The ability of global reinsurers to earn returns above their cost of capital has declined significantly in the soft market environment, as low interest rates and a series of underwriting headwinds persistently erode the profitability of the sector, according to Standard & Poor’s (S&P).
International ratings agency, S&P, in a recent global reinsurers report, has warned of declining profits across the global reinsurance industry, suggesting that it might not be too long before companies are failing to meet their cost of capital.
In 2016 the reinsurance sector recorded a return on capital of 8.6%, and S&P expects this to fall to between 5% and 7% by the end of 2017. At the end of 2016 the industry’s cost of capital reached 6.5%, and S&P anticipates this to increase marginally throughout 2017 and into 2018.
“These trends indicate that, even if prior-year reserve releases remain favourable for the next two years, reinsurers are likely to barely cover their cost of capital under a normalised level of natural catastrophe losses,” explains S&P.
Furthermore, the ratings agency highlights signs that prior-year reserve releases could decline, which suggests some reinsurance companies could have less room to navigate an uptick in catastrophe losses or additional pressure on the underwriting side of the balance sheet.
S&P notes the ongoing low-interest rate environment, steadily declining reinsurance pricing, and the competitive influx of alternative reinsurance capital as drivers of “strained reinsurer profit margins,” which the company says has “impaired their ability to sustainably earn above their cost of capital.”
During the first six months of this year the global reinsurance industry generated returns only 1.2% above its cost of capital, which is the lowest excess in more than ten years, excluding years that experienced heavy catastrophe losses, says S&P.
And with S&P expecting the sector’s return on capital to decline through this year and into 2018, it might not be too long before companies and even the industry as a whole is failing to meet its cost of capital, further supporting the need for continued discipline and innovation in the current marketplace.
