By: Best’s Briefing, December 2017
A.M. Best is maintaining its outlook for the reinsurance market segment at negative but expects overall market conditions to actually improve slightly over the near term, following the catastrophic events that occurred in the third quarter of 2017.
The main reason for maintaining the negative market outlook for the near term is the considerable uncertainty surrounding the level and sustainability of any improvement in the reinsurance market’s environment. Earnings going into the third quarter had already been depressed compared to historical trends because of ongoing market challenges that suppressed current accident year underwriting performance, which, together with lacklustre investment returns, has served to drag operating and overall performance for the sector to a level only marginally sufficient to cover the average cost of capital for many reinsurance-predominate companies.
The negative impact of catastrophe losses on underwriting earnings in 2017 has further eroded the segment’s historical earnings, although the market’s capacity to absorb these events has once again proven resilient, and balance sheets remain solid going into the critical January 1, 2018, renewal season.
At this point, A. M. Best estimates a combined ratio of approximately 110% and an Roe of -1% for the full year 2017 for the global reinsurance composite, and a meager Roe of approximately 8% based on a full year average through 2017. This does not factor in the potential for further adverse loss reserve development (on top of the losses reported thus far from the recent catastrophes), a scenario that seems probable given the difference between insured losses reported and the various modeling rms’ estimates of what the reported insured losses should be.
When considering recent years’ performance relative to the average cost of capital for the sector, we see a need for a sustained improvement in market conditions, and the events of 2017 should serve as a catalyst for that improvement.
A. M. Best 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 it historically has been the case. This is an important distinction as regards current market dynamics. Any nearterm improvement in the market may be relatively short-lived given the current level of excess capacity in the overall market today. This is compounded by the continued in ow of alternative capacity that was seen in the fourth quarter of 2017, which has helped offset the collateralized capacity that is currently trapped until losses from 2017 work their way through the settlement process.
Nevertheless, we see some potential positive factors that could favourably impact the reinsurance market over the near term, that may be sufficient cause to revise our market outlook from negative to stable.
• The 2017 events have proven to be a significant test for alternative capital, which up to this point had enjoyed significant protection attributable to relatively benign catastrophe losses in the U.S. over the previous 10 years. The 2017 US hurricane season had more than the usual number of storms: 17 named storms, 10 of them hurricanes, six of which were major; the average is 12 named storms, six of them hurricanes, two of which would be major. But 2017 was not a record breaker! The year 2005 blew away records, with 28 named storms, 15 of them hurricanes, three of which gave birth to the abbreviation “KRW”—Katrina, Rita, and Wilma.
The difference between now and then is alternative capital had a relatively insignificant participation then. Should the frequency and severity of these recent losses help set a floor on catastrophe pricing and alleviate the prolonged erosion in risk returns, it could help stabilize the overall market.
• Improvement in the global, and in particular, the U.S. economic picture, as well as future economic benefits stemming from U.S. federal tax reform, will provide opportunities for organic growth and improved utilization of excess capacity, which should also aid in improved risk pricing.
• Similarly, an increase in cessions from primary companies owing 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 Plan in the U.S., as well as opportunities in cyber, mortgage, and other emerging risks, should allow for greater utilization of available market capacity.
• An improving interest rate environment, with controlled in action, will provide more pricing flexibility and improve the overall returns for reinsurance companies, and allow them to earn back losses more quickly following significant loss events.
• Last, 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
Much of this remains uncertain at this point and the existing risks tothe market remain in play—as do one-off risks such as the potential fallout from Brexit and what that may mean to the global economy. It is our expectation that, at a minimum, underwriting and overall performance will improve slightly and stabilize over the near term, resulting in an average Roe of between 7% and 10% over the cycle.
For the most part, rated balance sheets are well capitalized and capable of enduring various stress situations. However, this strength may be eroded for some carriers as earnings come under increased pressure, favourable reserve development fades, and importantly, the ability to earn back losses following events is limited by the immediate in ow of capital and competition from traditional and nontraditional sources.
Our view from previous years about what constitutes stronger companies remains the same. Companies with robust balance sheets, diverse business portfolios, advanced distribution capabilities, and broad geographic scope are better positioned to withstand thepressures in this type of operating environment and will be better able to target pro table opportunities as they arise.