S&P maintains negative reinsurance outlook amid “endless barrage” of headwinds

S&P Global Ratings has maintained a negative outlook on the global reinsurance sector despite expectations that improvements in underwriting profitability will continue in P&C reinsurance into 2023.

Reinsurers will continue to struggle to sustainably earn in excess of their cost of capital over the next year, S&P said, owing to potential heightened natural catastrophe losses, capital market volatility, the increasing cost of capital and high inflation.

The rating agency said high inflation was “no longer a transitory phenomenon”, having prompted a rapid change in central banks’ course of action.

S&P warned of the threat of stagflation, leading to slowing economic growth and lower demand for insurance.

The rating agency flagged natural catastrophe risk as another significant headwind, amid heightened frequency and severity of weather-related events as a result of climate change.

On average, the capital of the top 21 reinsurers is more exposed to natural catastrophe risk, with S&P noting that net exposure as measured by a 1-in-250-year return period had grown 4 percent year on year.

In addition, average capital at risk increased by 1 percentage point year on year to 28 percent in January 2022.

S&P said that reinsurers are increasing their nat cat budgets to allow for this exposure growth, with the top 21 reinsurance groups increasing their budgets to $15.5bn.

The outlook noted figures from Swiss Re on the protection gap, with the reinsurer estimating the (re)insurance industry covered around 40 percent of the $270bn total global economic losses due to nat cats in 2021.

In addition, secondary perils – such as severe convective storms, floods and wildfires – accounted for 73 percent of all nat cat losses in 2021.

S&P added that losses have been exacerbated by factors including urbanisation, higher asset values, underestimated exposures, supply chain disruption, increased material costs and labour shortages due to Covid-19, inflation and climate change.

The rating agency noted a divergence of strategies over nat cat risk, with some reinsurers growing their nat cat net exposure while others adopt a more cautious and defensive stance.

This divergence in strategies reflects assessment of risk appetites, uneven pricing adequacy despite years of improved pricing and loss fatigue, S&P said.

Turnaround?

Elevated nat cat losses in recent years have also ignited reinsurance pricing increases – a trend S&P expects to continue into the 2023 renewals.

Pricing momentum is supported by a combination of inflation, climate change, macroeconomic uncertainties and rising unmodelled risks.

The global reinsurance sector entered 2022 with robust capitalisation – however, S&P expects the capital adequacy buffer to erode in 2022 owing to market volatility and mark-to-market losses.

The sector outlook added that this will be offset by prospective strong underwriting earnings and increasing investment income, noting that the majority of the top global reinsurers have well-diversified investment portfolios that are generally conservatively managed.

S&P noted that reinsurance renewals have become an increasingly dynamic process in recent years, with property cat reinsurance rates increasing since 2018 owing to higher cat losses exacerbated by inflation and supply chain issues.

Elsewhere, casualty reinsurance lines have also seen compounded multi-year rate increases owing to adverse loss trends in certain lines and rising loss-cost trends from social inflation.

Although these tailwinds of pricing improvements, robust capitalisation and higher investment income partially offset the headwinds in the global reinsurance sector, S&P does not expect that they will be sufficient to fully offset the conditions and prompt a turnaround in the sector.

Looking forward

S&P expects alternative capital to remain an important pillar in the reinsurance space going forward.

Alternative reinsurance capital sources held their ground amid rising interest rates and capital markets volatility, reaching the previous all-time high of $97bn from 2018.

This growth, particularly in catastrophe bonds, demonstrates that reinsurers are more sophisticated in terms of their capital management and can better address shocks.

However, ILS investors are wary of elevated losses and trapped collateral, with a separate report by S&P forecasting that growth in cyber ILS will be slow in the short to medium term as investors remain hesitant over the potential for significant accumulation risk.

Overall, S&P described reinsurance sector performance over the past five years as poor, but recognised that the last 18 months have seen improved underwriting results.

The sector outlook concluded that disciplined underwriting and adequate risk pricing, as well as tighter terms with clear exclusions and overall sophisticated risk management, will be key for reinsurers to defend their competitive position and preserve earnings and capital strength.

The rating agency originally placed the sector on a negative outlook in early 2020 – prior to the pandemic outbreak – as reinsurers found it difficult to meet cost of capital.

As of 31 August 2022, S&P noted that 19 percent of ratings on the top 21 global reinsurers were on CreditWatch with negative implications or a negative outlook.