The first-half of 2014 saw reduced profitability in the global reinsurance sector, according to Fitch Ratings, but while still profitable the results show deteriorating underwriting returns, as higher non-catastrophe losses and underlying loss ratios began to bite.
High-levels of capital in the reinsurance sector, both traditional shareholder equity and alternative capital from the growing capital markets investor interest in reinsurance and insurance-linked securities (ILS), continues to apply pressure to reinsurers, making the outlook less than certain.
A deterioration in the quarters' results is evident in the non-catastrophe loss numbers, which are up on prior quarters, while the underlying loss ratio run-rate is rising, which combined has resulted in an increase to calendar-year reinsurance combined ratio, which hit 87.4% in 1H14, up from 85.9% for the comparable half-year earlier and 85.5% at year-end, according to Fitch.
Fitch explains the increased combined ratio, across the global reinsurers it tracks as a sector, as due to the increased attritional non-catastrophe losses experienced but also due to the shift away from property catastrophe by some traditional reinsurers looking to avoid the areas of the market where pricing is deemed to be worst.
Reinsurers have been shifting towards specialty risks and casualty business, as a result of the competition and the negative impact to property catastrophe reinsurance prices. Many reinsurers have deemed large swathes of the catastrophe reinsurance market to be inadequately priced now, meaning that they are looking to these other lines of business for underwriting with a better margin. The side-effect of moving into many of these lines is the longer-tail and also the higher combined ratio that comes with a shift into them, which has affected the sector's results to a degree.
Competitive market pressures are forcing reinsurers into exploring new business areas, making changes to their business mix and, as a result, feeling the impact to combined ratios. Often when entering a new business area, particularly casualty, the combined ratio is expected to begin higher and then to come down over time. In the current market environment, of high competition and high levels of capital and price pressure, how long reinsurers will have to reduce their combined ratios remains to be seen.
Another factor influencing the combined ratio is a shift by some reinsurers towards more quota share business, rather than excess of loss where premium rates have been so heavily affected by the competitive market and the influence of lower-cost third-party capital. Quota share business carries a higher, but less volatile, loss ratio than excess of loss or property cat, explains Fitch.
Catastrophe losses remain below average at approximately $17 billion for the first-half of 2014, which is below the long-term average of $25 billion. However the increased non-cat loss figures are attritional and impacted some reinsurers' first-half results, said Fitch.
Fitch notes that reserve releases remained constant in recent months, adding approximately 6.1% to the combined ratio. However, while these releases remain adequate, they are expected to decline and any reduction in reserve releases could put increased pressure on the future profitability of the reinsurance sector.
Fitch points out the irony that the favourable underwriting results posted by reinsurers since the loss-heavy 2011 have fostered the currently challenging market environment. Profitable results have promoted product innovation and attracted more capital to the sector from new sources, including private equity firms, hedge funds and the pension funds which enter the space largely through ILS managers.
It is this increased supply of capital, triggered by the improved underwriting results of recent years, which have raised the level of competition in the reinsurance sector, created excess underwriting capacity, which have then stimulated the price competition and the decline in reinsurance rates.
This competition then begets even more competition, resulting in the relaxation of terms and conditions and raising concerns about some reinsurers' exposure to future events. While current results still reflect underwriting discipline, according to Fitch, it will be interesting to see if that remains the case in quarters to come.
Fitch does not foresee a turn in fortune for the global reinsurance sector. Its outlook for the reinsurance sector remains negative, as do all the other major rating agency views, and it sees no reason for this to change in the immediate future.
“The fundamentals of the reinsurance sector have deteriorated with declining premium pricing and weakening of terms and conditions across a wide range of lines,” explains Fitch. The rating agency said that it views current market conditions as; “Unlikely to improve in the near term given the competition in the reinsurance market.”