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Forecast underwriting profit rise won't help reinsurers' ROE: S&P Global Ratings

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Forecast underwriting profit rise won't help reinsurers' ROE: S&P Global Ratings

S&P Global Ratings has predicted an improvement in the top reinsurers' underwriting profit, but said it will not result in a commensurate uplift in return on equity.

The rating agency's 2020 reinsurance sector outlook, published Sept. 3, predicted a combined ratio of between 95% and 98% for the top 20 global reinsurers in 2019 and 2020, an improvement on its previous forecast of between 96% and 99%. The forecast assumes that catastrophe losses will add between 8 and 10 percentage points to the ratio.

A combined ratio is a key measure of underwriting performance, with ratios below 100% indicating an underwriting profit. The higher profit expectation has been driven in part by the rate increases that reinsurers achieved in the April, June and July renewals in 2019 following the heavy catastrophe losses in 2017 and 2018.

The predicted outcome is "a comfortable combined ratio to be in" for company CFOs, Ali Karakuyu, a director at S&P Global Ratings, told journalists in London.

However, S&P Global Ratings kept its collective ROE forecast for the 20 reinsurers static at between 7% and 9%, giving a return on capital of between 6% and 8%.

David Masters, also a director at S&P Global Ratings, said the reason for the lack of movement in the ROE forecast was that interest rates were now expected to remain lower for longer, constraining reinsurers' investment returns.

"Compared to where we were last year, we have a slightly more pessimistic view around the investment return expectations for the sector," he said, adding that this and the improved underwriting performance "roughly offset each other."

Karakuyu noted that the forecast ROE meant that the reinsurance industry would be "just about" meeting its cost of capital of between 6.5% and 7.5%, having come up short in 2017 and 2018 as a result of the hefty catastrophe claims bills in those years. But in the context of corporations more generally, "it is still not a bad place to be ... because you are achieving your cost of capital, bearing in mind the economic conditions we are in," he said.

S&P Global Ratings has said previously that it would likely reduce its stable outlook on the reinsurance sector to negative if it believed that its return on capital would drop sustainably below its cost of capital. Masters noted that the industry was roughly 5.4 percentage points below its cost of capital in 2017 and 4.6 points below in 2018.

But he added that "the trajectory is improving significantly," with the return on capital being just short of the 6.6% cost of capital in the discrete second quarter of 2019.

He noted that although the industry experienced lower-than-usual catastrophe losses in the first half of 2019, "the picture hasn't been totally rosy" given the "pretty anemic" investment returns, in part thanks to events such as Brexit and the putative trade war between China and the U.S. Reinsurers have also had to strengthen reserves because of worse-than-expected losses from Typhoon Jebi and Hurricane Michael.

Masters said S&P Global Ratings expected reinsurers' return on capital to improve partly because "we hope the Jebi loss reserve development is largely behind us now" and because of the price rises seen in the mid-year renewals. The agency is expecting mid-single-digit price increases on average heading into 2020, following on from the rises already seen.