Rating agency Standard & Poor’s highlights the importance of strong enterprise risk management (ERM) at this point in the reinsurance cycle in a recent report.
Reinsurance firms can be tempted to take on more risk in a soft market environment, as they try to offset price declines by holding greater amounts of risk in order to maintain their profit levels, rating agency Standard & Poor’s explained.
The rating agency said that it sees “some evidence” of this, as reinsurers are offering multi-year contracts, widening their terms and conditions, and paying higher ceding commissions which can be as much as 35% to 38% in some lines, S&P says.
For a reinsurer, this can be a safe strategy in a benign loss environment, as we’ve seen in recent years and this could be a case of some complacency creeping into the market at a time when rates are down and still reinsurers have been able to report profits.
S&P notes that it is only seeing this kind of risking-up behaviour “at the margins” and that it is not yet widespread in reinsurance.
However there is a concern that the current softer for longer reinsurance price environment could eventually result in more reinsurers being tempted to take on increasing risk, in an effort to gain better returns for their shareholders.
Encouragingly, S&P say; “We believe that reinsurers’ overall strong ERM capabilities have helped them manage their risks and exercise underwriting discipline during this soft market.”
ERM could result in the need for some strategic changes at reinsurers, S&P believes, as relative risk adjusted returns decline some reinsurers could be forced to implement changes based on the guidance provided by their ERM function.
S&P also notes that as the softening continues in reinsurance pressure on underwriting, catastrophe and reserving risk controls will increase, adding that over the coming two years we could see reinsurers making meaningful responses to signals sent by their ERM frameworks.
Strong ERM is increasingly vital in a reinsurance market where margin is dwindling, while competitive pressures aren’t abating. Any reinsurers who let their risk controls slide could quickly find themselves on the wrong side of their shareholders and the rating agencies.
