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Higher margins may offset fading investment income for major reinsurers: Fitch

29th May 2020 - Author: Luke Gallin

The financial earnings of the big four European reinsurers will be affected negatively by the COVID-19 pandemic in the short-term, but moving forward, improved technical pricing could largely offset fading investment returns, according to Fitch Ratings.

europe-mapAs evidenced by first-quarter 2020 results, the financial impact of the COVID-19 pandemic for the four major European reinsurers (Munich Re, Swiss Re, Hannover Re, and SCOR) varied in the opening months of the year.

In light of the current crisis, Fitch has conducted a review of the big four European players.

Ultimately, the ratings agency expects the “financial earnings of the four major reinsurers to be affected negatively in the short term, while the mid-term impact of the pandemic may be largely neutral.”

Analysis by Fitch shows that the difference between the reinsurers’ net income returns on equity in Q1 2020 was mostly driven by uneven exposure to event cancellation claims.

At €800 million, Munich Re announced the largest COVID-19 related claims impact in Q1 out of the big four, followed by Swiss Re at €476 million and Hannover Re at €220 million, while SCOR has almost no exposure to event cancellation and subsequently reported an immaterial underwriting impact in the quarter.

The wide-reaching, systemic nature of pandemic risk means that losses are appearing in numerous lines of business, and, combined with the potential for claims delays owing to litigation surrounding business interruption, as well as time lags in lines such as credit and surety, it could be some time before the ultimate underwriting loss is fully understood.

Of course, through Q1 reinsurers were also exposed to COVID-19 related financial market volatility and stressed equity markets, although while the asset hit was large for some, Fitch notes that investment income proved to be resilient in Q1 “as all reinsurers successfully hedged their investment portfolios”.

In Fitch’s coronavirus pandemic review, all four reinsurers showed a resilient capital position, scoring ‘Very Strong’ as measured by Fitch’s Prism Factor-Based Capital Model. In addition, liquidity also remained strong across the cohort of reinsurers, with all four having no mandatory debt maturities in 2020 and 2021, while being able to draw on unused bank lines or letters of credit if required is another benefit.

Prior to the pandemic, reinsurance rates had been on the rise in part as a result of consecutive heavy loss years and subsequent loss creep, prolonging an overall theme of declining profitability across the space.

The general view across the marketplace is that the pandemic will exacerbate rate hardening. Fitch says that primary insurance premiums might well contract in 2020 as the effects of the recession kick in, while carriers are also likely to purchase more reinsurance coverage.

“Fitch believes prices will move higher as available reinsurance capital will decline due to the pandemic. Higher margins may largely offset lower investment income due to falling interest rates,” says the ratings agency.

On the April renewals, Fitch highlights strong rate increases and an indication of an increasingly hard reinsurance market. Moving forward, the ratings agency expects to see prices trend higher in both the June and July renewals as available capital declines on investment losses and risk appetite, while demand for reinsurance surges.

“Fitch expects that financial results will continue to suffer from pandemic-related losses in coming quarters. Credit and surety losses and possibly business interruption claims may weigh on technical results while a return of financial market volatility may depress investment income. Longer-term, better pricing for reinsurance covers may offset some of those losses,” says Fitch.

Turning briefly to life and health reinsurance, and Fitch notes that this segment remained unaffected by the pandemic in Q1 2020 and continues to be an important earnings contributor for firms.

Yesterday, Fitch announced that the global reinsurance sector will fail to earn its cost of capital in 2020 amid the COVID-19 pandemic.

These are challenging and uncertain times for the risk transfer industry, with the duration of the pandemic, the potential for a second wave and various other micro and macroeconomic factors set to influence both claims development and financial market stability.

The financial impact has been varied for reinsurers and it will be interesting to see what happens to both reinsurance rates and demand at the upcoming renewals. An expectation of higher rates and a surge in demand suggests an opportunity for some to take advantage of improving market dynamics.

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