CORRECTION: An earlier version of this story incorrectly stated that A.M. Best had changed its outlook for the global reinsurance sector from ‘Stable’ to ‘Negative.’ In fact, the outlook changed to ‘Stable’ from ‘Negative.’ Canadian Underwriter apologizes for the error.
A.M. Best has changed its outlook for the global reinsurance segment to stable from negative, based in part on the role of alternative third-party capital in stabilizing pricing at “levels still below long-term adequacy.”
“That the glory days of a robust non-life pricing environment may not return is clear,” the ratings agency states in its Best’s Market Segment Report, released Wednesday. “Rates have stabilized, as the industry was reminded again in 2017 that almost $150 billion dollars of capital can disappear over a very short period of time.
“What’s also clear is that property catastrophe pricing is still being driven by the availability of alternative third-party capital and is not as heavily influenced by the traditional reinsurance companies.”
A.M. Best reported a decline in global reinsurers’ capital consumption and earnings volatility caused by tail events, due in part to the increased use of third-party capital in retrocessional programs, and the growing alignment between traditional and third-party capital.
Alternative third-party capital appears to be a double-edged sword when it comes to reinsurance pricing. Although it “remains disruptive due to pricing,” the ratings agency found, “it also represents a benefit in the form of stabilized earnings of rated balance sheets due to tail risk being assumed by this capital.”
Insured losses due to natural disasters in the United States in 2017 totaled $78 billion, according to Munich Re, more than triple the $23.8 billion total for 2016. In Canada, insured losses due to natural catastrophes in 2017 reached $1.33 billion, according to Catastrophe Indices and Quantification Inc. (CatIQ).
The catastrophic events of 2017 “constituted the first significant test of alternative capital use, which has led to both an affirmation of the alternative capital owners’ persistency as well as the re-evaluation of the return requirements and governance of the structures providing alternative reinsurance capacity,” the report states.
The ratings agency also observed that rising interest rates could lead to alternative investment opportunities for third-party capital. While rising interest rates could cause mark-to-market losses for bond portfolios, investment incomes could increase for reinsurers that have managed their duration profile prudently.
“In the face of a persistently competitive market environment, non-life reinsurance pricing appears to have settled at the bottom of the cycle for the near future,” the ratings agency reports. “Significant factors supporting the revision of our outlook [include] the belief that alternative third-party capital will hold the line on future return expectations following the catastrophe losses incurred in 2017 and 2018.”
Other factors leading the ratings agency to downgrade its outlook for global reinsurance from stable to negative include:
A renewed emphasis on underwriting discipline driven by potential loss cost inflation, coupled with lower loss reserve redundancies
Ongoing U.S. economic growth, greater use of reinsurance by cedents, new risk transfer opportunities, and M&A all providing greater growth opportunities.