It is the smaller reinsurance firms that cannot take advantage of current market conditions and rate firming which are the most vulnerable to takeover right now, according to Chris Grimes of Fitch Ratings.
Grimes, Director of Insurance at the rating agency, explained to us in an interview that despite the improved reinsurance price environment, not every company will be able to capitalise on this.
Larger reinsurers have been growing their books at recent renewals, eager to capitalise on higher rates.
But the smaller players do not have the capacity to deploy and so look increasingly at-risk of being unable to sustain their business models it seems.
Discussing recent reinsurance market forces, Grimes explained, “We are starting to see price improvements gaining momentum but expect credit fundamentals to continue to reflect both intense pricing competition and low investment yields, which will continue to limit profitability.
“The traditional reinsurance sector continues to maintain very strong capital adequacy, robust risk management and generally solid business profiles which have helped to mitigate the effects of the challenging market conditions in recent years.”
On smaller reinsurance firms, Grimes explained that while they have publicly discussed their efforts to reduce expenses, they face scale disadvantages that are hurting them.
“The focus in 2019 has been on organic growth opportunities in the likely fleeting favorable market environment,” Grimes said.
Continuing, “However, to the extent that market firming does not benefit all players, those that are smaller players that unable to take advantage of current opportunities are vulnerable to takeover.”
As well as size and market forces threatening the business models of smaller reinsurance players, there are a number of other issues that heighten risk for some reinsurers, Grimes explained.
“Risk-adjusted pricing has shown signs of improvement in 2019 but competition remains intense and pricing remains well below historical highs. While pricing generally continues to be at least keeping pace with loss cost inflation, the underlying loss cost trends are deteriorating, with rising social inflation, a worsening tort environment and weakening liability reserves.
“This market fear should compel reinsurers to maintain underwriting discipline and manage risk appetite as they push for more needed rate,” he said.
In the longer-tailed casualty lines of business there are signs of weakening of reserves, which can be a threat over the longer-term for those unable to rebuild them.
Grimes explained, “Our reserve analysis of traditional reinsurers indicates that casualty reserves generally remain adequate but are weakening. We expect contributions from prior-year casualty reserve surpluses are expected to show a marginal decline in future periods, although overall development will remain favourable.”
Reserves are an issue across catastrophe lines as well, with these brought into view thanks to the significant loss creep of recent year catastrophe events.
Grimes commented that, “In light of the of the adverse reserve issues that the industry has faced on recent catastrophe events, conservatism in the setting of reserves and accuracy of loss estimates are certainly top of mind issues in the industry.
“The magnitude of some of the recent prior year reserve adjustments that have been reported in the sector highlight the meaningful impact they can have on current year results and third-party perceptions of reserve adequacy.”
Loss reserve management is “critical for the smaller markets” Grimes stressed, with this being key to credit fundamentals as well as reinsurer valuations.
Typhoon Jebi and 2017’s hurricane Irma have also highlighted another risk for the reinsurance industry, Grimes said.
These storms, “indicate that the challenge in setting reserves with asymmetric information on claims and exposure between primary insurers and reinsurers is a worldwide issue and not limited to any region,” he stated.