Regulator outlines potential dangers associated with its opportunities.
In June, AM Best upgraded its forecast for the global reinsurance sector from Stable to Positive, marking the segment’s first such shift. The shift is due to a growing emphasis on technological profitability in recent years.
According to AM Best, unlike previous cycles, a combination of climatic trends, a complicated risk environment, and persistent higher interest rates suggests that enhanced underwriting profits may last for a few years, assuming underwriting discipline is maintained.
The segment’s excellent technical earnings are largely the result of comprehensive risk-reduction initiatives, increased alignment between reinsurers and primary carriers, and superior pricing.According to AM Best, a shift away from high-frequency layers, tighter contract wording, and a more defined area of coverage have refocused reinsurers on capital protection rather than earnings stabilisation.
These changes followed several years of underwhelming underwriting performance, during which reinsurers struggled to meet their cost of capital, even amid historically low interest rates until about three years ago.
Hard pricing conditions are expected to endure longer than in past cycles due to several factors. Persistent high claims activity, as highlighted by AM Best, is driven by the accumulation of medium-sized losses and secondary perils, rather than by major catastrophic events.
The segment remains well-capitalized, and although companies have taken steps to manage their capital more efficiently, their solvency positions have not faced significant pressure. This contrasts with a temporary reduction in capital and surplus caused by unrealized investment losses on fixed-income instruments following the rise in interest rates in late 2022
According to AM Best, when global reinsurers have faced negative rating pressures, the primary cause has been technical underperformance rather than balance sheet strength.
The current harsh market cycle has not been characterised by capital depletion. AM Best notes that the market disruption during early 2023 renewals was caused by a rapid withdrawal of capacity.
Companies restrained the use of current capital while keeping enough buffers on their balance sheets. This atmosphere has favoured well-established, well-capitalized firms, who have been able to take advantage of the severe pricing environment while showing little interest in investing fresh start-ups.
Positive technical results for reinsurance
AM Best stated that its decision to assign a favourable outlook to the global reinsurance business is largely based on positive technical results seen in three consecutive years, with hopes for sustainability in the next years.
Following substantial losses in 2017, the segment’s combined ratio approached 110. Repricing, de-risking, and diversification methods required some time to stabilise, but by 2021, the segment was earning positive profit margins, albeit still dependent on favourable reserve development.
The much improved underwriting performance in 2022 was offset by unrealised investment losses due to rising interest rates, resulting in return on equity (ROE) values close to zero, according to AM Best.
For 2023, the average combined ratios for reinsurance subsegments in Europe, the US & Bermuda, and Lloyd’s were all below 90. The adoption of IFRS 17 by most non-US and Bermuda-domiciled groups in 2024 has introduced new challenges for performance benchmarking across the globe.
Despite the benefit of discounting claims reserves under IFRS 17, European reinsurers reported a combined ratio nearly two points higher than their US and Bermuda counterparts, at 87.0 compared to 85.1. AM Best reports that the Lloyd’s market, with a larger share of highly profitable primary specialty business, achieved even better results, with a combined ratio of 84.0.
Across the global reinsurance segment, results were still supported by favorable reserve releases, despite material reserve strengthening in US casualty business written between 2016 and 2019.
Bottom-line results have improved significantly, with several companies reporting ROEs exceeding 20%. Bermuda-domiciled carriers benefited from a one-off deferred tax asset following the implementation of the Bermuda Corporate Income Tax Act of 2023.
European players generally have lower ROEs than their US and Bermuda counterparts, but this could be due to changes in accounting standards, non-recurrent effects, or the more stable and diversified profile of the Big Four, whose results have historically been less volatile.
AM Best attributes the strong results to improved technical returns, combined with higher reinvestment rates.
AM Best believes that the corrective measures taken in recent years, along with current market and economic conditions, will support sustainable profit margins in the medium term. Higher return expectations from investors, combined with the lack of new market disruptors, should maintain ongoing hard market conditions.
Outlook for 2024 remains strong
Despite above-average catastrophe loss activity during the second quarter of 2024 and a few large losses, such as the collapse of the Baltimore Bridge in March, results remain strong and on track for another profitable year, according to AM Best.
Although the rate of hardness decreased during mid-year renewals, Guy Carpenter’s Global Property Cat Rate-On-Line Index has already surpassed the harsh levels observed in 2006, following hurricanes Katrina, Rita, and Wilma.
While the current Atlantic hurricane season is being studied, severe convective storms, the most common small to medium-sized threat, are less seasonal and increasing in frequency.
Outside of the natural disaster area, AM Best has expressed worries about the performance of legacy US casualty and some life insurance portfolios, particularly following reserve strengthening efforts. The industry is keenly monitoring how widespread these issues are and how successfully impacted carriers are resolving them.
AM Best believes that the global reinsurance segment is more resilient than in prior cycles due to strong underwriting margins, increased reinvestment rates, and diversity. While the adverse development of historical liability books may have an influence on performance indicators, it is unlikely to have a significant impact on risk-based capitalisation in a segment with high Best’s Capital Adequacy Ratio (BCAR) scores or earnings.
Concerns about societal inflation in US liability have resulted in more stringent underwriting, client selection, and pricing adjustments for new business.
The exceptional achievements achieved in 2023 are unlikely to be duplicated, and most companies’ objectives for 2024, while enthusiastic, are more modest. However, AM Best argues that performance in the first half of 2024 is comparable on an annualised basis, indicating a reasonable margin for unpredictability.
Please feel free to share your comments below.