Identifying a bottom to the current stage of the reinsurance cycle has become somewhat of an obsession for market participants. Theories abound as to reasons for the length and depth of the current pricing decline, but S&P Global Ratings generally believes it can be attributed to a continuation of trends we have observed in many renewal periods so far: an abundance of reinsurance capacity and many years of modest insured losses.
In addition, competitive pressures in the industry remain fierce, as cheaper alternative capital sources continue to enter the market and crowd out the traditional players, especially in lines exposed to natural catastrophes. Collectively, these forces have put predictable downward pressure on pricing, which is testing reinsurers' ability to source attractively priced risks and adapt to the environment. Nevertheless, reinsurers are navigating these issues with sophisticated enterprise risk management (ERM) programs, strong capital adequacy, and still-rational underwriting (so far). All this supports our stable outlook on the reinsurance sector and our ratings on the majority of companies in it.
Pricing Has Varied, But The Trend Remains Downward
According to reports from multiple industry sources, reinsurance pricing at this year's Jan. 1 and April 1 renewal periods appeared to be still on its downward trend--though falling at a slower pace than last year. For example, Guy Carpenter's Global Property Catastrophe Rate-on-Line Index showed a pricing decline of 3.7% as of Jan. 1 2017, compared with an 8.8% drop for the same period a year earlier. These declines were echoed in April, with prices dipping about 5%.
Table 1: Reinsurance Broker Pricing Movement Estimates at the Jan. 1 and April 1, 2017, Renewals
|Business line||Jan. 1, 2017||April 1, 2017|
|Global property catastrophe||(4%) to (6%)||Consistent with Jan. 1|
|U.S.||Flat to (5%)||Consistent with Jan. 1|
|Europe||(4%) to (15%)||N.A.|
|Asia||(5%) to (15%)||(10%) to (20%)|
|Assumed retrocession||(2.5%) to (5%)||Similar pricing floor to Jan. 1|
|Aviation and marine||(5%) to (15%)||(5%) to (20%)|
|Casualty lines||Flat to (5%)||N.A.|
|E.U. motor||Flat to (5%)||N.A.|
Sources: Guy Carpenter, Willis Re, and JLT Re. N.A.-Not available.
However, according to JLT Re's Risk-Adjusted Florida Property-Catastrophe Rate-on-Line Index, the pace of rate reductions appears to have reaccelerated as of this year's June 1 renewal, with rates down 5.1% versus 3.1% for the same period last year. This marks the sixth consecutive year of rate decreases in JLT Re's index. We attribute it to the intense competition between traditional and alternative capital providers, and a recent vendor-model update that has lowered the expected loss estimates on certain natural catastrophe risks. Overall, one of the leading Bermudian reinsurers described the Florida market in June as "an orderly renewal."
Table 2: Reinsurance Broker Pricing Movement Estimates at the Florida June 1, 2017, Renewal
|%||June 1, 2015||June 1, 2016||June 1, 2017|
|Risk-adjusted Florida property catastrophe rate-on-line index||(8.5)||(3.1)||(5.1)|
Source: JLT Re.
Casualty pricing at the January and April renewals was flat to down 5%, as rate decreases were generally in line with those of last year's renewal period. Retrocession pricing declines were less dramatic as of Jan. 1, as rates fell 2.5%-5% compared with 5%-20% a year ago; April renewals showed a similar trend. Although catastrophe activity increased in 2016, the effect on retrocession pricing was comparatively limited.
Cedents continue to pressure for higher-ceding commissions for pro-rata treaty placements, some of which were met. Furthermore, to diversify reinsurer panels and secure adequate coverage for risk exposures, cedents purchased more occurrence coverage with one reinstatement.
Access To Cheap Alternative Capital Is Crowding Out More-Established Players
The tide of alternative capital flowing into the reinsurance market continued its inexorable rise in 2016, growing to a record $81 billion from $72 billion in 2015. According to an Aon Benfield report, alternative capital grew by 12.5% in 2016, on par with the previous year but below the 10-year compound annual growth rate (CAGR) of 16.9%. Meanwhile, traditional capital grew at a more modest 3.4% 10-year CAGR to $514 billion in 2016.
