Average returns on equity (ROE) across a group of property & casualty reinsurance firms operating in the U.S. have tumbled “materially” on an operating basis and “precipitously” on an income basis, according to rating agency Fitch.
It’s been clear for a number of years that reinsurance company returns on equity (ROE) were on the wane, with the impact of steep pricing declines and high competition, combined with the influence of new capital and business models all impacting the profitability of the sector.
The added pressure from poor investment returns and unrealised losses on certain assets, premium growth that is failing to keep pace with loss cost trends, plus more attritional loss experience, both man-made and more frequent catastrophe or weather, has all driven the decline.
Fitch’s data shows that across the group of eight P&C reinsurers, the return on operating equity “declined materially” from 13.1% in 2014 to 10.8% in 2015, resulting in lower performance than a group of P&C personal lines insurers the rating agency also tracks.
But it is on an income basis that the ROE decline has been sharpest, with average net income ROE dropping “precipitously” from 2014’s 14.6% down to just 8.4% in 2015.
The average combined ratio, excluding catastrophe losses and prior-year reserve development, declined by 1.4%, from 90.7% in 2014 to 92.1% in 2015. It’s easy to see how any major loss event, catastrophe, casualty or other lines, that affects the market could very quickly throw the group into negative territory, in terms of ROE’s.
Perhaps a little surprisingly, the reinsurance group of companies reported the greatest increase in catastrophe loss experience for the year, although impact on the reinsurers results from catastrophe losses reported was only 2.7% of earned premiums.
It is perhaps surprising that in a year of relatively benign major catastrophe activity, when more attritional events were the main cause of loss across the period, that it is reinsurers who experienced the worst loss experience increase, not primary companies.
Could the trend towards aggregate covers, multi-year contracts and expansion of terms be already showing in the shape of more losses flowing through to reinsurers?
Competitive pricing and conditions in the reinsurance market are also showing their effects in premium growth of just 0.9% for the year, the slowest rate of growth of all the groups of commercial diversified, regional and specialty insurers, personal lines companies or the reinsurers.
Fitch maintains its view that the reinsurance sector outlook is “negative as intense market competition and sluggish cedant demand resulted in a soft reinsurance market.”
The data from Fitch demonstrates the difficult operating conditions faced by reinsurance firms, as an overabundance of capital, intense competition, soft market pricing and sluggish demand from cedants all combine to ramp up the pressure.
Add in the influence of the growing ILS market, which is taking increasing shares of business, as well as reinsurers own use of third-party capital, which can have the effect of diluting returns if not wielded strategically, and it’s easy to see why the pressure is so evident in reinsurer returns.
Of course, right now the market is facing a near perfect storm, of particularly soft pricing at a time of particularly depressed investment returns. The question is will those effects turn, or can reinsurers learn to optimise returns, focus on more profitable areas, use third-party capital intelligently to add incremental earnings and become more performant investors?
Or if conditions persist, what happens when the next major loss occurs when returns could look very negative indeed?
It will be interesting to watch this market work to improve its returns, what strategies are employed and how reinsurers can become more efficient, effective and indeed profitable.
Of course lower returns is affecting the ILS market too, resulting in greater efforts to bring capital closer to the source of the risk as ILS managers look to extract additional value for their investor base out of the rate-on-line available.
Reinsurers look set to join this trend, to shorten, break-down, or disrupt, the risk to capital value-chain and if lower returns are the new normal, these efforts can’t come soon enough.