Fitch expects flat reinsurance renewals but revises sector outlook to stable

Fitch expects most reinsurance renewals to be flat for the remainder of this year and into next as rate increases lose momentum. However, despite this prediction and 2017’s heavy losses, the ratings agency has revised its outlook for the sector to stable from negative, citing more modest but less volatile returns for the market. In a press briefing ahead of the Monte Carlo Rendez-Vous next week, Fitch said growth of alternative capital has altered reinsurance market dynamics, making capacity shortages less likely and the underwriting cycle flatter. Fitch expects alternative capacity will continue to grow, helping keep pressure on reinsurance pricing at upcoming renewals. “We actually think pricing competition could start to intensify, particularly if we continue to see the benign start to the year continue in terms of losses. We are now in peak hurricane season and so far we haven’t seen anything much yet. If that continued for the rest of the year, we could start to see a return to some quite intense price competition,” said Graham Coutts, director at Fitch. In a separate briefing, S&P said reinsurance rates are likely to come under further pressure at upcoming renewals as alternative capital continues to expand. According to Aon Benfield, overall reinsurance capacity was up 1% at H1 2018 over year-end 2017 to $515bn, with alternative capital up 7% to $95bn. The losses sustained in 2017 have been followed by historically low numbers during the first half of 2018 of about $20bn. This is well below the $35bn average of the past ten years. Although reinsurance rates went up in 2018 following last year’s heavy losses, the increases were “modest” and remain 30% below 2013’s peak, said Fitch's MrCoutts. The increases were less dramatic than those seen in 2006 and 2013 following previous heavy loss years. Mr Coutts explained that rates trended up modestly across most reinsurance lines at last January’s renewals, but momentum was lost throughout the year for most cover outside of loss-affected nat cat business. A key reason for this and expected flat renewals going forward is that alternative capital quickly reloaded. “Pretty much across the board in January you had rate rises, they were modest but trending up. But by the June/July renewals you started to see prices falling again. Improvement on loss-affected lines has held up pretty well but if you look across the other classes, rate improvements have not been maintained,” said Mr Coutts. Adding: “The ILS sector saw quite significant losses in 2017, but they were relatively quick to reload their capital and return to the market with increased capacity. In January, they hadn’t had time to reload but as the year progressed, more of the capital was able to return to the market.” Mr Coutts and Fitch believe alternative capital and the insurance-linked securities (ILS) market “is here to stay and is likely to grow”. The reinsurance business offers diversification benefits, so rising interest rates are therefore unlikely to lead to an exodus of alternative capital, said Fitch. Mr Coutts noted that ILS investors are quite sophisticated and therefore not scared by the recent losses we have seen. It would likely take several years of losses to have an impact on the ILS market, he argued. Mr Coutts also said cat bonds and ILS capital remain heavily focused on US nat cat risk but are expanding to other geographies and perils, such as motor. Despite the ratings environment, increased interest from alternative capital and last year’s losses, Fitch has – after five years – revised its reinsurance sector outlook to stable from negative. This is based on its belief that there has been a secular market shift in recent years, and that a “new normal” now exists, with more modest returns but lower volatility. Fitch said this new normal has seen reinsurers’ expected return on equity (ROE) fall from between 10% and 15% to more like 5% to 10%. This ROE is modest but manageable, said Mr Coutts. “Given that there were significant cat losses, it might seem like a strange time to make this decision on the sector outlook, but there a number of factors behind it. The main focus is we think there has been a secular shift in the reinsurance market. There is now a new normal in the sector and this normal can be characterised by more modest returns than we have seen in the past, but with lower volatility. That is partly due to the amount of alternative capital in the market, where alternative capital has increased the pressure on pricing and fundamentally reduced the returns available to the traditional insurance market,” said Mr Coutts. But he said there are also benefits to the alternative capital for the reinsurance sector. “It improves the ability of traditional reinsurance capacity to manage its own balance sheets by passing off some of its risk. We saw in 2017 some quite significant losses, but the balance sheets of the reinsurers were relatively healthy despite these losses, and that was partly down to being able to manage some of that risk by passing it over to alternative capital,” explained Mr Coutts. The overall ratings outlook for reinsurers monitored by Fitch remains stable, anchored by strong capital, solid risk management and robust business profiles. “Most rated reinsurers were therefore well positioned to absorb above-average 2017 catastrophe losses, although a small minority suffered notable hits to capital, leading to a limited number of negative outlooks,” the ratings agency said.

Fitch expects flat reinsurance renewals but revises sector outlook to stable

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