Ratings agency Standard & Poor’s said today that the global reinsurance sector is facing heightened risks with the threat of negative rating actions continuing as soft reinsurance market conditions look set to extend beyond the mid-year renewals.
S&P’s report discusses various downside risks for the insurance and reinsurance industry, most of which the rating agency expects will ease in 2014, apart from the risks faced by reinsurers due to softening reinsurance pricing. S&P believes that the ratings-trend impact will be negative for reinsurers, after eight years of stability, with the softening market the key cause.
S&P expects the soft market conditions seen in reinsurance so far this year to continue into the mid-year June and July renewals and likely beyond. As a result it says that reinsurance sector risks are heightened, after the long period of stability, and maintains its negative outlook for the sector.
S&P sees two key risks which continue to show an increasing risk trend at the moment, one being the risk to reinsurer ratings from soft pricing created by the highly capitalised and competitive marketplace, exacerbated by the continued and growing interest shown by alternative capital and ILS investors, the other being regulatory uncertainty caused by issues such as Solvency II.
“Reinsurance sector risks have heightened after a long period of stability, as we expect earlier soft market- pricing conditions to continue into the June/July renewal season,” said S&P credit analyst Michael Vine, in the report. “Regulatory uncertainty around the impact of global systemically important insurers, Solvency II, and business conduct regulation, amongst others, continues to pose strategic and operational challenge.”
The report continues; “After a long cycle of ratings stability in the global reinsurance sector we see a possible negative ratings trend in 2014, following evidence of competition in premium rates and conditions that we believe will weaken profitability in 2014 and 2015.”
S&P highlights evidence from the April reinsurance renewals, when headline rates were down 10% to 15%, as well as the expectation that reinsurance rates are set to decline further, perhaps even more sharply, at the June and July renewals.
The tipping point for S&P to adopt a negative outlook for the reinsurance sector came in January, when it observed the increasingly competitive behaviour between reinsurance companies and it became clear that pricing had softened further than perhaps expected at the renewals with little to expect pricing pressure to decline at the time.
The downward pressure on reinsurers top lines, created by the competitive environment and soft market conditions, leads S&P to think that reinsurers face weakened profitability in 2014 and 2015. It the rating agencies opinion the competition-related risks are the most prominent threat to the reinsurance sector right now and it estimates that nearly half of its global reinsurance ratings are exposed to these threats.
Reinsurers that are unable to effectively navigate the evolving reinsurance landscape could experience negative rating actions, S&P says in this new report which is possibly its strongest statement on the potential for downgrades yet.
S&P also highlights reinsurers ability to capture the risk, capital allocation and pricing of unmodelled catastrophe risks as an issue for the reinsurance market, as it typically represents 10% to 15% of a reinsurers capital. S&P says that insurance penetration in emerging markets looks set to outpace the development of robust risk models, meaning that reinsurers are likely to assume more unmodelled risks.
S&P explained; “We suggest that insurance penetration in developing markets will outpace modelers’ ability to generate reliable models for those perils/regions, so the amount of un-modeled risk on primary and reinsurance companies’ books could increase in coming years, adding to risk profiles.”
This could be exacerbated further by reinsurers desire to expand and find new opportunities away from the most competitive area of the market. S&P notes that 2014 could see a paradigm shift for reinsurance as reinsurers are forced to differentiate themselves in order to succeed.
S&P stresses the need for reinsurers to leverage their expertise, scope, diversification and global reach to survive and says that it is noticing a bifurcation of the market at renewals. This is the split between those reinsurers that can command attractive signings, due to their scale and competitiveness, versus those smaller reinsurers which risk becoming increasingly marginalised.
S&P says; “Complacency is a real risk, and if insurers don’t innovate and maintain their relevance to the marketplace, they risk being marginalised or swallowed up by a competitor.”
S&P’s warnings on reinsurance ratings are getting more strongly worded as we move through the year. It will be interesting to see how they word their first statement on reinsurance ratings after the mid-year renewals are completed.
Also read our article from earlier on the pressures now converging on U.S. P&C insurers.
Here are a selection of recent articles from Artemis which discuss these reinsurance market trends and its outlook: