Reinsurers enjoy ‘hard-earned’ positivity and upgrades: S&P

S&P Global Ratings’ recent upgrades of the outlooks of reinsurance industry giants Munich Re and Swiss Re were partly driven by the ratings agency’s decision to upgrade its view of the sector as a whole from negative to stable, the agency has said.

“Bottom lines will be materially higher due to investment earnings.” Ali Karakuyu, S&P Global RatingsS&P, which gave a pre-Monte Carlo Rendez-Vous briefing on the sector in London last week, said the change was due to “hard-earned” and “much-needed structural changes in reinsurance underwriting, including tighter terms and conditions and repricing of risk during the 2023 renewals”.

S&P Global director Ali Karakuyu said: “We have changed our view of the global reinsurance sector to stable from negative because we expect it will earn back its cost of capital this year and next year based on favourable property casualty pricing conditions, pre-pandemic earnings levels in life insurance and increasing net investment income.”

That should result in improved credit ratings as well, he said.

He added: “Because the sector is producing better results, there is a positive momentum.”

He noted that recoveries in the investment market would begin, unwinding some of the mark-to-market losses that eroded capital buffers in 2022. Improvements in the markets and rising interest rates would boost returns on fixed income investments. “The sector is well-placed to recoup investment income,” Karakuyu said. “Bottom lines will be materially higher due to investment earnings.”

However, S&P added some caveats.

“Reinsurers have tightened policy wording for exclusions for certain risks.”“Although we expect recent structural changes to provide a long-lasting tailwind, challenges such as elevated natural disasters, increasing cost of capital, financial market volatility and inflation risk persist,” the S&P briefing said.

Karakuyu said S&P expected rates to continue to increase in 2024 and said premium hikes were still needed in the casualty segment.

While property premiums had seen increases, “more needs to be put in place in terms of rate rises, especially due to social inflation” for casualty, he said.

Asked why no “class of ’23” of newly capitalised reinsurers had emerged with the hard market, Karakuyu said “the story is different” from previous hard markets such as the 2006 class which followed Hurricane Katrina and had been caused by a lack of capacity.

In 2023, he said: “Investors were quite aware that the rate rises that were taking place in recent times were really needed, as opposed to a capacity shortage. The story is different.

“Keep in mind that while investors are deciding whether to put money into the sector they are also weighing it against what else is out there, so they also have other opportunities.”

S&P associate director Maren Josefs noted there remains uncertainty around climate change and Karakuyu said reinsurers were putting in new reinsurance arrangements such as stop-loss policies which supplanted the need for new capital to some degree.

He added that while reinsurers had built inflation into their budgets, there remained a key risk of “unexpected inflation”, which he said could be “quite challenging” for reinsurers.

S&P has calculated that the net combined ratio of the top 20 reinsurers was 96 percent in 2022, down from the high of 104.8 in 2020—the third consecutive year of underwriting losses—and was projected to be between 92 percent and 96 percent in 2023 and 2024.

Karakuyu said 2022 was the fifth most expensive year for insured losses from global natural disasters with $132 billion in claims. This was 57 percent above the 21st century average. He noted that the last six years had all been above the average of $83 billion.

However, property catastrophe rates had risen by 27.5 percent according to a Guy Carpenter index and were at a multi-decade high.

“Reinsurers have tightened policy wording for exclusions for certain risks (such as cyber, war and terrorism), raised their attachment point, scaled down limits and offered meaningfully less capacity to lower layers and aggregate covers,” he said.

S&P noted that reinsurers had narrowly earned their cost of capital in the first half of 2023, having failed to so in the preceding three years.

The weighted average cost of capital in the first six months of 2023 was 8.4 percent—the highest it has been since 2009—while return on capital was 9.3 percent, the highest since 2019, but still below the peaks seen in 2012 to 2014 when the industry experienced returns of more than 10 percent when the cost of capital averaged 7 percent.

S&P said catastrophe bonds were continuing to fill gaps in capacity with total outstanding growing to $37.8 billion and total issuing exceeding $8. billion so far in 2023.

But Karakuyu cautioned that investors had more choices due to rising interest rates and would ask themselves whether they wanted to invest in insurance-linked securities or in more conventional bonds where there was less risk.

Simon Ashworth, head of analytics and research, said the changes in S&P’s view were key for changing the outlooks on Munich Re from stable to positive, and on Swiss Re from negative to stable. S&P had had a negative view of the sector since 2020.

He said among reinsurers overall, the number of companies with a negative outlook had dropped from 15 percent to 5 percent.

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