After global insured natural catastrophe losses hit record highs in 2017, will reinsurers be able to withstand another year of active natural catastrophes?
S&P Global Ratings indicates that while reinsurers are entering this year’s hurricane season with robust earnings and capital buffers, a repeat of 2017’s losses could test earnings, capital adequacy levels and could result in negative rating actions for overexposed reinsurers.
In a report on the sector, S&P revealed that the top 20 global reinsurers absorbed about 20 percent of the total insured natural catastrophe losses in 2017, which Swiss Re’s sigma says reached $138 billion. S&P said this amounted to a one-in-25-year aggregate loss for the group.
“The loss magnitude, roughly 3x what reinsurers would expect in an average nat cat year, hurt the industry’s earnings and a few players’ capital adequacy, but failed to materially push up global reinsurance prices,” said the S&P report titled “Are Global Reinsurers Ready for Another Year of Active Natural Catastrophes?”
As a result, some reinsurers have decided to reduce their exposure to catastrophe risk, while others maintained or increased their exposure, the report said, noting that half of the top-20 reinsurers are more exposed to nat cat risk in 2018 than in 2017.
“Earnings at risk also rose to 0.89x profit before tax in 2018 versus 0.85x in 2017,” the report said. “Following a 1-in-10-year aggregate loss (global insured losses of roughly $100 billion), reinsurers are still likely to show profitable results on average.”
An aggregate loss of this magnitude could become a capital event for a third of global reinsurers, the report explained.
“We have seen a number of reinsurers taking defensive actions to reduce their exposure to extreme events,” S&P said, pointing to the fact that absolute net exposure to a 1-in-250-year aggregate loss has reduced by more than 10 percent for more than one-third of reinsurers.
“However, as reinsurers balance the need to improve their risk-return profile against the need to protect their balance sheet, it is not surprising that some reinsurers increased their risk exposure this year as a result of price increases…,” the report confirmed. S&P explained that after the January 2018 renewals for U.S. property catastrophe business, rates on loss-affected lines were up 10 percent to 25 percent, while non-loss-affected layers of loss-affected lines were flat to up 10 percent, and non-loss-affected lines were flat to up 5 percent.
How Resilient Is the Sector?
Analyzing data received from the top-20 reinsurers, S&P estimated “a nat cat budget of about $11 billion, or 8 percent of the combined ratio in 2018, which, if not exceeded, should enable the sector to post profits before tax of about $21 billion in 2018.”
S&P further estimated that an aggregated 1-in-10-year loss event, which would bring losses of around $21 billion, would exceed the annual nat cat budget, hit the sector’s earnings but not its capital on aggregate.
“In the case of a 1-in-50-year aggregate catastrophe loss event, the sector would take losses beyond $35 billion, which would exceed the annual catastrophe budget and the assumed earnings for 2018,” the report said.
“We found that eight of the top-20 global reinsurers are unlikely to maintain capital adequacy of at least ‘AA’ confidence level following a 1-in-250-year aggregate loss…”
The least resilient in the sector are Bermuda property catastrophe specialists and London reinsurers as a result of their higher exposure to catastrophe risk, the report affirmed.
Last year’s nat cat losses showed that global reinsurers can adjust their exposure relatively quickly after large events, the report indicated.
“We generally observed disciplined management of catastrophe risk appetites because of only modest price increases,” the report said, explaining that reinsurers weren’t tempted to excessively expand their cat exposures.
“Although the sector is entering the 2018 cat season with robust capital and earnings, a repeat of 2017 nat cat losses would likely wash away full-year earnings and cat budgets and further test reinsurers’ capital resilience.”
With a repeat of 2017 losses, S&P predicted that price hikes would be more likely, leading more playing to take on more risk, thereby leaving the sector more exposed.
Modeling and Exposure Disparities
The 2017 nat cat losses highlight disparities in reinsurers’ exposures, with return periods ranging from below 1-in-10 year to up to 1-in-60 year for the annual aggregate loss in the peer group of 18 reinsurers that S&P examined.
“[T]he wide range of estimated return periods comes as a surprise,” and is not only explained by exposure variations, emphasized S&P.
“As most reinsurers rely on third-party vendors or internally developed catastrophe models to form their own view of risk, we see significant uncertainty and disparities in modeling assumptions and adjustments in the industry,” the report added.
In S&P’s rating analysis, it assesses the extent a reinsurer has the capacity to adequately model these risks as part of its enterprise risk management (ERM) assessment. As a result of the experience from events in 2017, S&P said, it will “review the effectiveness of reinsurers’ risk modeling and processes as well as ERM scores and risk position assessments.”
S&P noted the estimate of return periods might be revised as loss reserves develop and claims are paid.
“The actual loss estimates might vary across reinsurers because the uncertainty is high on losses incurred but not yet reported (IBNR)” from Hurricanes Harvey, Irma and Maria (HIM), said S&P.
The ratings agency assessed that IBNR represents on average 50 percent of loss estimates. “As an example, the loss estimate from Hurricane Maria that hit Puerto Rico is believed to be relatively uncertain as we understand that the claims are being reported slowly and information is lacking on the island,” S&P went on to say.
Source: S&P Global Ratings
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