With reinsurance pricing now much higher than before, S&P Global Ratings said that, while it continues to have a negative view on the sector, a tipping point is nearing where better profitability could change its view to stable.
S&P notes that a “combination of challenges” has driven the current hard market in reinsurance pricing and it believes this hard market will continue in 2023 for short-tail lines and across geographies.
However, reinsurers have failed to earn their cost-of-capital in the past five out of six years (2017-2022), S&P explains.
Which is what drives its negative view on the sector, as the rating agency believes reinsurance lacks profitability.
“The question now is whether the pricing improvements are sustainable, and whether they are enough to combat the endless headwinds the sector has faced that have muted performance for the past several years,” S&P said.
Adding that, “Even though we are cautiously optimistic, we believe it is not done and dusted yet–reinsurers need to maintain underwriting discipline, proactively take underwriting actions, and continue to seek price adequacy in the upcoming renewals.”
As a result, S&P says, “We maintain our negative view on the global reinsurance sector, but we believe the tipping point is coming for a more stable sector view if reinsurers maintain discipline and demonstrate the ability to sustainably earn their cost of capital.”
The outlook is far more positive now, thanks to harder reinsurance pricing, S&P believes.
“We believe the significant price increases, along with these portfolio underwriting actions, will boost reinsurers’ underwriting performance in 2023,” the rating agency said.
Adding, “We believe reinsurance pricing momentum will continue for the upcoming renewals in 2023.”
The retrocession dislocation could persist as well, as capital may not come back in to the degree required to stem the hardness of that part of reinsurance, S&P believes.
This retro dislocation could support continued reinsurance rate momentum in 2023, S&P Global Ratings said.
While there could be a tipping point, in terms of the reinsurance sector becoming profitable enough to allow reinsurers to meet their cost-of-capital, there is a caveat to that.
S&P notes that costs-of-capital are rising around the world, meaning the returns needed to meet it are rising too.
“Expected improving underwriting earnings, increasing investment income, prudent capital management, and sophisticated levels of risk management should sustain the industry’s capital adequacy,” S&P said.
Although it’s not clear whether adequacy will deliver the stable sector outlook on its own.
In addition, S&P says, “Speculation remains whether the rate improvements in the reinsurance markets will be enough to entice new capital into the space.”
Summing up, the rating agency said, “Natural catastrophes continue to challenge the space and have largely been the motivation behind multiple years of rate increases with little chance of letting up.
“Now, as central banks hike interest rates to tame inflation, reinsurers’ cost of capital is also rising — making it even harder for reinsurers to earn and exceed their cost of capital.”
While traditional reinsurance firms could find besting cost-of-capital a challenge, this does read-across positively to the insurance-linked securities (ILS) space, as well as alternative reinsurance business models, where cost-of-capital may be more closely matched between the capital markets and the involved players.
Of course, there is one item within the reinsurance chain that adds weight to capital, effectively increasing costs, and that’s the relatively inefficient way risk and capital continue to be matched.
There is a huge opportunity, especially in a hard reinsurance market, for participants to remove excess cost from the risk transfer equation (taking fat out of the transaction itself, as well as the chain, plus expense out of the business), allowing for cost-of-capital to be more easily met and exceeded.
It’s too early in this hard market cycle for much noise to be made about the costs of doing business in reinsurance, but as clients make noise about the increased price of coverage, there is likely to be a focus on increasing capital-efficiency, margins and making meeting capital costs a little easier through efficiency gains and lowering expense.
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