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AAA © Standard & Poor's 2014.
and reinsurers typically hold larger reserves because policyholder payments come in well before claims typically occur.
In our view, pairing capacity from the capital markets with these alternative business models could allow for wider coverage for more lines of business, such as liability. It could also provide reinsurance for catastrophe-prone regions and types of peril that don’t already have coverage. However, in practice, the new capacity is instead flooding into established lines of business in which the competition between traditional reinsurers is already strong, such as property catastrophe or specialty lines. The effect is to force down pricing and to push out some traditional reinsurers from those lines. In addition, as reinsurers look to redeploy capital to other lines of business, we are seeing increased capacity and reduced pricing spill over into those markets.
Better risk management is reducing insurers’ need to cede risks to reinsurers
Previously, when premium rates have declined, insurers have tended to buy more protection. However, this time, many large insurers are buying less reinsurance protection. Not only have the balance sheets of many large reinsurance buyers recovered following the global financial and European sovereign debt crises, but their enterprise risk management and capital modeling capabilities have also improved. As a result, they can assess their risk exposures on a portfolio basis, rather than at an individual entity or regional level. This allows them to optimize their reinsurance purchasing,
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Chart 2: Reinsurer Historical Capital Adequacy 2013
2012 2011 2009 2008
“Reinsurers’ recent track record of strong earnings, has attracted new forms of capital to the market because investors are keen to diversify their risks and find ways to achieve better yields while interest rates remain low.”
which typically means that they buy less reinsurance.
Ceding companies are also tending to streamline their reinsurance programs, that is, they are using fewer reinsurers for protection. Many large, global insurance companies are choosing to do business with a select few reinsurers that can offer significant capacity across a range of lines and regions. This is increasingly marginalizing less-diversified small and midsize reinsurers.
Under our insurance ratings methodology, these trends could have a negative impact on the competitive positions or business risk profiles of reinsurers that lack price leadership, differentiation, or other competitive advantages. The relationship between pricing and operating performance is fairly clear to see: As prices decline, margins compress. Through our assessment of operating performance in competitive
position, we can identify underperformers and reflect this in our ratings. In our view, reinsurers who undercut pricing in order to retain clients and market share could see a deterioration in their brand or reputation. We can also reflect reinsurers’ exposure to heightened competition by adjusting our view of their business risk profiles. Our view of the reinsurance industry’s overall risk profile as intermediate reflects earnings, pricing, and settlement characteristics across all lines of reinsurance business (see “Insurance Industry And Country Risk Assessment On The Global Property/Casualty Reinsurance Sector Is Intermediate”). Reinsurers with a well- balanced, truly global product offering can benefit from profitable diversification and are less acutely exposed to the pressures in property-catastrophe lines of business. However, if a reinsurer’s business profile places greater weight on a line of business or region that implies more risk for the reinsurer than the rest of the market (for example, property catastrophe), we may adjust our view of the company’s business risk to reflect this concentration.
Insufficient Returns Will Make It Difficult To Maintain Capital Levels
The industry has survived thus far because of its strong capitalization, but our forecasts indicate that it is becoming increasingly difficult for reinsurers to generate returns that meet their cost of capital. In our view, the rate reductions in 2014 will contribute to a deterioration in the sector’s aggregate annual combined ratio to 95%–100%, down from a five-year average of 92% for 2009– 2013. The combined ratio is a standard industry measure of profitability, with lower numbers indicating higher profitability and anything greater than 100% signifying an underwriting loss. The rate reductions, combined with lackluster investment returns, will lead to a forecast return on equity (ROE) of 7%–9%. During the five years to 2013, the average ROE was 14%. The sector has delivered strong results through the first half of the year, primarily because catastrophe losses have been lower than the historical average. The combined ratio so far in 2014 is 88%, and the ROE was 13%. Although these appear strong, we believe that material prior-year reserve releases and a lack of catastrophes have inflated them. On average, historical catastrophe rates add around 10 points to the sector’s combined ratio. Our full-year
Global Reinsurance Highlights 2014
Average sector redundancy
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