Vol: 43 Issue: 3 | Oct 2020For reinsurers, the beginning of 2020 was looking challenging enough. The sector had already endured several years of large natural catastrophe losses and plenty of fierce competition.
According to S&P Global Ratings’ Melbourne-based credit analyst Michael Vine the reinsurance sector has struggled to earn its cost of capital since 2017.
2019 was particularly rough, affected by the likes of Hurricane Dorian in the Atlantic, two typhoons in Japan and devastating fires in Australia, the United States and elsewhere.
Then COVID-19 struck, taking its toll on the sector’s investment returns, claims and underwriting results.
According to Fitch Ratings, these factors will limit reinsurers’ earnings in 2020, but losses are expected to be manageable.
Indeed, Siew Wai Wan, senior director of APAC insurance at Fitch Ratings, views the reinsurance sector’s resilience favourably.
‘It’s benefited from a trend of recent price improvements, very strong capital adequacy going into 2020, robust risk management and generally solid business profiles,’ he says.
INVESTMENT MARKET RISKS FOR REINSURERSThe spread of COVID-19 created significant investment market volatility and caused global equity markets to slump in the first quarter of 2020.
According to Moody’s, this drop, together with wider credit spreads, had dented the total shareholders’ equity of the reinsurers it reviews by 14.4 per cent by end-March.
Since then, equity markets have rebounded and credit spreads have tightened.
But Carlos Wong-Fupuy, senior director of global reinsurance ratings at AM Best, notes that most reinsurers have relatively conservative investment strategies with low equity risk exposures.
‘This is partly due to regulatory pressures, with regulators demanding they put up more capital to back up riskier assets.’
As a result, Wong-Fupuy says reinsurers are generally more invested in high credit quality, liquid bond portfolios.
Given this, John Philipsz, CEO of Willis Re Australia, warns that a ratings migration, defaults on corporate bonds, a decline in interest rates or a big move into cash could affect reinsurers’ returns going forward.
He estimates that the hit to reinsurers’ capital bases from investment markets is around 7 per cent, or US$38 billion.
‘This estimate had been 20 per cent, or US$110 billion, as of late March, which illustrates how volatile the situation is,’ he says.
RATES: ONWARDS AND UPWARDSOn the positive side, reinsurers’ underlying underwriting results should benefit from price rises in 2020.
One factor behind the price increases in certain US casualty lines is ‘social inflation’ — that is, the impact that factors such as litigation funding, class-action lawsuits and public distrust of corporate defendants have had on insurance claims in recent years.
Wong-Fupuy says that as a result of these pressures, as well as several years of catastrophe losses and large events, reinsurers started to see some improvements in rates in 2019.
‘Fortunately, that trend has been strengthened and we have seen this in the January 2020 renewals and later in April and July,’ he says.
S&P confirms this firming trend, adding that the increases were necessary given 2019’s natural catastrophe losses, prior years’ natural catastrophes loss creep and scarcity of retrocession capacity.
A DIFFERENT BREED OF CLAIMSClaims in 2019 were mostly related to physical catastrophes, but everything changed with the arrival of COVID-19.
Vine says losses now largely include event cancellation claims, but reserves have been set aside for business interruption, directors and officers, credit and travel insurance.
Losses from these — together with losses from other lines such as aviation, errors and omissions, and workers compensation — are expected to grow as COVID-19 takes its toll on many economies.
‘Fortunately to date, the life insurance industry’s exposure to mortality has been low and manageable,’ says Vine.
‘However, we would expect greater propensity for disability income claims under trying social and economic conditions.
LIFE EXPOSURE LOW‘In key areas, those exposed to COVID-19 appear to be the elderly or lower socio-economic groups, based on their work profiles, so they are less likely to have material life insurance cover.
‘That said, some areas of property claims could fall because more people are working from home and travelling less. This, for example, could lead to fewer motor accidents and burglaries, and people observing things around the home like water leaks.’
Philipsz says that an early consensus on COVID-19 industry loss estimates is emerging, with a broad range of about US$30 billion to US$100 billion.
‘Given the complexity of the loss,’ he adds, ‘it is not surprising that individual company booked losses vary significantly, with the impact ranging up to 10 per cent of shareholders’ equity.’
CHANGING SOURCES OF CAPITALWong-Fupuy says another trigger for rate rises was the flight to quality of alternative capital.
‘Third-party or alternative capital providers have become more selective in the types of reinsurers they will support following adverse claims experiences in previous years,’ he says.
‘At the same time, we have seen some increased appetite from equity investors, and there have been several cases where companies have raised additional capital or subordinated debt.’
Fitch estimates that more than US$5 billion in new equity funds has been raised over the past few months.
‘Publicly traded re/insurers have raised billions from secondary offerings, while privately held firms have raised capital from existing shareholders, debt issuance and recapitalisation backed by private equity [PE] firms,’ says Wan.
He also predicts reinsurers will utilise additional tie-ups with PE companies and sidecars to raise and deploy capital and scale their existing businesses, rather than relying on start-ups or new market entrants ‘given the inherent challenges’.
CASH IS KINGTo support their short-tail businesses and balance sheets, Wan says many reinsurers have a portion of their investment portfolios in cash and liquid investments, such as money market funds or bonds with maturities of less than one year.
