Winners and Losers: the reinsurance landscape according to S&P

26-09-2018

Winners and Losers: the reinsurance landscape according to S&P

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Every year, S&P Global Ratings in partnership with Intelligent Insurer publishes its annual Global Reinsurance Highlights, which offers analysis of the main talking points and trends in the industry and ranks the top 40 reinsurance groups globally by net reinsurance premiums written. Here, we highlight some of the main themes from this year’s report.

In its annual Global Reinsurance Highlights, S&P Global Ratings’ analysis of the global reinsurance sector represents something of a mixed bag for the sector. While the 2018 report highlights many positives for reinsurers, including robust capitalisation, strong enterprise risk management (ERM), and modest price increases, there are also many challenges.

The report notes the fact that the sector is still facing weak business conditions, as the influx of alternative capital continues to challenge reinsurers’ business models while eating up more traditional property catastrophe capacity. Even incorporating the benefits of modest rate increases in 2018, reinsurers’ profitability is likely to barely exceed their cost of capital in 2018 and 2019.

The report highlights an increasing gap emerging between the top five global reinsurers, which have defended their leading positions well in the past decade, and the rest. The rating agency says that it believes these five are well-placed to retain the top ranks by separating themselves from the pack through steps such as more involved client relationship management.

In the foreword to the publication, authored by S&P analysts Johannes Bender, Taoufik Gharib and David Masters, it notes that discussions for 2019 renewals in Monte Carlo are happening after a tough natural catastrophe year in 2017, which appeared to be among the costliest years on record, reminding the sector of its tail exposure. “After years of declining property/casualty rates, renewals in 2018 brought modest increases and a temporary breather for the sector. However, this effect is now fading and the sector continues to face weak business conditions,” they write.

In the publication’s lead article, The Top Global Reinsurers Are Breaking Away From The Pack, S&P discusses why it still views business conditions as weak even after modest price increases in 2018 and a slightly upward trend in earnings anticipated for 2018 and 2019. It also outlines that the sector’s strong ERM and robust capitalisation are the main pillars for its stable outlook on the sector and for the majority of the reinsurers it rates.

The article discusses which players are best placed to be winners in the market and addresses the question: What would happen to its view on the sector if its return on capital falls sustainably below its cost of capital?

This article also notes that weak market conditions have driven reinsurers to rethink their short- and long-term strategies. This has led many to pursue M&A, divest nonperforming businesses, diversify into less-commoditised lines of business, and embrace third-party capital.

“They’ve also adjusted risk exposures while shifting their underwriting appetite to primary and proportional reinsurance and away from non-proportional reinsurance, and they’re actively managing their capital structures through share buybacks, special dividends, and refinancing their maturing securities with more cost-effective ones,” the article notes.

Outlook: Stable

S&P Global Ratings notes that it will maintain its stable outlook on the global reinsurance sector and on the majority of the reinsurers it rates. This is mostly because of reinsurers’ still-robust capital adequacy and because underwriting has remained relatively disciplined, at least so far, supported by overall strong ERM.

“At the same time, we continue to believe the global reinsurance sector is facing weak business conditions because the fundamental challenges of the sector have not abated, even after 2017’s heavy natural catastrophe losses,” it says.

It comments on the cost of capital, which has consistently fallen in recent years but appears to have reached a floor at year-end 2016, increasing through 2017 due to rising interest rates and the volatility stemming from heavy catastrophe losses. Operating conditions for global reinsurance remain difficult despite modest 2018 renewal rate increases.

“We believe reinsurers’ returns will be close to their cost of capital in 2018 and 2019. If the industry’s return on capital declines sustainably below its costs, which causes market growth prospects to suffer, we could reassess our view of the sector.”

The report stresses the fact that global reinsurers continue to enjoy robust capitalisation despite severe catastrophes, which racked up more than $138 billion in insured losses globally in 2017. These catastrophe losses wiped out 2017 earnings for a number of reinsurers and became a capital event for a few outliers.

“The sector demonstrated its resilience, managing the record catastrophe year with just a relatively small net loss, though the specific impact varied widely by reinsurer. This reflects the sector’s diversification benefits from writing other noncatastrophe-exposed lines of business—such as casualty and primary insurance—as well as life reinsurance. In addition, it reflects the sector’s sound ERM capabilities, which help them maintain catastrophe losses generally in line with risk appetites and leverage the retrocession market through alternative capital while ceding some of the tail risks,” S&P notes.

Therefore, it adds, the 2017 hit to capital was not severe enough to cause industrywide panic or major declines in risk-adjusted capitalisation. But in addition, the losses were not severe enough to lead to sustained industrywide price hardening. When overall industry capitalisation deteriorated, it was viewed as manageable, with most of the affected companies positioned to replenish their lost capital with a year or two of normalised earnings. As a result, the 2017 catastrophe losses resulted in only a handful of negative rating actions.

Returns 

Elsewhere in the report, the article Global Reinsurers’ Returns Will Barely Cover Capital Costs In 2018 And 2019 discusses the development of the sector’s returns compared with its cost of capital. In 2017, cost of capital increased again after years of decreases, while returns were hit heavily in 2017 following large natural catastrophe losses. “Although we observed moderate reinsurance rate increases, we believe reinsurers’ profitability will barely exceed its cost of capital in 2018–2019 and reinsurers continue to compete with alternative capital sources that typically have a lower cost of capital,” S&P notes.

In an article titled Are Global Reinsurers Ready For Another Year Of Active Natural Catastrophes? S&P takes a closer look at the 2017 natural catastrophe losses and how they compared with reinsurers’ exposure and modeling capabilities. Moreover, it discusses the sector’s appetite for catastrophe risk after 2017 losses and earnings and catastrophe budget buffers for 2018.

In 2017, the top-20 global reinsurers lost their capital redundancy at the ‘AAA’ confidence level for the first time since the 2008 financial crisis. However, capital remained a strength for the sector. In Capitalisation Remains A Pillar Of Strength For Global Reinsurers, it takes a closer look at the development of risk profiles and capital adequacy of the sector.

Alternative capital in the form of insurance-linked securities has transformed the market, especially in the property catastrophe space, and even the natural catastrophe losses of 2017 have not dented investors’ enthusiasm for the asset class.

In How Reinsurers Have Learned To Align Third-Party Capital With Their Needs, S&P discusses what effect continued growth of alternative capital has on reinsurers’ competitive positions.

This year’s Global Reinsurance Highlights also again includes a peer comparison supplement that exhibits some of the important data points and trends identified from its analysis of the sector. This year’s publication captures the key issues facing reinsurance management, investors, and other stakeholders.

For the full report, visit www.spratings.com/GRH

S&P Global Ratings, Reinsurance, Rism management, Outlook, ERM, Alternative capital, Global

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