RATING AND PERFORMANCE
position also incorporates our analysis of its catastrophe exposure, and the potential for material volatility in earnings or capital due to that exposure, both on an absolute basis and relative to the rest of the industry. Chart 8 demonstrates a relative ranking of reinsurers’ catastrophe exposures using a combination of metrics collected from our annual catastrophe surveys (see Chart 8 and “Global Reinsurers’ Appetite For Catastrophe Risk Remains Largely In Check” for details on the metrics that we use to benchmark the reinsurers’ catastrophe exposure and that inform our view of their risk positions).
Investment strategies remain generally conservative
Global reinsurers tend to invest in high- quality assets and generally espouse conservative investment strategies that focus on assets that are high in credit quality, short in duration, and liquid. To protect themselves from a likely rise in interest rates, most reinsurers keep their asset durations shorter than their liability durations. The simple average asset duration over the 23 rated reinsurers in this sector is 2.4 years. In response to low investment yields, some companies have slightly increased their exposure to risky assets such as private loans, common equities, and alternative investments (for example, private equity and hedge funds) to hedge against potential inflation. Although the ratio of high-risk assets to total adjusted capital varies from 2% to 55%, we consider the average of 26% to be low enough that reinsurers’ risk positions and capital should not come under pressure.
Significant capital returns boost financial flexibility
Most global reinsurance companies can gain access to the capital markets through public listings or debt and hybrid issuances, giving them adequate financial flexibility. Certain reinsurers have strong financial flexibility because they have been able to gain access to capital via multiple avenues, such as sidecars, contingent capital, and issuances to different geographies, and have so differentiated themselves from their peers.
Valuations also affect our view of the industry’s financial flexibility. They have recovered over the past couple of years; on average, reinsurers’ stocks currently trade slightly above book value. In our opinion, strong earnings over 2012–2013 and the wider recovery in the capital markets have boosted valuations. As a result, reinsurers
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“Where we assess ERM as at least strong and management and governance as satisfactory or strong, we modify the anchor up by one notch.”
have returned a material amount of capital to investors in the form of special dividends or share buybacks. Global reinsurers returned almost all of their 2013 net income (excluding realized/unrealized gains) to shareholders. Share buybacks and special dividends have not affected our ratings, as long as reinsurers retain sufficient capital to support the ratings.
The investor base for large global and London market players tend to prefer regular dividends. These companies returned 88% of their 2013 net income in regular and special dividends, but did not engage in significant share buybacks. By contrast, Bermuda-based reinsurers, midsize global reinsurers, and property- catastrophe/short-tail reinsurers returned to shareholders a total of 107% of their 2013 net income (excluding the realized/ unrealized gains). Of this, 60% was returned through share buybacks. Despite the high levels of capital returned to shareholders, we consider that reinsurers retained sufficient capital to support the ratings.
Strong Risk Management Uplifts Anchors Due to the complexity of the risks reinsurers have underwritten and the volatility of the business, we consider ERM to be of high
importance to the sector. Global reinsurers’ ERM practices tend to be stronger than those of the rest of the insurance sector. We have modified our ratings on nine of the 23 global reinsurers we rate by one notch to reflect their ability to manage their companies successfully and within their risk tolerances. Under our criteria, we combine a reinsurer’s business and financial risk profiles to derive an initial assessment of creditworthiness or “anchor”. Where we assess ERM as at least strong and management and governance as satisfactory or strong, we modify the anchor up by one notch. As a result of these modifications, the sector’s ratings distribution is concentrated at a higher level than the anchors, at the ‘A+’/‘A’ level.
A Material Deterioration In Competitive Position Could Cause Downgrades Although our ratings on 20 of the 23 global reinsurers have a stable outlook (see Tables 1 and 2), continuing competitive pressure, reduced earnings potential, and increased industry risk in some segments of the market could cause more outlooks to turn negative. While reinsurers’ capital cushions may be robust enough to withstand the strain in the near term, ratings could migrate downward over time if we revise the subscores that underpin individual reinsurer ratings downward.
In response to this threat, global reinsurers are reducing their exposure to certain underwriting risks and withdrawing from markets where prices are unsustainable. Faced with investment yields that may remain low, some have chosen to slightly increase their exposure to higher-yielding, if riskier investments. We anticipate that such moves may protect global reinsurers’ financial strength, as long as their investment adjustments remain within prudent risk tolerances and they maintain competitive positions and investment leverage that support the ratings.
Ali Karakuyu
London, (44) 20-7176-7301
ali.karakuyu@standardandpoors.com
Adrian Nusaputra New York, (1) 212-438-7255
adrian.nusaputra@
standardandpoors.com Taoufik Gharib
New York, (1) 212-438-7253
taoufik.gharib@
standardandpoors.com
Global Reinsurance Highlights 2014
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