Fitch Ratings says that the reinsurance sector’s capitalisation and claims paying ability has improved over the last year, in their latest outlook on the global reinsurance industry. Overall, Fitch gives the reinsurance sector a stable ratings outlook over the next 12 to 24 months, and expects reinsurer ratings to be supported by the sectors capital, underwriting practices and operating trends.
Fitch publishes these reports regularly, looking at trends in the reinsurance sector and giving their view-point on how well capitalised reinsurers are and how able to pay claims should major disasters strike. They always give a view as to what sort of size of catastrophe would change their rating outlook on the sector to give readers an idea how large a loss would be needed to negatively affect the reinsurance industry. Their recent updates are timed to be released prior to the Monte Carlo Rendezvous event at which the reinsurance market discusses trends, rates and upcoming renewals.
Fitch says that a large catastrophic loss event is the most likely threat to the reinsurance sectors stable ratings outlook at this time. The strengthened capitalisation of reinsurers has led them to revise upwards the single-loss event value that Fitch considers necessary to trigger a revision of the sectors outlook. Before this report Fitch thought a $50 billion loss event was required to make their outlook on the sector negative, today they revise that upwards to a $60 billion loss event.
It’s interesting given the fact that 2011 saw the second highest catastrophe loss year that the reinsurance industry has ever dealt with. In fact it’s quite amazing that reinsurers are so well capitalised after such a disastrous year. That could be further evidence of the impact that capital inflows to the reinsurance sector are having, not just into collateralized vehicles and the catastrophe bond market, but also into traditional reinsurers as the sector continues to be an attractive space for money to be invested.
The report from Fitch contains some other interesting points. Fitch expects reinsurance price increases to slow as reinsurance supply is expected to exceed demand across many classes of business over the coming year. They expect a lower level of price increase at the January 2013 renewals compared with those achieved a year earlier. Fitch said at a pre-Monte Carlo press event that they believe that weakening pricing in reinsurance could affect the amount of catastrophe bond issuance in 2013. However, in their report released last week on the alternatives to reinsurance they said that cat bonds are a viable and sustainable form of risk transfer and likely to see usage no matter how reinsurance rates fluctuate.
How this weakening price pressure will impact other markets such as collateralized covers, ILWs and cat bonds remains to be seen, and a lot will depend on how efficiently those markets can operate and how much interest from investors there is to put capital to work. One positive for instruments such as cat bonds could be that the higher capitalisation of reinsurers may mean that for investors to put capital into the space the convergence arena could be their best and most attractive opportunity in 2013. A lot will become clearer as we approach the January renewals on the prospects for the convergence markets in 2013 and cat bond issuance levels in Q4 2012 will be telling.
Fitch also says that reinsurers are likely to scrutinise opportunities for deploying underwriting capacity and will be seeking to maintain underwriting discipline after the huge losses of 2011. That could offer opportunities for other collateralized and convergence markets to deploy capacity on higher risk, higher return business where reinsurers are staunchly requesting higher rates. Again, the January renewals will be telling.
Finally, it’s interesting to see that Fitch discusses capital markets alternative sources of reinsurance cover with reference to what they call a ‘muted’ level of activity in mergers and acquisitions in the reinsurance space. Fitch believes that increased use of capital market alternatives, such as catastrophe bonds, collateralised quota-share reinsurance vehicles (“sidecars”) and other risk-transfer structures has dampened M&A activity. They suggest that there are perhaps better opportunities to make a profit putting capital to work in reinsurance by participating in these activities rather than through a merger or acquisition.
With investors in the capital markets increasingly looking to risk and reinsurance as a way to garner attractive, uncorrelated returns, it looks like 2013 is hard to call. Will we see continuing capital markets growth in reinsurance? We believe the signs point to a continuation of the high interest from capital sources, but a lot will depend on how reinsurers react at the renewals and whether they begin to try to fight back and compete to win business against capital market alternatives. Of course many would say that the sensible reinsurers will embrace the alternatives and look to how they can leverage this growing piece of the reinsurance market and fit it into their business model, as a number of market participants already do.
You can download Fitch Ratings full report (you may need to sign-up or login to access it): 2013 Outlook: Global Reinsurance – Earnings Pressure to Return in 2013; Pricing to Stagnate