Further profit deterioration is expected for the reinsurance sector in the coming months as ample capacity and a return to more normalized loss activity exacerbates the effects of price softening, driving firms into specialty lines, according to Fitch Ratings.
The combined ratio for non-life reinsurers deteriorated to 93% in the first half of 2016 from 88% in the previous year, and Fitch expects this trend to continue as the market moves towards the end of 2016 and into 2017.
"Fitch expects the reinsurance sector's combined ratio to deteriorate further to 94.2% in 2016 and 99.2% in 2017, due to falling reinsurance prices, reduced reserve redundancies and catastrophe losses increasing to long-term historical averages," said Fitch, in a recent reinsurance dashboard publication.
Catastrophe losses in the first half of 2016 included the Alberta, Canada wildfires, earthquakes in Japan and Ecuador, and severe storms in parts of the U.S. and elsewhere in the world, resulting in increased losses for reinsurers when compared with the recent, benign experience.
Hurricane Matthew and Hurricane Nicole recently impacted parts of the Caribbean, the U.S., and Bermuda, further highlighted the potential for losses in the remaining months of the year and adding pressure to an already stressed marketplace.
At the same time, and as highlighted by Fitch, it's been reported that reserves are running thin for the sector as companies have utilized prior year reserve releases to bolster diminished underwriting and investment returns, a result of the softening reinsurance market cycle.
The ratings agency also expects ROEs in the space to fall further, noting that in the first half of this year, net income ROE dropped below 10%, to 9.2%. Fitch expects this to fall to 8.5% in the remainder in 2016, and to 8% in 2017, as low interest rates keep investment returns down and underwriting margins shrink.
It wasn't too long ago that industry analysts and experts noted the need for a large loss event in order to remove sufficient capital from the space and drive an increase in rates, ultimately a turn in the market.
But with the flow of alternative reinsurance capital continuing to enter the sector, albeit at a slower pace than in previous years, competition remains high and while catastrophe events in H1, and so far in the second half of the year, has incurred losses for the sector, it doesn't appear to be enough to produce any price surge.
This is potentially a very dangerous and difficult situation for reinsurers. With combined ratios deteriorating closer to the 100% threshold and diminishing reserves limiting the ability to make up for reduced profitability, a return to more normalized losses absent any post-event rate hike leaves firms with little room to maneuver.
Rate declines are expected to slow somewhat in the coming months for the business lines under the most pressure, such as property catastrophe, but nevertheless decline.
As a result, companies will be eager to increase efficiency and lower costs, while looking to other areas for more desirable returns, explains Fitch.
"Reinsurers are expanding into casualty/specialty lines as prices continue to drop in property and catastrophe business due to competition with alternative markets," said Fitch.
If catastrophe losses continue their return to more normalized levels and the flow of alternative capital persists at a time of shrinking reserves, it might not to be too long before some reinsurers come under substantial pressure, which might well already be the case for some in the sector.
Innovation, discipline, and efficiency have become essential to surviving the current marketplace, and with conditions as they are and the expectation that they will deteriorate further, it's easy to see why such skills could be the difference between winning and losing the reinsurance market cycle.
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