10 September 2017 Insurance

Rating risks loom as reinsurers’ returns drop below cost of capital

A mix of further declining rates, low investment returns and unsustainable reserve releases could push the return on equity of the reinsurance sector below the cost of capital and trigger a rating review, according to S&P Global Ratings.

While many observers have predicted that property/casualty (P&C) rates will find a floor in 2017, the softening of reinsurance rates accelerated in the June Florida renewals.

“For the rest of 2017 and obviously heading into the 2018 renewals we expect further rate softening,” said David Masters, director, financial group at S&P Global Ratings, at a pre-Monte Carlo briefing in London.

Excess capacity in the market continues to pressure rates. Traditional capital levels in the global reinsurance sector increased again in 2016 to $443 billion shareholders’ funds, according to S&P. Alternative capital grew to record levels in 2016 to an estimated $81 billion, although the rate of inflows has slowed to around 12 percent.

Pricing is declining in all lines and regions as more sophisticated insurers are rationalising and optimising their reinsurance purchasing, buying less reinsurance from fewer players, according to S&P.

Thanks to below average large events, P&C reinsurers have been able to boost their profits through prior-year reserve releases, helping to counterbalance declining underwriting profitability. However, this might not go on forever.

“This is not a sustainable level of reserve releases,” Masters said.

S&P is forecasting for 2017 a calendar year combined ratio of between 96 and 100 percent for the reinsurance sector. This includes 8 to 10 percentage points for natural catastrophe losses and an assumption of 5 to 6 percentage points of prior-year reserve releases. The deterioration of the combined ratio compares to 93 percent registered for 2016.

On an accident year basis, stripping out the prior-year reserve releases, the combined ratio is expected to land between 102 and 105 percent. The sector would therefore be generating an underwriting loss on average in 2017 without the reserve releases, Masters explained.

The sector’s ability to earn above its cost of capital has fallen and the margin is shrinking, S&P warns.

The ratings agency forecasts a return on equity of 6 to 8 percent for the reinsurance sector in 2017 which equates to a return on capital of 5 to 7 percent. This assumes favourable prior year reserve releases and nat cat experience. The forecast cost of capital for the sector in 2017 is just over 6.5 percent. It might get tight for the industry.

“If the sector’s cost of capital is sustainably higher than its return on capital, profitability dips below investors’ minimum return expectations, and we would likely revise the outlook on the sector to negative,” Masters said.

However, S&P also noted that issuer-specific rating actions are more likely than sector downgrades due to robust capital levels in the industry.

Get the latest re/insurance news sent to your inbox every day -  Sign up to our free email newsletters

Today’s Monte Carlo stories

Insurtech risk selection may diminish the role of reinsurers: Swiss Re CEO

Ogden-hit reinsurers may seek clawback from cedants

London ILS could be a game-changer

We want profits for our partners: Aspen

Hurricane Harvey shows lack of awareness of flood risk

Cyber tops reinsurers’ concerns for first time

Monte Carlo Survey: How can innovation enable our industry to be more resilient?

Harvey will reflect what reinsurers have learned since 2005

The importance of capital optimisation

Creating data you can trust

How some reinsurers stand apart

‘Client centricity is in our DNA’

More insurers are converting to MGAs

Don't miss our insurtech email newsletter - sign up today

Already registered?

Login to your account

To request a FREE 2-week trial subscription, please signup.
NOTE - this can take up to 48hrs to be approved.

Two Weeks Free Trial

For multi-user price options, or to check if your company has an existing subscription that we can add you to for FREE, please email Elliot Field at efield@newtonmedia.co.uk or Adrian Tapping at atapping@newtonmedia.co.uk