Hurricane Irma puts reinsurers in firing line, says S&P

As the annual renewal kicks off in Monte Carlo next week, reinsurers face potential losses from another powerful hurricane, in what is an already weak market. Hurricane Irma, a powerful category 5 storm, could have greater impact on the reinsurance sector than Hurricane Harvey, which deluged Texas and Louisiana last week, according to S&P Global Ratings (S&P). If Irma makes landfall in Florida, as expected this weekend, it could be a major event for the reinsurance sector, according to Taoufik Gharib, an analyst at S&P. Florida is the world’s largest property catastrophe insurance and reinsurance market and is a peak catastrophe zone, he told a pre-Monte Carlo Rendez-Vous de Septembre webinar on Wednesday. “If there is a major event, reinsurance companies would cover the losses and it could impact earnings. It is early to speculate on the impact [of Irma] but if it is a one in 50-year event it would hit earnings, but above that it could be a capital event,” said Mr Gharib. In contrast, Hurricane Harvey is likely to impact primary insurers rather than the reinsurance market, according to S&P. The bulk of insured losses from Harvey is expected to fall on US state-backed flood insurer the National Flood Insurance Program (NFIP). Property/casualty reinsurers are expected to see losses of $1.5bn to $2bn from Harvey, while the NFIP faces claims of up to $9bn, S&P said. Reinsurers may also see additional losses from the Texas Windstorm Insurance Association, which has $2bn of reinsurance protection from Bermudian and European reinsurers, including Lloyd’s. According to Mr Gharib, Harvey is therefore unlikely to affect global reinsurance capital, which reached a record $605bn at the end of the first quarter of 2017. As such, S&P does not expect Harvey to change reinsurance pricing at a global level. However, the hurricane could lead to a hardening of rates in loss-affected lines of business, according to Johannes Bender, analyst at S&P. Energy, commercial property and business interruption have all been affected and could see price increases, although this could be limited to the US, he said. “Business interruption is very difficult to project but we can assume there is a significant loss potential,” said Mr Bender. Despite the storms and soft market, S&P has opted to maintain a stable ratings outlook on the reinsurance sector, driven by the industry’s capital strength and strong enterprise risk management (ERM). Some 80% of S&P’s ERM assessments of the top 40 reinsurers carry a score higher than adequate. However, S&P notes that the market is characterised by weak business conditions, even before this year’s hurricane season. There are no positive ratings drivers for the global reinsurance sector, according to S&P. Pricing pressure is ongoing, with decreases of up to 5% expected into 2018, and alternative capital continues to flow into the reinsurance market. “The length and depth of the current soft pricing cycle have surprised many market participants; these declines are primarily attributable to an abundance of reinsurance capacity and multiple successive years of modest insured losses,” S&P states in its annual reinsurance report published this week. “Furthermore, 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,” it adds. Interest rates remain low and reserve adequacy has been deteriorating as prices have fallen. While benign catastrophe losses have kept combined ratios at around 93% during the past seven years, the ratio is expected to reach 96% to 100% this year, notes S&P. Terms and conditions have been resilient, but demand for reinsurance is flat. There have only been pockets of increased demand in cyber, flood, mortgage and life reinsurance, S&P reveals. Even with cyber, the market remains relatively small – about $3bn to $4bn – compared with other lines, according to Mr Bender. While there is growth potential, reinsurers have been cautious when it comes to cyber because of a lack of loss data and the constraints of ERM. After years of a soft market, easy “tactical manoeuvres” are running out for reinsurers, according to S&P. The number of mergers and acquisitions has slowed in 2016 and 2017, while activity has failed to have a material impact on industry capital. “We expect deals to continue creating fewer but larger reinsurers in the sector. Small-to-midsize companies trading at reasonable valuations with quality underwriting and books of business will likely be the targets of choice,” states S&P in its report. “We do not see M&A as a catalyst for changing the industry backdrop, and we expect M&A to be partly inhibited over the next 12 months, primarily because of the market placing high valuations on companies,” it adds. Many reinsurers are allocating more capital to insurance and tailored solutions, as well as moving away from catastrophe business. Cost of capital overtaking return on capital could be one trigger for reinsurance rating downgrades and a negative industry outlook. The margin between these two indicators has been narrowing. Return on capital has fallen from 8.6% at the end of 2016 to 8.4% at half year 2017, while the cost of capital has increased to 7.2% from 6.5% during the same time period. “The sector's margins will likely continue to erode, subject to natural catastrophe experience and reserve release levels. However, reinsurance still offers returns that exceed those of most competing asset classes, limiting the likelihood of a mass investor exodus from the sector in the short to medium term,” S&P notes in its report.

Hurricane Irma puts reinsurers in firing line, says S&P

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