Rating agency Moody’s has maintained its stable outlook for the global reinsurance industry going into 2020, with strong capitalisation and rising prices offset by low interest rates and falling reserve releases.
Analysts at the firm noted that reinsurers’ regulatory and economic capital has remained resilient thanks to increased use of retrocession, which has help to reduce the catastrophe losses of 2017 and 2018.
Increased take-up of retro has generally broadened the distribution of peak risk exposure, but for some reinsurers the increased reliance on annually renewable retro has negatively affected capital quality.
Similarly, more pro-active engagement with alternative capital has helped many reinsurers to boost capacity, limit exposure to peak risks, and generate more fee income, but at the same time has increased their exposure to the market’s supply and demand dynamics.
Moody’s also acknowledged that pricing improvements finally materialised during the 2019 renewals, relieving some of the profitability pressure on some reinsurers.
On the other hand, pricing increases have largely been limited to loss-affected lines, and have been dampened by abundant alternative capital capacity.
For example, while prices on loss-free property lines were flat on average through the 2018 and 2019 renewal season, cat-loss affected property lines rose by up to 20% in the most recent July renewals, up from 10% the year before.
Reinsurers’ ability to absorb higher than average catastrophe losses from earnings therefore remains limited, the firm concluded, with many companies not making sufficient profit to provide an effective cushion against above-average loss years.
One of the key drivers of lower profitability has been the diminishing earnings potential from US property catastrophe reinsurance, as alternative capital has become more entrenched, and as the business has become more commoditised, Moody’s argued.
The persistent low interest rate environment presents a further headwind for reinsurers, analysts said, as low returns push companies to take on more risk by investing in higher-yielding corporate debt and illiquid assets.
Against a backdrop of low inflation and weakening economic growth, Moody’s anticipates further deterioration as low interest rates and negative sovereign bond yields continue to erode reinsurers’ investment income and put earnings under additional pressure.
Finally, Moody’s expressed some concerns about the slowdown in reinsurance reserve releases, as business written in more profitable underwriting years runs off.
Looking ahead, climate change was also identified as a major potential source of risk for the reinsurance industry, primarily in terms of its effect on the frequency and severity of natural catastrophes.
Wildfire risk in particular has been viewed as becoming less predictable due to the effects of climate change, following unprecedented losses in California in the last two years, which may require reinsurers to review their modelling practices.
Environmental liabilities, potential declines in the value of carbon-related investments, and increased regulatory scrutiny present additionally climate-related risks, Moody’s said.