Reinsurance sector retains strong base despite headwinds

The reinsurance industry is still operating from a strong capital base as it approaches the end of 2015 and, even though the soft market continues, an easy landing might be ahead, rating agency Standard & Poor’s (S&P) said in a briefing covering the state of the reinsurance market at the Singapore International Reinsurance Conference yesterday (Tuesday November 3).

Dennis Sugrue, director of insurance ratings at S&P, said that credit conditions remained negative, but that a strong base and a sound defence from reinsurers has enabled most to buy some time.

“We took a negative view on the reinsurance market in January 2014 and since then we don’t think that credit conditions have improved much,” he said. “Credit conditions remain negative and re/insurers are under a lot of pressure. But we also think the industry has reacted responsibly and appropriately in response to those pressures.”

According to S&P, supply and demand dynamics continue to impact pricing. Capital levels are at an all-time high, alternative capital has hit record levels and is expected to grow further.

In addition, Sugrue said, buyers’ purchasing patterns are changing, reducing the level of demand. In addition, organic growth was becoming difficult to come by for reinsurers.

S&P expects that reinsurance pricing will continue to decline, but at a less drastic rate than in 2014. Nevertheless, softening pricing will pressure the reinsurance sector’s operating performance in 2015 and 2016 compared with recent years.

Sugrue also said that while low interest rates persist, S&P forecasts modest increases in interest rates in 2016, which should help improve yields over time.

Reinsurers may start to augment their investment portfolios to improve yields, S&P said. They may extend the duration of their asset portfolios, take more liquidity risks via longer-term assets such as infrastructure and real estate investments, and take on higher allocations of assets such as equities and high yield corporate debt, the rating agency suggested.

Sugrue added that many re/insurers’ profits are currently reliant on prior-year reserve releases, which is not sustainable.

Looking at recent regulatory changes around the world, Sugrue said these have resulted in some regulatory fragmentation, leading to uncertainty. This, in turn, might increase capital requirements.

As a result, smaller, less diversified re/insurers will continue to be squeezed and these players could be candidates for future consolidation, S&P said.

Yet despite these strong headwinds affecting the global reinsurance industry, Sugrue added that the sector itself had a strong base and had been using a robust defence strategy, which has bought time for most players in the market.

He pointed out that capital adequacy for the industry as a whole remained at triple-A levels and had continually improved since 2012. He added that enterprise risk management capabilities in the industry were also increasingly sophisticated, in the view of S&P.

Sugrue said the recent wave of consolidation has been triggered by reinsurers seeking greater scale and diversification. Well capitalised and diversified re/insurers would be in a better position to navigate the challenging conditions; those able to adapt and remain relevant to their clients should be able to meet their return targets.

As a result of all of the above, Sugrue said that S&P does not expect many rating actions, either positive or negative, over the next 12 months.

Speaking of the Asia-Pacific area specifically, Connie Wong, managing director, insurance ratings at S&P, said that S&P was revising its Asia-Pacific reinsurance outlook from stable to negative for a number of reasons. Although she said that no ratings had yet been affected, this could change.

According to Wong, the Asia-Pacific region is subject to greater downward pressure on earnings than elsewhere, with the soft market leading to fierce competition, greater catastrophe risks due to concentration and cedants increasing their retentions.

Wong added that the regulatory changes in some markets such as China and Indonesia might impact the reinsurance market.

While the investment behaviour of re/insurers remains prudent at the moment, companies might look for higher yields from riskier investments, Wong said.

However, she added that the credit trend for the Asia-Pacific insurance sector remains stable. “Premium rates for non-catastrophe risks remain competitive and the life sector is seeing growth prospects, albeit subject to a possible future slowdown.”