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Back to the “new normal” for reinsurers

Overall market conditions for reinsurers are expected to remain very competitive over the near term, says A.M. Best which is maintaining its outlook for the reinsurance market segment at negative.

A.M. Best, in its annual commentary on the global reinsurance sector, points out that the degree of optimism for a sustainable improvement in reinsurance pricing that existed immediately following the 2017 catastrophe losses did not develop as anticipated and while pricing terms and conditions did stabilise, they continue to remain below expectations for producing a reasonable risk-adjusted return relative to the average cost of capital for most reinsurers. Improvement in interest rates should have a positive impact on the bottom line, but the momentum will emerge gradually as a flattening yield curve is deflating the effects of a rising federal funds rate in the US.

News Reinsurance05 Sep 2018

Global:Back to the “new normal” for reinsurers
By AIR team | 05 Sep 2018
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Global Reinsurance

Overall market conditions for reinsurers are expected to remain very competitive over the near term, says A.M. Best which is maintaining its outlook for the reinsurance market segment at negative.

A.M. Best, in its annual commentary on the global reinsurance sector, points out that the degree of optimism for a sustainable improvement in reinsurance pricing that existed immediately following the 2017 catastrophe losses did not develop as anticipated and while pricing terms and conditions did stabilise, they continue to remain below expectations for producing a reasonable risk-adjusted return relative to the average cost of capital for most reinsurers. Improvement in interest rates should have a positive impact on the bottom line, but the momentum will emerge gradually as a flattening yield curve is deflating the effects of a rising federal funds rate in the US.

Earnings for the full year 2017 reflect the significant impact of catastrophe losses, which compound the weakness in historical trends attributed to the ongoing market challenges that curtail the underlying accident year underwriting performance. Taken together with lacklustre investment returns, this has served to drag operating and overall performance for the sector to a level only marginally adequate to cover the average cost of capital for many reinsurance-predominant companies.

Nevertheless, the international credit rating agency says that it expects that the majority of reinsurers’ ratings will be affirmed with stable outlooks given their respective “Strongest” or “Very Strong” balance sheet assessments, “Adequate” relative operating performance, “Favourable” business profiles, and appropriate enterprise risk management as demonstrated by the majority of rated global reinsurance companies.

Alternative capital

A. M. Best says that it is concerned that property catastrophe pricing is somewhat at the mercy of the alternative capital market and is not as heavily influenced by the traditional reinsurance market as historically has been the case. Any hope for near-term improvement in the market is directly correlated to the current level of excess capacity in the overall market today. This is compounded by the continued inflow of alternative capacity that was seen in the fourth quarter of 2017 and through 2018, which has helped offset the collateralised capacity that is currently trapped until losses from 2017 work their way through the settlement process.

Favourable factors

On a positive note, improvement in the global and, in particular, the US economic picture, as well as future economic benefits stemming from US federal tax reform, will provide opportunities for organic growth and improved utilisation of excess capacity, which also should aid the drive for improved risk pricing. This is evident in the top line growth exhibited in the first half of 2018. Similarly, an increase in cessions from primary companies due to recent loss experience may positively influence the supply/demand equation. A potential increase in demand from government risk pools such as the National Flood Insurance Program (NFIP) in the US, as well as opportunities in cyber, mortgage, and other emerging risks, should allow for greater utilisation of available market capacity.

An improving interest rate environment, with controlled inflation, will provide more pricing flexibility and improve the overall returns for reinsurance companies over time, and allow them to earn back losses more quickly following significant loss events.

Further consolidation in the global reinsurance segment is likely to continue, which, if done prudently, should help improve the efficiency of the market’s overall capacity and lead to greater operational discipline.

However, much uncertainty remains at this point and the existing risks to the market remain in play, as do one-off risks such as the potential fallout from Brexit and a global trade war and what these may mean to the global economy. A.M Best expects that at a minimum, underwriting and overall performance will improve slightly, absent abnormal catastrophes, and stabilise over the longer term, resulting in a five-year average ROE of between 6% and 8% over the cycle.

For the full year 2018, A. M. Best estimates a combined ratio of 94.8% and an ROE of about 8%, assuming a normal level of catastrophes.

“New normal”

The rating agency says that the “new normal” for reinsurers looks to be one where returns are less impressive and underwriting and fee income become larger contributors to profits. Better risk selection, greater diversification of product offerings, a wider geographic reach, and conservative loss picks are keys to survival. Those factors, combined with the ability to take advantage of the new “cheaper” capital coming into the market by investors that may not have the reinsurance and underwriting expertise, could lead to significant success for some reinsurers.

2018/09/12 News
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