Table 3: Global Reinsurance Capital
|Year-over-year growth (%)||N.A.||5.4||(17.3)||17.8||18.3||(4.3)||7.7||6.3||4.3||(3.5)||4.3|
|Year-over-year growth (%)||N.A.||29.4||(13.6)||15.8||9.1||16.7||57.1||13.6||28.0||12.5||12.5|
|Global reinsurance capital||385||410||340||400||470||455||505||540||575||565||595|
|Year-over-year growth (%)||N.A.||6.5||(17.1)||17.6||17.5||(3.2)||11.0||6.9||6.5||(1.7)||5.3|
Source: Aon Securities Inc. N.A.-Not available.
Due to the low interest environment, institutional investors have been attracted to insurance-linked securities (ILS) because they provide higher yield and portfolio diversification benefits than natural catastrophe risk, which is fundamentally uncorrelated with traditional asset classes. Because the path of least resistance for these institutional investors tends to be dedicated ILS funds, which can cheaply and efficiently source natural catastrophe risk, these new entrants can push down pricing in the more catastrophe-exposed lines and crowd out traditional reinsurers.
Insured Catastrophe Losses Have Returned To Normal Levels
Insured catastrophe losses in 2016 returned to normal for the industry, coming in at $54 billion (slightly above the 10-year average) for the first time since 2012. Catastrophe activity in 2016 was also the sixth highest in the past 25 years.
Table 4: 2016 Top 10 Global Catastrophes Economic and Insured Losses
|Rank||Date||Event||Location||Economic loss (bil. $)||Insured loss (bil. $)|
|1||April 14 & 16||Earthquake||Japan||38||5.5|
|3||Sept. 28 - Oct. 10||Hurricane Matthew||U.S., Caribbean||15||5|
|6||May and June||Flooding||Western/Central Europe||5.5||3.4|
|10||May and June||Wildfire||Canada||4.5||2.8|
|All other events||83||33|
Source: Aon Benfield.
As a result of amplified catastrophe losses, many key global reinsurers have factored catastrophe-related losses of 8 to 10 percentage points into their combined ratios (a ratio above 100% indicates that incurred losses and operating expenses exceed premiums received). By contrast, in 2014 and 2015, catastrophe losses added just 3.7 and 2.8 percentage points, respectively, to the combined ratio of the top-27 global property/casualty (P/C) reinsurers. Despite the industry having catastrophe losses slightly above the 10-year average, reinsurers maintained capital at record levels through year-end 2016.
Table 5: Top-27 Global Reinsurers' P/C Reinsurance Business
|(Mil. $)||2011||2012||2013||2014||2015||Five-year average||Five-year median|
|P/C reinsurance gross premiums written (GPW)||89,429||95,696||99,185||95,265||93,305||N.M.||N.M.|
|Change in GPW (%)||5.1||7||3.6||(4.0)||(2.1)||1.9||3.6|
|P/C reinsurance net premiums written (NPW)||80,354||86,560||92,036||88,557||86,297||N.M.||N.M.|
|Change in NPW (%)||5.3||7.7||6.3||(3.8)||(2.6)||2.6||5.3|
|P/C reinsurance net premiums earned (NPE)||77,405||84,775||88,591||86,255||84,581||N.M.||N.M.|
|Change in NPE (%)||3.6||9.5||4.5||(2.6)||(1.9)||2.6||3.6|
|Retrocession utilization (%)||10.1||9.5||7.2||7||7.5||8.3||7.5|
|Expense ratio (%)||28.7||28.6||28.8||29.9||31.2||29.4||28.8|
|Loss ratio (%)||82.4||61.3||58.7||57.6||56.4||63.3||58.7|
|Calendar combined ratio (%)||111.1||89.9||87.5||87.5||87.6||92.7||87.6|
|Prior year (favorable)/unfavorable reserve development||(4,380)||(5,818)||(6,291)||(4,337)||(5,596)||(5,284)||(5,596)|
|Impact on the combined ratio (%)||(5.7)||(6.9)||(7.1)||(5.0)||(6.6)||(6.3)||(6.6)|
|Accident-year combined ratio (%)||116.8||96.7||94.6||92.5||94.2||99||94.6|
|Natural catastrophe losses||22,983||8,199||5,814||3,231||2,382||8,522||5,814|
|Impact on the combined ratio (%)||29.7||9.7||6.6||3.7||2.8||10.5||6.6|
Top-27 global reinsurers: Munich Re, Swiss Re, Hannover Re, Korean Re, PartnerRe, SCOR, Everest Re, TransRe, GenRe, Maiden Re, AXIS Re, XL Re, CCR, Odyssey Re, Arch Re, Toa Re, RenRe, Deutsche Re, Endurance Re, Aspen Re, Sirius Re, Validus Re, Chubb Tempest Re, Allied World Re, W.R. Berkley Re, Hiscox, and Lancashire Re. N.M.-Not meaningful.
