Reinsurance operating environment still “less than optimal” – A.M. Best

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The global reinsurance operating environment remains “less than optimal” for traditional firms, but the outlook for the segment is still deemed stable by rating agency A.M. Best.

Reinsurance renewals hope or despairDespite a somewhat improving pricing environment over recent quarters, the rating agency believes that the market remains incredibly competitive and that major reinsurance firms continue to utilise reserve releases as a way to remain profitable, something A.M. Best believes to be unsustainable.

While the outlook is looking better for reinsurers than a couple of years ago, it is far from certain as pressures of excess capital in the industry, the competition from capital markets players, the shift to more direct business, as well as disruption caused by technology and newer ways of doing reinsurance business, all still present their challenges to the traditional business model.

Reinsurance firms largely have robust balance sheet strength and continue to generate positive operating results despite what A.M. Best sees as “persistent underwriting and pricing pressures from extremely competitive market conditions.”

Since 2018 the reinsurance market has begun to shift in favour of reinsurance capital providers, A.M. Best explains, but overall the rating agency says, “the operating environment remains less than optimal and many reinsurers have been bolstering earnings through reserve releases.”

Leveraging prior year reserves to continue delivering profits is an “unsuitable” strategy for the long-term and reinsurers need to be able to demonstrate their accident year underwriting profitability, if they are to deliver quality earnings.

With investment yields remaining at or near lows, reinsurance firms cannot rely on the asset sides of their business to help them through either.

With reserves said to be shrinking for some, as releases have declined and headwinds here set to continue, according to our sister publication, the need to improve underwriting performance is clear and has been seen in actions being taken by major players in recent months.

It is possible we could see an acceleration of underwriting actions being taken over the coming months and year ahead, as reinsurers look to become more focused on areas of the business that boost overall return on equity (RoE), rather than detract from it.

A.M. Best said it maintains its stable outlook on the reinsurance segment, despite any ongoing challenges the sector may face.

A.M. Best had been negative on the reinsurance sector for a number of years, but changed its view to stable in late 2018, largely based on expectations that the insurance-linked securities (ILS) market would not reduce their pricing any further and so stop the gradual softening that had been seen.

The rating agency says that reinsurance pricing is now stabilised, but in terms of further increases A.M. Best explains that it believes pricing to now be “settled at the bottom of the cycle for the near future.”

Third-party reinsurance capital, deployed by insurance-linked securities (ILS) funds and the like, “remains significant relative to traditional capacity,” A.M. Best continued.

While reinsurance pricing has improved “slightly” since 2018, A.M. Best says that the investment climate for reinsurers may actually have worsened again, due to interest rate pressures and a slowdown in global economies.

As a result, the rating agency forecasts that in reinsurance “competition in the space means profitability will continue to be challenged” leading to an expectation that reinsurers’ are expected to deliver “rates of return below the historic mean.”

So the outlook remains gloomy for reinsurers, while there is a clear need for underwriting to be the area driving performance and for firms to demonstrate that to their shareholders it seems.

Reinsurers and ILS funds have every opportunity to demonstrate that in 2019, as long as major catastrophe losses remain at a benign level throughout the rest of the year.

But should major losses appear again the impact would almost certainly be more persistent upwards pressure on pricing, with something approaching a harder market being seen in 2020.

Absent losses though, reinsurers ability to generate a return in a low interest rate environment seems set to be challenging while underwriting results remain depressed, putting an increasing focus on the need for efficiency and lower costs, to raise profitability and overall returns for their shareholders.

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