Exposure to natural catastrophe risk has raised reinsurers’ earnings volatility as firms are now twice as likely to report a natural catastrophe related underwriting loss than in 2012 and profit margins are challenged by soft market prices, said S&P.
While reinsurers’ balance sheet exposure to extreme natural events remains largely unchanged, earnings exposure has increased to 0.85x from 0.69x, according to the report.
S&P Global Ratings analyst Charles-Marie Delpuech, commented; “Global reinsurers’ exposure to unpredictable and high-severity natural catastrophe events is a major driver of reinsurers’ earnings and capital volatility, and while we are seeing capital at risk reduce slightly as a percent of equity, earnings exposure is up.”
Although most global reinsurers remain well capitalised, softening prices have put pressure on firms’ profitability levels, making earnings more vulnerable to natural catastrophe related losses.
Delpuech continued; “Given that prices are continuing to soften across all lines of business and global property catastrophe prices were down about 4%-6% during 2017 renewals, we consider more-frequent catastrophe losses will become a bigger threat to underwriting profits and capital than they were in the past.
“Reinsurers are therefore likely to see heighten volatility in earnings, in our view.”
Growing earnings volatility from catastrophe exposures has meant that 30%, or 7 out of the 20 reinsurers rated by S&P could see diminished capital bases from an annual aggregate loss in the 1-10 year return period range this year.
Firms believed to be most exposed to this risk are Bermudian reinsurers with a high proportion of property catastrophe business and London firms who show low levels of capitalisation and a slightly higher appetite for catastrophe risk than their counterparts.
“Based on 2016 combined ratios, we assess that, on average, an annual aggregate catastrophe loss of 13% (as a percentage of combined ratios) would result in an underwriting loss.
“This is a loss 8 percentage points below that implied by 2012 profitability levels. Based on our calculations, it is now twice as likely that the industry would suffer combined ratios above 100% due to natural catastrophe as it was four years ago,” the S&P report said.
This is a marked change in the rating agency’s position on capitalisation and earnings adequacy of reinsurers from last year when no firms’ capital levels were rated as under threat.
“We find that the contribution of catastrophe risk to a reinsurer’s capital volatility is, indeed, relatively high as measured by earnings-at-risk exposure to a 1-in-10-year annual aggregate net loss and by capital-at-risk exposure to a 1-in-250-year annual aggregate net loss,” said S&P.
To offset current reinsurance business conditions, many firms have already been carefully managing balance sheet exposure to property catastrophe risk, transferring risk through retrocession or rebalancing their portfolio exposures.
However, in coming years firms could have to step up efforts to minimise catastrophe loss exposures, with this risk predicted to pose a bigger threat to capitalisation than it has in the past.
While many companies still enjoy the cushion of strong capital adequacy, reinsurers are advised to examine exposure levels to catastrophe risk and rethink their appetite for high exposure levels to property catastrophe risk to maintain a strong earnings and capital base for long-term sustainability.