‘In some markets, regulators have also encouraged or potentially forced financial services companies not to pay cash dividends to maintain cash and liquidity,’ adds Greg Carter, AM Best managing director, analytics, based in Singapore.
‘We have seen some reinsurers do this as well. There’s an element of stockpiling cash to prepare for potential new challenges ahead.’
In addition, Moody’s notes that many reinsurers have suspended share buybacks to preserve capital, given the economic uncertainty and ahead of the hurricane season.
RETROCESSION MARKETS HARDENWong-Fupuy says the retrocession markets have been hardening faster than the insurance market.
‘Retrocession has predominantly been covered by third-party capital,’ he says.
‘Retrocession from a cedant’s point of view is also becoming a bit more difficult to obtain. It’s more expensive, so some reinsurers are having to retain a bit more risk.’
Jerome Haegeli, group chief economist at Swiss Re, says the retrocession market already showed signs of reduced capacity at the January 2020 renewals, which translated into rate increases of 20–30 per cent.
‘We expect to see a new equilibrium of supply and demand, based on the new realities in the post-COVID world,’ he adds.
THE APAC SITUATIONHaegeli says reinsurers in Asia Pacific are taking stock of the impact of natural catastrophe losses from the past two years, in particular due to typhoons Faxai and Hagibis in Japan in 2019, and this has resulted in further rate hardening in related business lines.
‘At the same time, primary insurance business growth in Asia remains better than other regions, thus reinforcing the belief that Asia offers better growth opportunities for reinsurers, at least in relative terms,’ he says.
Carter notes that reinsurers in Asia Pacific have probably been more sensitive to pandemic risk than those in Europe or the US.
‘They are more likely to have had tighter wordings because of their experiences with SARS [severe acute respiratory syndrome], MERS [Middle East respiratory syndrome] and so on,’ he says.
A GOOD LOOK FOR DOMESTIC MARKETS‘You also have a number of local or regional reinsurers in Asia Pacific that are very much focused on their domestic markets.’
For them, there may be good news.
‘From an economic perspective, the larger and more developed Asian markets appear to be rebounding ahead of some other regions,’ says Vine.
‘There is also arguably less exposure to the legal interventions such as class actions than you see in Europe or the US.
‘Overall, Asian markets do seem to be handling the pandemic more effectively than others and they have come out of the economic cycle a bit quicker. And, the return to work is closer to normal than in the US and some European markets.’
REVISED OUTLOOKSBoth Fitch and S&P have revised their outlooks for the global reinsurance sector to negative (from stable) because of COVID-related concerns.
S&P sees COVID-19 preventing the sector from meeting its earnings expectations or earning its cost of capital in 2020.
‘But it’s fair to say the top 20 reinsurers are at least an A or stronger rating,’ says Vine.
‘They have generally benefited from the risk management lessons from the global financial crisis — for example, in terms of managing low interest rates, having more liquid asset portfolios and relying less on derivatives.
‘There are probably just a few of the broader reinsurers that may face difficulty.
'It’s really those outliers that entered 2020 with an already weaker performance or that are more exposed to larger business lines affected by COVID-19 or that have a slightly riskier asset portfolio. But these would be in the minority.’
SUFFERING DOWNGRADESVine says that, globally, S&P has downgraded two reinsurers since February because of COVID-19 and oil price dislocations: Aspen Insurance in March and Toyota Reinsurance in May.
‘Globally, across the broader insurance sector that we rate, there have been 45 negative rating or outlook revisions to date, 17 of which are from the Asia-Pacific region,’ he says.
‘The 45 insurers represent 16 per cent of our rated insurance portfolio, which is one of the least affected sectors to be impacted by the pandemic / oil price event, relative to other corporate and sovereign sectors.’
For its part, AM Best has kept its outlook for the global reinsurance market as stable since 2018.
‘There are some positives and some negatives and they tend to cancel each other out,’ says Wong-Fupuy.
‘In many cases, reinsurers are still in a strong capital position. Some have experienced pressure on their underwriting performance, but that pressure doesn’t necessarily translate into ratings actions.
‘Some are better positioned because they are more diversified or better able to take advantage of improved market conditions. But there are also some that have a more limited business profile or more exposure to investment risk. They will probably suffer.’
AN UNCERTAIN FUTUREWong-Fupuy says COVID-19 is more about uncertainty than anything else.
‘COVID-related losses seem to be well contained,’ he says.
‘In terms of magnitude, they seem to be comparable to an active hurricane season. Having said that, it’s an event that hasn’t finished yet. Going forward, companies are trying to manage that risk by limiting cover and applying exclusions.’
Philipsz says future uncertainty centres around COVID-19 claim payments, with litigation potentially prolonging the uncertainty for many years as various pieces of legislation make their way into law and the numerous inevitable appeals from insurance companies are heard in court.
Haegeli, meanwhile, cites other factors clouding the future.
‘In our baseline, we expect the global economy to recover in 2021, although the recovery will be incomplete with globally lost output to pre-COVID-19 trends in the order of US$12 trillion,’ he says.
‘Nevertheless, at this point of heightened uncertainty, COVID-19 is still severe in some emerging markets and it also depends on what lockdown exit measures are taken.’