The outlook for the global reinsurance sector has been revised to stable from negative by rating agency A.M. Best, as the firm sees a more positive pricing outlook, with rates likely at the bottom of the cycle and alternative capital set to hold the line on any further declines.
It’s an interesting move, as it remains too soon to forecast exactly what will happen at the January reinsurance renewals.
Also it does seem that much of A.M. Best’s decision to revise the segment outlook for Global Reinsurance to stable is due to its expectation that insurance-linked securities (ILS) markets will not lower their pricing any further.
However, we’d suggest that this ignores the wider secular issues faced by reinsurers, who’s profitability is far below where it needs to be and are going to come under increasing pressure from moves to increase the efficiency of the risk transfer value-chain and to enhance the margins that can be earned from underwriting reinsurance business.
But that aside, A.M. Best’s move today reflects a market facing challenges, as we’ve been documenting in our series of articles on the upcoming renewals, the ILS market’s response to recent losses and the prospects for rates.
As well as the fact the rating agency expects that “alternative third-party capital will hold the line on future return expectations following the catastrophe losses incurred in 2017 and 2018,” the firm also expects greater alignment between traditional reinsurers and alternative capital will continue to emerge.
“A more-stabilized pricing environment—albeit at levels still below long-term adequacy—a rising interest rate environment, emerging growth opportunities and ongoing stability in the global life reinsurance segment also are factors in the outlook revision,” the rating agency explains.
Part of the greater stability is also attributed to reinsurers use of alternative capital to reduce volatility from tail events, thanks to greater use of third-party capital in retrocession arrangements.
At a time when third-party capital for retrocession is likely to reduce at the renewals, it is an interesting juncture to be highlighting this at, we feel.
A.M. Best also cites the old adage of rising interest rates, saying this “could lead to alternative investment opportunities for third-party capital.”
Most investors believe you’d need to see a huge rate increase for that to happen and it’s also apparent that many ILS assets would benefit from this anyway, being instruments whose return floats on top of treasuries in many cases.
Positively though, A.M. Best cites a renewed focus on underwriting discipline, something much-needed across the marketplace.
The rating agency says that property catastrophe pricing is driven by the availability of third-party capital, which is partly true of course.
But you only have to look at the European program renewals, regions such as Japan and Australia, to see that traditional reinsurers are solely responsible for the barely above expected loss levels of pricing in those regions.
Yes, alternative capital may have driven down the margin in U.S. property catastrophe risks, which is where the traditional reinsurance market had been deriving the majority of its profits. But to say that ILS and third-party capital is also responsible for the state of diversifying peril regions catastrophe rates as well seems to be jumping one step to far, to us at least.
A.M. Best says that, “Excess capital continues to exert pressure on risk pricing and poses a drag on equity returns, but reinsurers that welcome alternative capital will thereby enhance their relevance with clients and investors and garner the ability to earn low-risk, fee-based income in the process.”
With serious questions currently being asked by some investors about the performance of some reinsurers third-party capital vehicles and whether they are suffering from any adverse selection, after the losses of 2017/18, it remains to be seen whether this is enhancing for all reinsurers, or just those who can get the alignment of interests right.
Turning the outlook stable on the reinsurance sector at this key time when the market is seemingly under pressure and in flux, not just on the ILS side of it, could perhaps be viewed as the rating agency getting a little ahead of itself.
A lot could change in January and beyond, so it will be interesting to see whether stability in this key rating outlook can be maintained by the industry.
But it is a positive sign overall and the key message of stability in terms of price, rates and discipline in terms of underwriting are hopeful for all, as this is what the market really needs.