September 6, 2016

Reinsurance is on the edge of profitability

Reinsurance firms are on the edge of profitability, with combined ratios rising and an expectation that even an average year of catastrophe losses could tip some companies over the edge, as market pressures continue to bite.

Reinsurance is on the precipice - Image from FavImages

Bloomberg held a roundtable featuring some of the largest European insurers and reinsurers recently and it’s clear from the output that the reinsurance market accepts it is nearing the point where its profits could be eroded and that sustaining the softened rate environment will get increasingly difficult.

After a number of years of rate declines across the reinsurance sector, some lines of business, particularly catastrophe exposed, have now seen rates reduce further than the average catastrophe load, in fact to the degree that reserve releases are required in order to achieve a profitable return.

In Bloomberg’s article on the roundtable, Manfred Seitz from Warren Buffett owned reinsurance firm Berkshire Hathaway Inc. said that the P&C reinsurance sector is “getting very close to combined ratios of 100 percent.”

Even a normal catastrophe load in 2016 could result in some companies hitting the profitability threshold, Seitz said, suggesting that profits and returns are becoming ever more scarce in P&C reinsurance lines.

Fortuitously, rating agency Standard & Poor’s said in a report today (which we’ll cover in more detail soon) that it anticipates “Reinsurers’ profitability will soon drop below their cost of capital and could remain there until the underwriting and/or investment cycles turn,” which would have clear credit implications for the sector.

Matthias Weber, Chief Underwriting Officer at reinsurance giant Swiss Re, added that once reinsurers results are adjusted to take away the benefits of reserve releases and a normal level of catastrophe losses are factored in, profits “are not that fantastic anymore.”

Munich Re board member Ludger Arnoldussen commented that; “If you look at the combined ratios before reserve releases, then you can clearly see an impact every year from the softening in the market.”

A general worsening of profits is being seen, Arnoldussen implied, which has been reflected in the latest results season with reserve releases often making the difference between profit and loss in property and casualty reinsurance divisions.

But once again supply of capital is blamed for the issues being faced by large, global insurance and reinsurance firms and the market in general, with Bloomberg citing a “hedge fund incursion” as responsible for eroding pricing, “so much that a typical year of claims could move the industry into losses.”

Of course, while headline grabbing, hedge funds are really only smaller players in reinsurance these days, as the hedge fund backed reinsurers typically underwrite longer-tailed risks outside of property catastrophe, and insurance-linked investment funds are largely backed by pension funds, family offices and institutional capital.

But perhaps the article is equating an ILS fund with a hedge fund. However, even trying to blame the issues faced by reinsurers on ILS fund competition and their growing capacity is not really telling the full story.

The excess levels of capacity in traditional reinsurance markets and the aggressive nature of their pricing strategies in recent years has more than equaled (and in fact exacerbated) the pressure from ILS players. Reinsurers have contributed to the softening just as much as any hedge fund or ILS fund and, as has been repeatedly reported, the majority of ILS funds and investors show just as much discipline as your average reinsurer.

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Source: Artemis


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