is clearly a huge factor in the profitability of the Bermudian reinsurance market, with reinsurers located on the island set to take their share of recent loss events hurricane Dorian and Japanese typhoons Faxai and Hagibis.

The results of the Bermuda reinsurers are negatively influenced by higher catastrophe losses, Fitch Ratings explains, highlighting that the rising second-half cat bill in 2019 may dampen results for the full-year somewhat.

But the use of alternative or third-party capital from investors in managed structures from reinsurance sidecars, to insurance-linked securities (ILS) funds, or simply as straightforward retrocession, is increasingly helping Bermuda’s reinsurance sector to improve its profits by moderating the impact of major catastrophes to the market.

While Fitch sees alternative capital providers as a “source of reinsurance and risk mitigation competition that limits traditional market growth potential,” it also highlights that the way ILS and third-party capital is now helping to moderate the impact of catastrophes on the Bermuda market is increasingly significant.

“Reinsurers are more sophisticated in using capital markets as part of their own retrocession programs to help manage balance sheet risks,” Fitch says.

The result of which is that, “Traditional reinsurers’ exposure to large loss events are generally declining as measured by probable maximum losses reported in public filings.”

Retrocession is just one way that Bermuda’s reinsurers are leveraging the appetite of capital market investors to moderate their catastrophe exposure.

The other way is through joint-venture vehicles, ILS funds they manage, sidecar vehicles and other risk sharing initiatives, where the reinsurance company is not just benefiting from the retrocessional protection, but also from fee income earned for managing the third-party capital.

Managing the potential conflict of interest here is key for the reinsurance firms, which have to demonstrate their fiduciary duty to the third-party investors, while also keeping their shareholders best interests at heart.

That’s a difficult balancing act, as both sources of capital require their returns, but one form is serving a role as protection as well as underwriting capital.

It requires a clearly explained strategy to help third-party investors understand how their capital is valued in the operation, compared to shareholder backed balance-sheet equity. Alignment questions remain and we’re likely to see an ongoing evolution of this strategy as investor’s concerns and needs are addressed.

But as reinsurers become increasingly familiar and adept at navigating any challenges and their third-party capital vehicles grow, the ultimate result is a moderation of catastrophe loss impact to their earnings as ILS structures take their share of the global loss burden throughout the year.

In the last few years this has made a significant difference to earnings in a number of cases, as large shares of global catastrophe loss impact have flowed to the capital markets.

In 2019, with loss estimates developing for recent catastrophe events, the same is likely to prove to be the case as third-party investors support Bermuda reinsurance market losses for the third-year in succession.

This support from alternative capital is growing all the time and becoming an increasingly meaningful lever for Bermuda’s reinsurance market as it responds to catastrophe loss activity.