S&P Global Ratings has conducted a series of investment assets stress tests for North American reinsurers, which show that the COVID-19 pandemic will put pressure on already-thin capital buffers.
The rating agency felt that the majority of its rated North American reinsurers will be able to maintain capital adequacy, even for those that saw adequacy dip and become deficient at the end of 2019.
However, it warned that rating actions could be taken if reinsurers are unable to recover their capital positions over the next year or two.
“If the COVID-19 pandemic becomes a capital event rather than an earnings event for the few negative outliers, we will likely take rating actions if we believe that they won’t be able to rebuild their capitalization through earnings retention and capital management strategies over the next 12 to 24 months,” said S&P Global Ratings credit analyst Taoufik Gharib.
“We believe that in such times, prudence in capital management strategies is key,” Gharib added.
S&P believes that capital positions will undoubtedly take an immediate hit, with the path to recovery dependent on many factors.
On the macroeconomics level, the shape of the recovery will influence the reinsurance business conditions and the demand side of the equation, as some of the economic output could be permanently gone.
And on the microeconomics level, it will be based on the strength of a reinsurer’s starting capitalisation, the risk profile of its investment portfolio, its underlying earnings power, and management’s ability and strategies taken to preserve and shore up capital over the next 12-24 months.
Although the stress tests gave the green light to most reinsurers, S&P warned that capital buffers will be depleted by the pandemic, resulting in capital positions that are “too close for comfort.”
“With global economies in recession and reinsurance losses arising from COVID-19, reinsurers are facing an environment where uncertainty reigns, and the decline in capital resiliency could lead to more rating actions over the next 12-24 months,” S&P stated.
Additionally, analysts feel that it would be imprudent for reinsurers to pursue share buybacks, despite the current low valuations caused by the pandemic.
That said, investment losses and low interest rates depressing investment yields, along with reinsurance claims due to the outbreak, could further harden reinsurance pricing and maintain the momentum during the upcoming 2020 renewals.
In aggregate, this should help the sector partially mitigate some of the risks and uncertainties arising from COVID-19 and the resulting economic contraction, S&P said.
But capital buffers remain thinner than in previous years, meaning riskier investment strategies and outsized natural catastrophe exposure could be further exposed if 2020 ends up being an above-average catastrophe year.
