Earning returns above the cost of capital is becoming tougher
Lower investment returns and a continued softening of underwriting rates have increased pressure on reinsurers’ profitability to the point their ability to earn returns above their cost of capital has declined, according to a report by S&P Global Ratings.
The cost of capital for reinsurers rated by S&P has fallen steadily since 2005 but S&P suggested that although management can influence the cost of capital, ultimately, the capital markets will dictate a reinsurer's cost of capital.
It also highlights that natural catastrophes of the past few years have flattened reinsurer’s returns.
“In our view, given a more normalised loss experience, the reinsurance sector's overall profitability would not have exceeded its cost of capital, in either 2015 or so far in 2016,” said S&P.
S&P also suggested that investment yields have shown little sign of returning to levels that helped sustain profitability in 2005.
“We now anticipate that reinsurers' profitability will soon drop below their cost of capital and could remain there until the underwriting and/or investment cycles turn. This trend has significant credit implications, some of which will depend on how investors respond,” S&P continued.
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