As the underlying return on equity (ROE) surpasses the reinsurance industry’s cost of capital for the first time in a decade, it gives a sense of direction of the way forward and the level of profitability the sector has now reached, according to Brian Shea, Global Head of Strategic & Financial Advisory, Gallagher Re.
We spoke with Shea around the launch of the global reinsurance broker’s latest reinsurance market report, a bi-annual publication which examines the size and performance of the sector.
The two main takeaways from the report are that the underlying ROE has finally surpassed the reinsurance industry’s cost of capital, and that despite a 12% year-on-year drop in capital, on an economic basis, capital positions held up well.
“The reported ROE has been all over the place, and last year it was low, it was not above the cost of capital. But if you look at things on an underlying basis, it gives a sense of the direction of the way forward and that it is getting better,” said Shea. “It presents a promising picture for the kind of profitability level that the reinsurance sector has now reached, given a normal year.”
Gallagher Re’s data shows that, on a reported basis, the average ROE fell from 11.4% in 2021 to 6.8% in 2022, attributable to the year-on-year swing in investment gains. On an underlying basis, though, the average ROE moved from 6.3% in 2021 to 11.2% in 2022.
“We’ve been preparing this analysis for 10 years now, and it’s the first time that the underlying ROE has been above the sector’s cost of capital,” said Shea.
“We’ve been getting better rates, but for a long time there you had one step forward with the price increase, one step backward because the investment yield companies could earn was going down, or maybe one step backward because you had, recently due to inflation, big increases in loss costs, or one step backward because we’re all realising what is a normal degree of nat cat, and gosh, it’s a bit more than I thought. But finally, it seems to have gotten there,” he continued.
It’s also important to remember that Gallagher Re’s figures are based solely on 2022, so do not factor the very strong momentum seen at the renewals so far in 2023, which should be additive.
The other main conclusion from the report, Shea noted, is that the capital position of the industry is still healthy.
Now, this might seem a counterintuitive thing to say given the fact dedicated reinsurance capital dipped 12% in 2022 to $638 billion, but Shea emphasised two points: first that it’s really the first annual drop that Gallagher Re has seen across its long time series on capital; and second, is that this is an accounting view of capital rather than an economic one, which is really what drives decision making at re/insurance companies.
“It depends on which regulator or rating agency we’re talking about, but they tend to look at things in a more economic basis. And on that basis, capital positions actually held up well and for most companies actually improved last year,” said Shea.
“It’s also the case that even on an accounting basis, IFRS is about to change tremendously, we’re getting IFRS 17 in 2023. It also measures things much more on an economic basis, and if IFRS 17 had been in place last year, the actual headline message on capital would have also been less negative.
“And so, the point is, don’t get fooled by the headline measures of capital, in Gallagher Re’s opinion, the capital position and solvency position in the global reinsurance sector is still very healthy,” concluded Shea.