Reinsurers Have Been Adapting
In our discussions with management teams across the reinsurance industry, the conversation inevitably turns to the pricing environment and management's strategy for managing the cycle. The common initial response is to revert to underwriting discipline. However, beyond this, strategies vary, as each management team is taking a different approach that plays to its firm's individual strengths. These include:
- Pursuing mergers and acquisitions to capture the benefits of increased scale and diversification;
- Expanding primary insurance operations;
- Offering tailor-made solutions and moving up the value chain to more-complex risks and away from the more-commoditized, catastrophe-exposed lines that are coming under intense pricing pressure;
- Staying the course, using the soft market to add protection cheaply, writing less business in line with the reduced opportunities, and returning the excess capital to shareholders.
Although there is bound to be some undisciplined behavior at this stage of the cycle, we have found that in general, reinsurers' ERM programs have allowed them to manage the cycle more effectively by making strategic decisions on a more-disciplined, risk/reward basis than in cycles past.
Areas For Growth Remain, Though Sparse
Despite the soft market's shadow over the reinsurance industry, there are still opportunities for disciplined growth. For example, the mortgage reinsurance sector remains attractive as the U.S. housing market continues to strengthen. Since the 2008 financial crisis, U.S. mortgages' credit risk profile has tightened and underwriting standards have improved significantly. Private mortgage insurers are looking to shore up their capital, and government-sponsored entities are looking to cede more risk. As a result, many reinsurers are considering taking on or increasing their exposure to mortgage risk in the hope of benefiting from still-robust returns--and diversifying risk in the process.
In addition, demand for newer lines such as cyber and terrorism risk continues to grow in the wake of recent high-profile attacks, as cedents seek to manage exposures to these risks proactively. For instance, May's "WannaCry" ransomware attack got the attention of many company boards and management teams, driving potentially increased demand for insurance coverage. However, from a re/insurance perspective, it has been a relatively benign event as these risks are still largely unpenetrated markets for re/insurers. Currently, the global cyber insurance market is estimated to be $3 billion to $4 billion in gross premiums written, which is dominated by North America, and likely to grow to about $14 billion by 2022.
Earlier this year, the U.S. National Flood Insurance Program (NFIP) tapped the reinsurance market to cede about $1 billion of its flood risk. As the NFIP reauthorization is approaching, we expect reinsurance to play an increased role, as it has described the 2017 reinsurance transaction as "setting the foundation for a multiyear reinsurance program."
Emerging markets with relatively low insurance penetration also present an opportunity as these economies grow and the domestic insurance market matures. Specifically, China and India are large markets that maintain a significant disparity between natural catastrophe risk and coverage. Like any emerging market, these tend to have great volatility in pricing and terms and conditions, which could be sources of great risk and opportunity for the enterprising reinsurer.
In The End, It's All About Pricing
Although a number of challenges still face the industry, we believe that reinsurers' strong balance sheets and ERM practices will keep their creditworthiness stable in the next 12 months. Thus far, reinsurers have done a good job adjusting their business tactics to adapt to persistently soft market conditions by building large capital bases while maintaining disciplined underwriting anchored around their ERM strength.
We have been monitoring reinsurance pricing and its effect on underwriting results. As part of our discussions with reinsurers' management teams, we will continue to question underwriting discipline, pricing adequacy, and risk-adjusted returns relative to their cost of capital. If reinsurers start underpricing risk to grow aggressively, especially in softer lines of business, we will likely take negative rating actions.
Only a rating committee may determine a rating action and this report does not constitute a rating action.