Reinsurers will work hard to rid negative outlook
Rating agency AM Best recently revised its outlook for the reinsurance sector to negative, citing the ongoing market challenges that will hinder potential positive rating outlooks and upgrades, potentially resulting in negative rating pressure.
“Declining rates, the unsustainable flow of net favourable loss reserve development, the low investment yields and the continued pressure of convergence capital are significant concerns for the reinsurance sector,” said Robert DeRose, vice president, reinsurance ratings.
“The simple fact is that reinsurers are being paid less and less to bear risk and will ultimately place a drag on financial strength.”
DeRose explained that the rating outlook was based on a longer term view than the typical 12 to 18 months, and said that while a significant number of negative outlooks or downgrades wasn’t expected in the near term, the market dynamics present longer term challenges.
“In comparison, we looked at the traditional market’s increased use of capital markets capacity to help optimise results, net probable maximum loss (PML) for peak zones as a percentage of capital, the degree of cycle management and oscillation between primary and reinsurance platforms, the subtle migration into asset classes that will produce some increased yield, and the focus on producing fee income,” said DeRose.
“Broadly speaking, rated balance sheets are currently well capitalised and capable of withstanding various stress scenarios. However, over time this strength may be eroded as earnings come under increased pressure, favourable reserve development wanes, earnings grow more volatile and the ability to earn back losses following events is prolonged by the instantaneous inflow of alternative capacity.”
Speaking of the market’s rate adequacy, DeRose said that it would take “optimal conditions” such as benign or near benign catastrophe years, a continued flow of net favourable loss reserve development and stable financial markets to produce even low double-digit returns.
DeRose concluded by saying that AM Best would favour companies with diverse business portfolios, advanced distribution capabilities and broad geographic scope as they are better positioned to withstand the pressures in this type of operating environment and have greater ability to target profitable opportunities as they arise.
