Standard & Poor’s (S&P) has attributed the continued strong performance of global reinsurers in 2015 to the benign catastrophe loss environment and reserve releases, citing that these factors are masking true business conditions, which are to remain challenging and competitive in 2016.
Reinsurance pricing continued to soften at the key January renewals; notes S&P, as ample capacity from alternative reinsurance capital providers continued to heighten competition, as well as a noticeable absence of catastrophe losses, low investment returns, and a high level of reserve releases.
Without high levels of reserve releases and the continuation of a benign loss landscape, S&P feels “that the adjusted results support our view that business conditions for the sector remain weak.”
Fellow financial services rating agency Fitch highlighted recently how reinsurers are edging closer to breakeven on a normalised basis, as market analysts and experts appear keen to remind global insurers, reinsurers, and also insurance-linked securities (ILS) funds and managers that losses will return to a more normal level at some stage.
Those that were perhaps too aggressive with reserve releasing might find themselves in a difficult position when the market does start to turn and losses begin to normalise somewhat, a warning that Artemis has discussed before.
The inflow of alternative reinsurance capital continued to exacerbate the softening reinsurance pricing landscape at 1/1, but like other analysts and observers of the space, S&P noted the slowing entry when compared to previous renewals.
That being said, ILS is expected to grow its share of the overall reinsurance market in the coming months and, unless it can find its way into new risks and regions outside of the highly pressured U.S. property catastrophe space, it’s likely to add further pressures to international reinsurers.
“Top lines are suffering not only from lower prices, but also from a fall in the level of reinsurance purchased by cedants in recent years and difficulty finding areas where profitable organic growth is possible.
“The problem is compounded by low interest rates globally; reinsurers can’t rely on investment income to boost bottom-line profitability. Lower reinvestment rates for assets imply that returns are likely to remain anemic and won’t offset the weaker premium rates being achieved,” said S&P.
During 2015, as adverse market conditions intensified, efficiency became more and more important, reflecting the limited growth opportunities outside of consolidation.
In their hunt for efficiency market players increasingly utilized the wealth of alternative reinsurance capital to supplement, or even replace existing catastrophe programmes in 2015, a trend that also helped to increase the acceptance and sophistication of the expanding ILS space.
Utilising the wealth of efficient capacity in the capital markets enabled some reinsurers to better navigate the challenging market conditions, increasing efficiency and diversification, something increasingly important at times of limited growth and profitability.
And as market conditions are expected to remain tough for the remainder of 2016 and beyond, it’s possible that ILS continues to gain momentum and expand into new perils and regions as reinsurers look to bring their cost-of-capital down and boost earnings.
“We anticipate that business conditions will remain weak for the global reinsurance sector. Prices are likely to continue to soften through 2016 and beyond, and investment returns will offer no solace. Therefore, normalized earnings will continue to deteriorate,” advised S&P.
The ratings agency expects the reinsurance segment to report a combined ratio of between 97% and 102% in 2016, with a return on equity of between 8% and 10%.
Retrocession and reinsurance optimization, which likely includes the use of efficient capital markets investor-backed capacity, and improved risk management efforts helped reinsurers offset some of the weak market conditions, says S&P.
“These actions have protected reinsurers from the weak business conditions, to some extent, for now. As a result, we expect to take few rating actions, up or down, over the next 12 months.
“However, if pricing continues to decline, T&Cs loosen further, and competition remains elevated over the next few years, then we expect the industry’s underlying earnings to continue to deteriorate,” warned the firm.
Beyond consolidation, which at this stage of the softening market could be more detrimental than some believe, and a return to normalized losses or even a substantial loss event or events occurring, reinsurers will need to show heightened discipline in order to remain relevant when the market does start to turn.
Innovation into new risks and regions from both traditional reinsurance and alternative reinsurance capacity is perhaps the best way to generate improved returns in the current market environment.
But as highlighted by S&P, neglecting discipline in order to boost profitability and essentially mask true underwriting performance is a dangerous game, and as a result “we could see increased capital volatility or deteriorating competitive positions; either could trigger negative rating actions,” warned S&P.