Reinsurers must remain responsive to market conditions and balance short-term opportunistic-moves with strategic long-term goals and sound risk management, in order to meet or remain above the cost of capital amid economic uncertainty, rising climate risk, and economic and social inflation, according to AM Best.
Because of rising interest rates and equity market volatility, the cost of capital – the minimum return that investors expect from a company based on the level of risk it takes – is higher than the historical average.
The reinsurance industry’s weighted average cost of capital decreased from 9.44% in 2010 to 6.38% in 2019, before spiking to 9.16% in 2021. It declined again in 2022, but reinsurers are still struggling to generate returns above the cost of capital due to market conditions.
A shortage of property catastrophe capacity, concerns about prior year reserve development, economic and social inflation, and a dearth of new capital have driven a hardening of the market, analysts explain.
Rates have increased significantly for property catastrophe exposures; with Guy Carpenter calculating a 30% increase in Rate- On-Line (ROL) for US and European property cat reinsurers, at January 1.
Analysts said: “The hardening market points to somewhat more sustainable pricing momentum, which could help reinsurers meet their cost of capital over the medium term period however.
“However, economic and social inflation and the growing frequency and severity of weather events will worsen the uncertainty period. Even as capital comes back cautiously in this environment, we are not seeing substantial erosion of pricing conditions.”
