Overall reinsurance sector outlook negative for 2016; major Tier 1 and small mono-line companies diverge: Fitch Ratings

The sector outlook for the reinsurance industry is negative for 2016, but major Tier 1 reinsurers with strong franchises and market positions are well-placed to adapt to – and profit from – the changing reinsurance landscape and mounting competitive pressures, suggests a new report from Fitch Ratings.

While major Tier 1 reinsurers stand to benefit most from current reinsurance conditions, small mono-line companies are not expected to fare as well, notes a statement from Fitch Ratings, which Thursday released 2016 Outlook: Global Reinsurance. “Small mono-line property catastrophe reinsurers, without other distinguishing attributes, remain most vulnerable to negative rating actions, through any protracted period of market price softening,” the company points out.

Overall, Fitch Ratings’ outlook for reinsurance industry is negative, “with premium prices expected to fall further in 2016 while investment yields will remain close to historical lows,” the statement notes.

“The current macro operating environment is likely to extend beyond a normal soft market cycle, with the continued growth of alternative capital, changes in the purchase and distribution of reinsurance and increased regulatory costs creating significant challenges,” the rating agency suggests. Soft market conditions will prevail, it predicts, especially where alternative capital and traditional reinsurers compete directly.

Recommending that underwriting retain a degree of discipline, “it remains unclear whether property premiums will stabilize, or if this is a lull before a more disorderly period of competitive rate cuts ensues,” Fitch Ratings points out. “Casualty rates are also expected to fall further in 2016 as reinsurers look to non-catastrophe lines for profit,” the company adds.

In a report earlier this week, Standard & Poor’s noted discipline is necessary as reinsurers adjust their exposure to catastrophe risk. Citing a divergence in reinsurers’ strategic reaction to softening markets, “two years of low claims have contributed to the current record high levels of capital in the industry and, thus, to the recent downward trend in catastrophe risk pricing,” notes an S&P statement.

“In our view, an increased focus on catastrophe risk weakens a reinsurer’s risk position by increasing volatility in earnings and on the balance sheet,” the company argues. “We consider underwriting profitability in the sector likely to become more vulnerable to natural catastrophes; therefore, we anticipate that operating performance could deteriorate at reinsurers that are more exposed.”

With regard to Fitch Ratings, despite a negative outlook for the reinsurance industry, the company maintains a stable rating outlook for the reinsurance sector. “This assumes a base case scenario that over the next 12-18 months, a majority of reinsurers will be able to maintain overall adequate profitability and strong capitalization despite softening prices, and that any decline in earnings will be within the ranges that current ratings can tolerate.”

Again, however, the outlook is not as good for a select group of smaller mono-line companies, which Fitch Ratings reports could suffer downgrades or be moved to negative outlooks.

Fitch Ratings also offers a caution with respect to mergers and acquisitions activity in the reinsurance industry – expected to continue in 2016 – that “a protracted soft market increases the risk of ill-conceived mergers that offer little prospect of generating long-term value.”

Despite current market conditions placing earnings under pressure, the rating agency notes, valuations for many companies are high, fuelled by the prospect of M&A.