Fitch Ratings said yesterday that while it maintains a stable rating outlook on reinsurers, the global reinsurance sector outlook is still negative and as a result the firm expects further deterioration of profitability for Bermudian reinsurers while market pressures continue.
Intense competition from both traditional and non-traditional reinsurance capital will continue, while demand from cedents is set to remain sluggish through 2015. Rates are expected to keep falling across wide swathes of the reinsurance market, with continued creep on terms and conditions, resulting in lower expected profitability.
Brian Schneider, Senior Director at Fitch, explained; “Fitch expects profitability to deteriorate as prices continue to fall and terms and conditions weaken in 2015 across a wide range of lines.”
With catastrophe losses once again remaining low in 2014 Bermudian reinsurers combined ratios remained roughly the same as 2013, at 86%, which has helped to drive profits and raise industry capital levels.
Net written premiums were up for the Bermudian group, with a 4% increase in 2014. This was largely due to expansion into specialty and casualty reinsurance and primary lines of business, as Bermuda’s reinsurers sought out more attractively priced business in areas of the market with lower competition.
However, the more telling figure perhaps is return on equity, with the 15 Bermuda based reinsurance firms that Fitch tracks reporting average return on equity of 11.2% in 2014, compared to 12.9% in 2013. Falling investment returns have exacerbated lower profitability on some business underwritten.
As underwriting margins decrease further in 2015, Fitch expects a continued decline in earnings. The question then will be how the sector reacts to a return to normal, or above normal, levels of catastrophe losses.
With rates down significantly and terms much broader, any return to normal or above normal catastrophe losses could show up the firms that have been taking on more risk than was perhaps advisable.
Additionally, Fitch expects favourable reserve development to slow going forwards, something Artemis has discussed before here, which has been adding around 6.3% to combined ratios in recent years. If that reduces the profitability of reinsurers will decline, adding pressure to run-rate profitability.
However capital remains strong, with aggregate shareholder equity across the Bermudian reinsurers increasing by 3% in 2014 to $95.7 billion. The high levels of capital mean the sector could tick along at lower rates for some time, but as reserve releases slow and with any uptick in major loss experience the pressure could begin to show in a reduction of sector capital.
Of course a reduction in sector capital would be welcomed and reinsurers would likely respond by trying to increase premium rates. It remains to be seen how successful those attempts would be and whether reinsurers would be able to experience the kind of rate increases seen in the past.
The general opinion among observers is that pushing through rate hikes is going to be significantly more difficult now than in previous years and that alternative reinsurance capital and insurance-linked securities (ILS) could find an opportunity at that point to undercut reinsurers price ambitions, thus making the capital markets an even more attractive reinsurance alternative.
The ongoing wave of mergers & acquisitions also shows no sign of abating, Schneider commented; “The recent increase in M&A could spark further activity in 2015 as difficult market conditions promote consolidation pressure.”
So, continued competition, ongoing pressures, more M&A is ahead for Bermuda and other regions reinsurers, in what could be a more challenging year than 2014. Fitch recently highlighted alternative reinsurance capital as an added catalyst for these trends, as it said that growing alternative capital would contribute to lower returns on equity for reinsurers and fuel the M&A trend.
Reinsurers have been underwriting more business as measured by premiums written, with combined ratios flat, but ROE’s down, all of which is set to continue as they become more expansive but at lower rates.
The business that is getting underwritten at lower rates and featuring broader terms insinuates that reinsurers are taking on additional risk for less return. At the same time reinsurers may not be able to rely on reserve releases forever, which could result in added pressure to find efficiencies elsewhere. And with no major losses on the horizon, with no guarantee that any loss will result in the hoped for hike in rates anyway, the pressure looks set to continue through 2015.