forecasts incorporate this load, and assume that reserve releases subtract six percentage points.


Interest rates have remained low, but in our base case we still assume a measured rise in rates during 2015 and 2016 (see Table 2). However, technical pricing will remain very important if reinsurers are to maintain earnings performance. Because the reinsurance industry’s asset portfolios have an average duration of two years, the sector’s earnings won’t benefit from the pick-up in yields for another 12–18 months because of the lag before reinsurers can reinvest their entire portfolios at higher rates.


Reinsurers’ recent run of success has boosted traditional capital to record levels (see Chart 1). In fact, we estimate that on average, the sector holds capital in excess of our ‘AAA’ stress scenario, and had a capital redundancy of $47 billion relative to ratings at year-end 2013 (see Chart 2). This is up nearly 40% over 2012, partly because strong earnings outpaced capital returns to shareholders but also because the payout on property catastrophe claims from 2011 and 2012 has reduced reserves, and thus reduced the required capital.


At the same time, we estimate that companies’ top lines will be flat to slightly up for full-year 2014. A combination of flat top-line premium at lower rate on line should lead to an increase in risk exposure. Reinsurers should reflect this price deterioration by booking higher loss reserves, which would reduce capital adequacy as a result. If reinsurers are not reflecting this pricing reduction in higher loss reserve picks, we believe this introduces potential for additional earnings and capital volatility to balance sheets as reserves may prove inadequate in future years.


Short-Term Wins Don’t Necessarily Add Up To Long-Term Success


We don’t expect that reinsurers will roll over in the face of increased competition; rather, we expect them to look for ways to sustain earnings. However, there are few quick-fix opportunities, and relying on finding them is not a sustainable recipe for success. Strong enterprise risk management and better understanding of capital modeling and risk/return tradeoff are pillars of the reinsurance market’s current financial strength. However, these also allow for more-efficient transfer of capital to new areas. As a result, windows of opportunities


Global Reinsurance Highlights 2014


Table 2: Economic Outlook–Interest Rates, Equity And Bond Markets (%, except S&P 500 Index) 2014f


U.S. 10-year Treasury note yield U.S. Three-month Treasury bill rate German 10-year bond yield U.K. 10-year bond yield


AAA Corporate bond yield (U.S.) U.S. Federal Funds rate


European Central Bank policy rate Bank of England policy rate S&P 500 Index


f = Forecast. Source: Standard & Poor’s economic forecasts


“We don’t expect that reinsurers will roll over in the face of increased competition; rather, we expect them to look for ways to sustain earnings.”


industry could provide private capacity and reduce the market’s reliance on government- subsidized schemes such as the Terrorism Risk Insurance Program Reauthorization Act of 2007 (TRIPRA) and the National Flood Insurance Program (NFIP). Although these two risks would have indeed provided an opportunity to deploy capital in an underserved market, we consider these risks difficult to model properly and writing this business carries increased risk exposures for reinsurers. In any case, the U.S. government will likely renew or amend both programs, shutting the door on this avenue for growth.


in profitable lines, such as accident and health, and global crop reinsurance, close quickly as other companies catch wind of them. Catastrophe business in Asia- Pacific offers a prime example of the speed with which the markets move. Following the earthquake in Japan and the floods in Thailand in 2011, reinsurers flocked to those regions to take advantage of spikes in premium rates. However, the rapid flow of capacity to meet the demand has resulted in price declines in 2013 and 2014. Rates are now back to below their 2011 level. Reinsurers have also looked for opportunities closer to home, and have recently been vocal about their ability to provide protection for terrorism and flood risks in the U.S. They argue that the


We have long recognized the benefits of geographic diversification. Profitable diversification can stabilize earnings and bolster competitive position. In addition, having a presence in emerging markets presents an opportunity for reinsurers to support shifting global economic growth trends. Many reinsurers trumpet their focus on emerging economies in their business plans. However, as some reinsurers have learned the hard way, growth in these emerging markets is a long-term commitment with many hurdles and pitfalls. Although many refer to emerging markets as a collective unit, in reality they are individual economies, each with its own regulatory and legal framework and economic growth potential. Reinsurers operating in these markets must adapt to different cultural norms, attitudes toward insurance, and consumer behaviors. Many


15


2013 2.4 0.1 1.6 2.4 4.2


0.10 0.55 0.50


1,642.5


2.7 0.1 1.7 3.1


4.3


0.10 0.16 0.50


1,904.1


2015f 3.3 0.4 1.9 3.3 4.8


0.40 0.20 1.00


2,126.4


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