Re/insurance executives fear large losses will hit 2017 profitability

As the re/insurance sector faces another year of soft pricing environment in 2017, market participants fear that large losses could significantly hit profits, which have been protected by the benign cat environment in recent years.

That was one of the key concerns raised by a number of senior executives speaking to Intelligent Insurer for a wider feature looking at trends and topics for 2017 (click here for full feature).

“Pricing and terms and conditions remain on top of the agenda for 2017,” according to credit analysts at S&P Global Ratings. “The high absolute level of traditional capital and alternative capital coupled with a relatively benign large loss development in 2016 and strong expected bottom line profits for the sector are dampening expectations for a significant turnaround in pricing (to a hardening market) in 2017,” Johannes Bender, Taoufik Gharib, and David Masters told Intelligent Insurer.

However, a push back particularly by large players trying to protect profitability seems to be having some effect on pricing.

“The slowdown in price declines to about 0 to 5 percent in 2016 and the slowdown in influx of alternative capital and a stabilised level of traditional capital in 2016 indicates a levelling out of price declines. Moreover larger reinsurers, in particular, appear to have pushed back on clients demanding looser terms and conditions, with only limited loosening experienced in 2016, but in areas that can be priced for. The question is if 2017 will be the bottom of the soft cycle and if the market starts the turnaround into a hardening market from 2018 onwards,” the S&P credit analysts said.

The cat environment has been comparatively benign in recent years, contributing to the current soft market. However, a normalization of loss events could severely impact the industry as rates and reserves may not cover the claims.

“We are well overdue a major loss that has really tested the fabric of our industry,” warned Paddy Jago, global chairman of Willis Re.

Jon Sullivan, portfolio director, short tail treaty, Brit, warned that as attrition moves up and expenses grow, “a ‘lucky’ [2017] cat year is becoming essential to create an ‘average’ year. Maybe 2017 is when cat frequency reverts to mean (or worse) and we start to see companies really struggle with the associated consequences for pricing and risk-taking,” Sullivan said.

Mark Watson, CEO of Argo Group noted that while 2015’s financial results benefited from prior year development and the absence of significant catastrophic activity, “in 2016 we have seen these tailwinds dissipate for some and shift 180 degrees for others. Underwriters must now stand on their own two feet knowing they will be judged tomorrow by what they put on the books today.”

S&P therefore suggested that the development of large losses/events will be an important factor for the industry in 2017 for both earnings and capital.

“We assume that the industry’s capital can withstand a number of shocks but the largest sensitivity for capital volatility resides in natural catastrophe risks and reserve risk. Reserve margins appear to be adequate in 2016 for the sector in aggregate, but some selective reserve strengthening measures of certain lines of business and by some primary writers coupled with some visible reserve releases in the last years could raise some questions around reserve adequacy in 2017.”

Profitability of the re/insurance sector has already come under pressure in 2016, if reserve releases are stripped out.

“Although 2016 will likely be a strong earnings year, the underlying normalised level of profitability is shrinking. 2016 will benefit from lower than budgeted large losses, albeit not the extent seen in 2015. Beside the potential development of large losses in 2017, the development of normalised earnings is expected to continue to be under pressure in view of the expectation that rates are levelling out (at best), together with declining investment returns,” according to S&P.

Although cost of capital is comparatively low due to the low interest rate environment, the re/insurance industry may face difficulties to generate enough profits to cover the cost of capital in 2017.

“The expected cost of capital in 2016/2017 will likely be around 6 percent and the return on capital could, in a normalised large loss environment, in 2017 be below the cost of capital,” the S&P analysts believe.

At least, the soft market may boost demand for re/insurance, believes Argo’s Mark Watson.

“For 2017, I expect there to be a shift back towards cedants buying more re/insurance, as re/insurance pricing continues to decline,” he said. However, growing demand is unlikely to result in a hardening of the market. “No-one should expect pricing to improve any time soon—there is still too much capacity in the marketplace,” Watson said.

In total senior executives from companies including Swiss Re, Argo, AM Best, Moody’s Markel, Advent, Barbican, Brit, Ed, Fitch, S&P Global Ratings and Willis Re participated in the piece looking forward to 2017. To read the full transcript of their thoughts and comments, please click here.