Strong Reinsurer Results Hide Difficult Business Conditions: S&P, Fitch Reports

By | March 24, 2016

Weak business conditions in the reinsurance industry are being masked by a low level of catastrophes and a high level of reserve releases, said Standard & Poor’s Ratings Services and Fitch Ratings in new reports.

“Stripping out these two factors, we see that the adjusted results support our view that business conditions for the sector remain weak,” according to S&P’s report on the reinsurance industry titled “Smoke and Mirrors: Reinsurers’ Strong 2015 Results Mask Weak Business Conditions in the Global Market.”

This message was echoed in a report issued by Fitch Ratings, which said the average reported property & casualty reinsurance combined ratios in 2015 for four major European reinsurers was 90.3 percent – an indication of strong underwriting performance and technical profitability.

However, Fitch emphasized, an analysis of the average “normalized” combined ratios was 98.5 percent, or just below break even.

Fitch’s report, titled “European Reinsurance Market Finely Balanced,” analyzed the results for Hannover Re, Munich Re, SCOR and Swiss Re.

“For each reinsurer, either major loss costs or prior-year reserve development, or both, benefited (i.e., reduced) the reported combined ratio,” Fitch said, noting that the strength of reported results contrasts with the challenging operating environment where “reinsurance prices are now falling for a fourth year.”

S&P agreed by saying that reinsurers’ strong earnings in 2015 benefited from “considerable good fortune” from the lowest levels of natural catastrophes since 2009. Quoting Aon Benfield statistics, S&P said global natural catastrophes caused economic losses that were 30 percent below the 15-year average of $175 billion. “Global natural catastrophe losses stood at just $123 billion, and this followed losses of only $132 billion in 2014.”

Along with low cat claims, Fitch said underwriting results also benefited from favorable development of prior-year loss reserves, a fortunate combination that “has occurred to a varying degree every year since 2012.”

The average normalized combined ratio for the four largest European reinsurers highlights a wider deterioration in market conditions, “driven by lower reinsurance prices feeding through to results,” Fitch said, warning that reinsurers’ future underwriting profitability could be affected by “even a modest rise in major loss claims.”

Price Competition Continues

Both ratings agencies indicated that low claims and reserve releases are masking the effects of ongoing price competition, which hasn’t yet hit the floor, although the downward trajectory is slowing.

Ongoing rate deterioration affects both top-line and the all-important bottom-line results, said S&P, noting that other factors reinforce weak credit conditions for global reinsurers in 2016, such as low investment returns, the ongoing influx of alternative capital and some evidence of the loosening of terms and conditions (T&Cs).

“Top lines are suffering not only from lower prices, but also from a fall in the level of reinsurance purchased by cedents in recent years and difficulty finding areas where profitable organic growth is possible,” said S&P. “The problem is compounded by low interest rates globally; reinsurers can’t rely on investment income to boost bottom-line profitability.”

January Renewals

S&P conducted a survey of the largest global reinsurers during the first quarter, which indicated that “reinsurance pricing across lines and regions has continued its downward trend into 2016, although the decline was less severe than [S&P] expected.”

Fitch affirmed the January 2016 reinsurance renewal for the four top European reinsurers showed “a price floor has yet to be reached,” although the downward pace has slowed. “Portfolio rate reductions for the major European reinsurers were kept to low single digits.”

“The renewal experience at Jan. 1 highlighted the challenges reinsurers are facing: excess capacity is chasing limited business and oversubscribed programs are contributing to further declines in pricing,” said S&P in its report.

S&P noted that pricing pressure varies among lines of business and regions. “Property lines are experiencing the greatest strain. So far, reinsurers claim to have accepted only those changes that can be modeled and appropriately priced,” the ratings agency said.

“We expect reinsurance prices to fall further through 2016, should the run of below-average major loss activity continue,” according to Fitch. “It is unclear whether the market will remain orderly or enter a period of aggressive price competition, as smaller players look to defend their market position. Further M&A is viewed as likely should the soft market continue.”

Terms & Conditions

Cedents are successfully obtaining broader definitions of events to increase the number of hours covered, said S&P, explaining that such “hours clauses” limit the losses a cedent can claim to those that occur during a specific period.

Ironically, the strong results reported by global reinsurers encourage cedents to push hard for more favorable T&Cs, S&P noted. “That said, the industry claims to have been largely successful in resisting the pressure to loosen T&Cs without charging appropriate premiums to reflect the additional risk.”

“Cedents are also attempting to broaden the scope of coverage in property-catastrophe programs to include lines that have not been covered historically, such as aviation, marine, terror, workers’ compensation and energy,” said S&P in its report. “In some cases they are also seeking to expand coverage to include cyber risk.”

For casualty lines, the S&P report said that reinsurers have “indicated that T&Cs have not slipped, but there is a general trend toward combining programs.”

Cedents’ Perspective

Cedents are tending to consolidate and combine programs to create economies of scale, said S&P. “This can work to the benefit of large reinsurers that offer a diversified product set and have a wide geographic presence, but that happen to be servicing a smaller portion of the business.”

Conversely, reinsurers can suffer if they do not have a “compelling value proposition or strong relationships with clients…,” S&P affirmed, adding that these reinsurers are more likely to accept lower rates and looser T&C.

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