ILS drives reinsurance capital growth, underlying reinsurer RoE’s decline: Willis Re

It was further growth of the alternative reinsurance capital and insurance-linked securities (ILS) market that drove an increase in overall reinsurer capital at the end of the first-half of 2018, according to Willis Re, but this comes against a backdrop of further deterioration for underlying reinsurer returns-on-equity (RoE’s).

The further decline in normalised and underlying reinsurance company returns suggests ongoing pressure on expenses and increasing needs for efficiency in the market, as reinsurers move ever closer to a point where profitability of these enterprises will increasingly be questioned.

Helping to stave off such questions at the moment are the significant returns of capital that reinsurance firms are making to their shareholders, which rose again in the first-half of 2018.

In its latest reinsurance market report broker Willis Re notes that profitability of the sector continues to wane.

At the same time shareholders equity declined, across the 34 firms that Willis Re tracks, however this was due to continued aggressive capital returns to shareholders.

Shareholders’ equity in the 34 reinsurance companies tracked in the Willis Reinsurance Index was $364.9 billion at the middle of the year, dropping by 1.6% from $371 billion at year-end 2017.

The drop in shareholder equity occurred despite better income, with net income improving nearly 75% to $14.5 billion, helped by lower catastrophe losses and the resulting reduced combined ratio of 94.3%, 0.7% lower than the first half of 2017.

The decline in shareholder equity was driven by capital returns to investors through dividends and share buy-backs, amounting to $11.1 billion at H1, 2018. Unrealised investment depreciation also wrote $8.3 billion off the tally, in part to rising interest rates.

Overall global reinsurance capital has actually risen in the last year though, but this is only due to increased alternative capital and ILS capacity which has helped to continue momentum and in making coverage available.

Willis Re notes that alternative capital increased to $88 billion by the middle of this year from $75 billion at H1, 2017. That’s a long way shy of the roughly $100 billion of ILS backed capacity that the market generally accepts to be in play currently, but clearly reflects the strong growth of the ILS market.

However, even including alternative capital, Willis Re’s measure of global reinsurance capital has fallen since the end of 2017, dropping to $663 billion as of the middle of 2018, from $674 billion.

Returns on equity (RoE’s) for the Willis Re tracked subset of reinsurance firms was 8.5% at the mid-point of this year, close to the 8.4% at H1 2017.

The broker notes that reserve releases continue to support RoE’s for this subset of major reinsurers, helping to deliver 2% of the RoE, which is slightly up from the 1.9% of RoE that reserve releases delivered a year before.

However, if normalised for a more typical catastrophe load ( which the broker puts at equivalent to a roughly 4% impact on RoE) and excluding reserve releases, the underlying profitability for the subset of tracked reinsurers declined to just 3.4% at H1 2018.

This is a continuation of the steady deterioration of reinsurer profits, which saw the subset RoE at 4.9% at H1 2015, 4.5% at H1 2016, and 3.7% at H1 2017.

How much further this could decline remains to be seen, but it clearly leaves the buffer of profitability even smaller, meaning any above normal catastrophe activity could dent reinsurers earnings very quickly.

ILS markets are providing an increasing proportion of global reinsurance capital, while reinsurers profits wane and they keen returning capital to shareholders, which in some ways must be to make up for the lack of RoE generation.

James Kent, Global CEO, Willis Re, commented, “Hopes for a hard market after the natural catastrophe losses of 2017 were not satisfied, but property cat pricing did rise overall during the first half of the year. Reinsurers are correcting prices when necessary and leveraging their continuously improving analytics and data. They are pricing more precisely, which is making the swings of the reinsurance pricing cycle shallower. This we believe to be the new normal.

“Despite a small decline in conventional reinsurers’ capital, the increase in non-traditional investment in our market means that global reinsurance capital is slightly higher than at the same time last year. Many reinsurance investment funds have increased their 2018 assets under management, which limited price rises after the Harvey, Irma and Maria losses, particularly in Florida.”

Also of note, Willis Re looked at how reinsurers are managing their reserves from the 2017 hurricanes and other catastrophe losses, noting that most reinsurers reported reserve releases at H1 2018 as their estimates for 2017 natural catastrophe losses were reduced compared to at year-end 2017.

Kent explained, “Notably, we found that 11 reinsurers reported reserve releases at H1, 2018 after they lowered their 2017 catastrophe loss estimates, but six had to add to their reserves. Looking ahead, longer-term reserve releases must be reaching exhaustion, which may have a deleterious effect on future results.”

The trend of waning reserve releases is one that is gaining increasing attention, as at now 2% of RoE it is highly supportive of reinsurance company profitability.

Should that 2% decline it will have an immediate impact on RoE’s and perhaps on reinsurers ability to return as much capital.

Those capital returns are clearly becoming a tool to satisfy the financial market, at a time when returns shareholders make on their investments in reinsurance equity are less than spectacular.

Of course the entire index of reinsurers that Willis Re tracks are not all suffering, in fact many continue to support 10% RoE’s or greater.

But the continued decline in the aggregate RoE shows the knife-edge of profitability that some reinsurers are teetering on right now and with alternative capital continuing to grow in stature, scale and scope the chances of competitive pressures letting up are slim.