Martyr Street
Weaker reinsurance firms face credit downgrades, warns Fitch Ratings
By James Brewer
Some of the world’s smaller reinsurers hit by a persistent pricing downturn are living with the prospect of credit rating downgrades or of being assigned a negative rating outlook.
Falling premiums and weaker investment returns will impact the profits of reinsurers next year, Fitch Ratings forecast as it launched its report 2017 Outlook: Global Reinsurance.
Since January 2014, Fitch has judged the sector’s fundamental outlook as negative, although it has allowed that the rating outlook is stable based on the majority of reinsurers maintaining credit metrics underlying their current ratings over the next 12 to 18 months.
Now the broad category of ‘stable’ could change to ‘negative’ after profits of several companies have diminished “notably” since 2012. Fitch monitors reinsurers which write a total of around $100bn annually in non-life net premiums.
The agency released its report just ahead of the major industry event for executives, the 60th Monte Carlo Rendez-Vous (September 10-15 2016).
Earnings have begun to deteriorate across the piece, and the smaller companies with limited diversification are at the greatest risk of negative rating actions – they rely on business lines where profit margins have fallen, while the major reinsurers are able to diversify. For instance, the four largest reinsurers – Swiss Re, Munich Re, Hannover Re and Scor – have life, primary insurance and other areas in their portfolios alongside generating 75% to 80% of their income from property and casualty underwriting.
Thinning underwriting margins will leave the industry as a whole more exposed to a rise in major loss claims, said Fitch. The agency’s senior director for insurance, Martyn Street, sees profit deterioration as the key risk for reinsurers in 2017 as a result of the combination of excess capacity and the low investment yield environment. He said it looks as though interest rates could remain at challenging levels for the next 12 to 24 months. As the investment portfolios of reinsurers often have an average duration of less than three years, the need to reinvest regularly at lower yields could weaken returns significantly.
At the same time, competition meant prices would continue to fall.
The slowing rate of price reductions in some lines would have limited significance in improving near-term profitability, said Fitch.
“While the rate of decline in some bellwether sectors such as Florida wind reinsurance has slowed to low single-digits, we believe this just reflects that cost of capital returns have fallen to virtually breakeven.”
Mr Street commented at a London briefing: “Yes, price reductions [in June and July 2016 renewals] have slowed, but they are slowing on lines that have been showing the greatest price reductions in previous years. On the casualty side, price reductions continue to be seen.
“Reinsurers are therefore likely to divert more of their underwriting capacity to those sectors where margins are currently more attractive, such as casualty. But this will lead to pricing pressure in these sectors, pulling down margins and contributing to lower profits for a significant number of reinsurers in 2017.” Smaller companies could find it challenging to defend their market share. Conditions were ripe for further mergers and acquisitions consolidation.
All are meanwhile alert to the unquantifiable implications of Brexit. Lloyd’s chairman John Nelson referred in a speech the previous day to the transient nature of the business that flows into the Lime Street market. Mr Nelson said that unless there were clear indications about the future of passporting rights for UK entities to transact in the European Union, business would leave London “more quickly than the renegotiation timetable.”
At the Fitch briefing, Mr Street said that for the last three years major catastrophe losses have been below average, although the first half of 2016 saw severe events including Japan earthquakes (insured loss estimated at $5.6bn), three bouts of US storms (totalling $7.3bn), storms and floods in Europe ($2.8bn), and wildfires in Canada ($2.5bn). The total insured loss of $28bn was double that in the corresponding period of 2015. “The magnitude is not sufficient to improve the overall direction of pricing in the market,” said Mr Street.
Swiss Re, Munich Re, Hannover Re and Scor are viewed as financially strong and are sitting in the double A credit range, said Mr Street. The last two years had seen their results benefiting from very low levels of major losses.
The increase in major losses led reinsurers generally to release prior-year reserves to supplement income. “We believe the ability to generate a reserve surplus from earlier underwriting years will become ever more important and increasingly difficult. Surpluses will provide the flexibility to supplement future results, while a need to top up reserves would be very difficult in a competitive and highly price-sensitive market,” said Fitch.
