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Reinsurance outlook stable, but climate change risks rising, Moody's says

Moody's said the outlook is stable for the reinsurance sector, with profitability improving, capitalization strong and prices set to rise in some sectors, though it warned that climate change risks are mounting.

The rating agency said Sept. 3 that demand for reinsurance was rising and that reinsurers' use of retrocession — spreading risk, increasingly by using alternative capital providers — has helped reduce reinsurers' catastrophe losses. Moody's did warn, though, that reinsurers too dependent on retrocession could see a weakening in their capital quality.

Overall reinsurance capitalization remained strong despite significant natural catastrophe losses in 2017/2018. Although regulatory capital for leading reinsurers declined slightly at the end of 2018 compared with two years earlier, it is still significantly above regulatory and risk-based capital requirements, Moody's noted.

The agency said prices for property catastrophe business have been rising since January 2018, and a majority of companies surveyed expect prices to remain flat or rise modestly, so boosting profitability. Primary insurers are driving price increases for property and casualty coverage while also reducing limits and buying more reinsurance.

However, despite the modest rise in U.S. and global property reinsurance prices since 2017, they remain about 20% below pre-2012 levels, and are proving more resilient to catastrophe events than in the past. For example, hurricanes Harvey, Irma and Maria in 2017 resulted in a far more moderate increase than did Katrina, Rita and Wilma in 2005, Moody's said, attributing this in part to an increase in the supply of alternative capital to cover natural catastrophe risk.

Efforts by Lloyd's of London to remove some underwriting capacity have also had an effect, said Brandan Holmes, vice president and senior credit officer at Moody's.

"There have been pricing improvements for two consecutive years now, [and] some of the changes made at Lloyds have filtered through to more buoyant prices," he said.

The limited nature of these rises means, however, that reinsurers are not sufficiently profitable to cushion against above-average catastrophe years, leaving earnings volatile and double-digit returns on equity elusive for many firms.

"On profitability, there are some headwinds, including persistent low interest rates which are a damper," Holmes said. Moody's noted that insurers and reinsurers have been increasing the proportion of higher-yielding and riskier assets in their investment portfolios, and the overall credit quality mix of a sample of reinsurers' fixed-income investments has declined modestly since 2012.

Moody's said reinsurers "have for the most part remained disciplined" but that the downturn in overall credit quality and the potential for market distress mean that their asset risk has increased and is likely to continue growing.

Reinsurers are also increasingly focused on the risks associated with climate change, Moody's said, citing recent remarks by Weston Hicks, CEO of TransRe parent Alleghany Corp., who said: "We believe that climate change is increasing the potential for severe catastrophe losses and the reinsurance industry needs to take a less sanguine view about future catastrophic risk."

The agency also noted that Swiss Re AG found that over 70% of the more than $55 billion in global insured wildfire losses between 1980 and 2018 have occurred in the past three years. However, Moody’s said it believed the risk associated with climate change will be manageable for the next five years at least, with reinsurers' current exposure to environmental risk classed as moderate given their ability to reprice property catastrophe cover.