Fading momentum, but better reinsurance margins (for a time): Fitch

While the momentum behind rate firming in reinsurance has continued to fade so far this year, the direction of travel has been positive and better margins are ahead for the reinsurance sector, according to Fitch Ratings.

Fitch has revised its fundamental outlook for the global reinsurance sector to ‘Improving’ from ‘Stable’, which it said reflects an “expected significant improvement in the sector’s financial performance in 2021 and 2022 on the back of higher prices in a hardening market environment, a strong rebound in economic activity, and lower pandemic-related losses.”

Possible dampeners for reinsurance firms include still challenged investment returns, a temporary pick-up in inflation rates and perhaps most importantly “a higher frequency and severity of natural catastrophe claims,” Fitch explained.

But, no matter these factors, Fitch is expecting better margins to buoy reinsurers performance, although additional major catastrophe losses could eat further into cat budgets and erode some of the gains.

Importantly, Fitch expects global reinsurance firms will be able to demonstrate the benefits of harder pricing, by evidencing the higher margins in their books over the coming year.

Investors and shareholders will be looking out for this, keen to see evidence that reinsurers have been reacting to heavy loss years and continued impacts from severe weather and natural catastrophe events.

Brian Schneider, Senior Director at Fitch commented, “Fitch forecasts an improving operating environment for the global reinsurance sector in 2021 and 2022 as higher risk-adjusted prices and strong premium growth will lead to a significant improvement in earnings, while the uncertainty tied to pandemic losses is diminishing.”

As we explained last week, some reinsurance investors are particularly concerned about how climate change will impact catastrophe claims for the sector, so it’s vital reinsurers can demonstrate they are making higher margins at this time.

The read-across for the insurance-linked securities (ILS) market is also positive, as higher margins should also flow through collateralized reinsurance structures and mean that catastrophe bond rates don’t need to soften much more.

For the cat bond market higher reinsurance margins can provide another opportunity to demonstrate the efficiency of capital as well, so it will be interesting to see whether cat bond rates follow reinsurance upwards at renewals, or remain around their current levels.

Capacity is seen as the main drag on reinsurance rate momentum and the factor that has caused hardening to slow.

There has been significant new capital in the traditional reinsurance sector, as well as in catastrophe bonds and a little new growth in some private ILS funds as well.

But because price growth has been strong over the last year or more, Fitch believes reinsurers have made sufficient gains to demonstrate better margins on their inwards business.

Fitch believes rate levels can persist for a time, but also cautions that capital could depress them further into the future.

“We expect risk-adjusted prices to remain largely unchanged in 2022,” the rating agency said. But warned that. “Favourable performance and underwriting capacity expansion will inevitably fuel price competition that leads to less attractive returns beyond 2022.”

We believe that how reinsurers respond to catastrophe losses this year could be critical, in enabling them to maintain margin gains and demonstrate to their investors that they take pricing seriously and influences like climate risk are being accounted for.

Investors will not want to see major industry losses like hurricane Ida come just before the market returns to a softening state, so reinsurers need to remain on their toes and continue to support the gains previously made.

It’s perhaps more important than ever right now that reinsurance firms begin to deliver on underlying returns-on-equity (RoE) that cover their capital and loss costs completely.

In conversations with a number of equity investors in the space, confidence in the market’s pricing has waned and they are keen to see evidence of discipline being maintained for a prolonged period of time.

Will Ida be sufficient to steel the industry to hold onto its rate gains? We’ll have to wait and see how January turns out.