Reinsurance returns on capital to be eroded by 2018 cat losses: S&P

The catastrophe loss activity witnessed so far in 2018 may be sufficient to ensure that reinsurance companies “return on capital in 2018 may not materially exceed reinsurers’ cost-of-capital,” according to rating agency S&P.

Standard & Poor’s warns that reinsurance firms may be on course for a second year where they struggle to meet costs-of-capital, after the impacts of hurricanes in the United States, a series of typhoons and weather related disasters in Japan and now the recent wildfires in California, are all accounted for.

In 2017, after the major hurricane losses led to the highest level of global insurance and reinsurance losses from natural disasters in any single year, the reinsurance sector struggled to make any kind of return for its shareholders.

S&P explained that the reinsurance sector only generated a return on capital of 1.2% for 2017, which is a full 6.3 percentage points below the sector cost-of-capital.

This return on capital was the lowest the reinsurance sector had experienced in over 13 years, the rating agency explains. But 2018 could see another year where returns are extremely low, despite the availability of some better pricing at renewals this year.

2018 reinsurance renewals did deliver some slight pricing increases, S&P said, but the rating agency notes that upward momentum is fading as we move towards 2019.

That leads S&P to ask whether pricing will keep pace with the reinsurance sector’s cost of capital? Saying that this remains an open question likely to be answered at future renewal seasons.

So far the catastrophe loss activity experienced in 2018 can be absorbed by the combined earnings of the U.S. insurance and global reinsurance sectors, S&P believes.

However, these losses may exceed some reinsurers catastrophe budgets for the year, S&P said, which suggests that return on capital will be eroded by them to a degree.

“Despite modest reinsurance price rises following the 2017 catastrophes, the return on capital in 2018 may not materially exceed reinsurers’ cost of capital, given the year-to-date catastrophe losses,” the rating agency said.

However, despite the fact that 2018’s catastrophe losses may exceed reinsurers budgets and erode their returns on capital for a second year running, S&P does not expect a meaningful pricing response at 2019 renewals.

“If 2017 is any indication of what will happen at the January 2019 renewals, year-to-date catastrophes won’t likely change the fizzling of the reinsurance pricing momentum–even as Hurricane Michael may provide some support for rate increases demanded by primary insurers,” the rating agency said.

Of course the California wildfires, being an ongoing catastrophe event, could provide some further impetus for pricing, especially if retrocession markets are hit again this year.

While the one wildcard for the renewals that could turn things more significantly could be the availability of capacity in some specific and important segments of the market, such as global retrocession.

But still, the readiness of capital to flow in and replace that which has been eroded by the 2018 losses suggests localised price rises, in terms of geography and reinsurance program, is the most likely outcome for January 2019.

While any gaps in capacity that emerge are likely to be readily filled by either the major traditional players, smaller opportunists, or indeed ILS specialists.