Ratings outlook for global reinsurance sector remains negative: A.M. Best

Significant ongoing market challenges that will hinder the potential for positive rating actions over time, and may translate into negative rating pressures, have contributed to A.M. Best maintaining its negative outlook for the global reinsurance sector.

Having revised its rating outlook for the reinsurance industry from stable to negative last August, A.M. Best explains in a statement Monday that “as compression continues bearing down on investment yields and underwriting margins, this strain on profitability will ultimately place a drag on reinsurers’ financial strength.”

In its latest A.M. Best Briefing, the company notes it is taking a view longer than its typical 12 to 18 months. “While A.M. Best does not anticipate a significant number of negative outlooks or downgrades over the very near term, the market headwinds at this point present significant longer-term challenges for the global reinsurance industry,” the report notes.

“Declining rates, broader terms and conditions, an unsustainable flow of net favourable loss reserve development, low investment yields and continued pressure from convergence capital are all negative factors that will adversely impact risk-adjusted returns over the longer term,” the briefing adds.

Reinsurers are responding to these challenges by employing greater capital market capacity, A.M. Best points out, adding that “cycle management has been a key strategy for those organizations capable of oscillating between primary and reinsurance platforms.”

In addition, there “has been meaningful effort to embrace new opportunities and geographies and produce fee income, as well as a subtle migration into asset classes that will produce some increased investment yield.”

The rating agency takes the view that companies with diverse business portfolios, advanced distribution capabilities and broad geographic scope are better positioned to withstand the pressures in the current operating environment and have greater ability to target profitable opportunities as they arise.

That said, further market consolidation is a “likely response to the current market environment as balance sheet scale becomes an even more important attribute to retain and win new clients,” the report adds.

There is increased concern that “underwriting discipline, which until recently had been a hallmark of the reinsurance sector, is beginning to diminish as companies look to protect market share at the expense of profitability.”

Challenges also exist for the property/casualty industry’s commercial lines segment in the United States. Ongoing concerns from potential adverse loss-reserve development, low investment yields and a moderation in commercial lines pricing has contributed to the rating agency maintaining its negative outlook for the segment.

The negative outlook, initiated in 2011, “signals A.M. Best’s continued concerns for those commercial lines insurers that have yet to recognize loss reserve deficiencies on their balance sheets, and the fact that current pricing levels, as well as reserves, may not be supportive of future loss-cost trends.”

While operating results for the commercial lines sector in 2015 are expected to be profitable, “profit margins continue to be pressured by low investment yields and another year of new money needing to be reinvested at a time when interest
rates remain at historical lows and yield curves relatively tight.”

A.M. Best’s rating outlook for the U.S. personal lines segment, however, remains stable. “The segment’s results continue to reflect the consistency of the auto line, with generally favourable, low-volatility performance posted on a year-over-year basis.”

But it is anticipated a number of dynamic trends will likely influence the segment in future years, including sophistication in pricing, greater refinement of multi-variate pricing models and greater focus on deepening customer relationships.

The market trends of pricing sophistication, scale/efficiency and risk management are unlikely to materially impact ratings in the segment over the near term, A.M. Best reports. Longer-term, however, “ramifications could be more significant, particularly for those carriers that do not effectively adapt to this dynamic market.”