Reinsurers set for more profitable year
Bermudian reinsurers have struggled for profitability over the past two years, but prospects are looking brighter in 2019, according to a top industry analyst.
Taoufik Gharib, senior director of S&P Global Ratings, said data over the first three quarters of the year suggested the group were on their way to achieving a significant improvement on the two previous catastrophe-hit years.
In 2017, the year of hurricanes Harvey, Irma and Maria, two major earthquakes in Mexico and wildfires in California, the Bermudian group made an underwriting loss and generated less than 1 per cent return on equity, Mr Gharib said.
Last year, which featured hurricanes Florence and Michael, the Camp Fire in California and Typhoon Jebi, the group broke even on underwriting and made a scored an RoE of 2.5 per cent.
Speaking before today’s S&P Bermuda Reinsurance Conference, to be held at the Hamilton Princess and Beach Club, Mr Gharib said over the first three quarters of this year, Arch Capital, RenaissanceRe and Everest Re were leading the way, generating strong underwriting profits and double-digit RoEs.
Investment returns have also improved, as the financial markets have bounced back to record levels from a dismal fourth quarter of 2018.
Mr Gharib said reinsurance rates on average had climbed modestly both last year and this year — flat to mid-single digits — in response to catastrophe losses that were of an unprecedented size over a two-year period.
“Reinsurance rates are improving and we believe that the momentum will carry on into 2020,” Mr Gharib said in an interview.
He listed several drivers of upward pressure on rates, including the loss events of the past 2½ years, an increase in the frequency and severity of wildfires in California, “loss creep” and hardening rates across many lines of primary insurance.
“The industry used to view wildfire as a secondary peril, now there is a question over whether it is a primary peril,” Mr Gharib said.
The loss creep phenomenon had been perfectly illustrated by Jebi, which battered Japan and Taiwan in September 2018.
“Estimated insured losses were initially about $5 billion, but that has tripled to $15 billion,” Mr Gharib said. “This did not influence April renewals, because the loss development took place after that. Then there were two major typhoons that took place this year, Faxai and Hagibis.
“So rates will be significantly higher for Japan in April 2020.”
Risk modelling firm AIR has estimated insured losses of $3 billion to $7 billion for Faxai and $8 billion to $16 billion for Hagibis.
Another influence on the market came from the primary insurance side, in which rates had hardened, partly due to a tightening of underwriting standards by several major players, including AIG, Lloyd’s of London and Zurich Insurance, Mr Gharib said.
S&P forecasts that the top 20 global reinsurers will generate a return on equity of between 7 per cent and 9 per cent in both 2019 and 2020, with combined ratios for both years of between 95 per cent and 98 per cent.
The rating agency’s research shows that RoE in 2017 was 1.6 per cent for the group and 2.9 per cent in 2018, as catastrophes took a heavy toll.
Bermudian-based companies have written between 7 per cent and 9 per cent of net reinsurance premiums over the previous ten years, Mr Gharib said.
Alternative capital fell by 4 per cent in the first six months of this year to $93 billion, according to Aon, the first such decline in about 15 years, Mr Gharib said.
“Most of that decline took place in the first quarter — it seems that in the second quarter, things stabilised. Our view is that it’s probably just a bump. It will ultimately regain its momentum.”
Factors influencing the decline were the catastrophe losses of 2017 and 2018, causing dismal returns for investors, loss creep that scared some investors, some governance issues at one of the island’s funds, and the question of climate change’s impact and whether rates are capturing that risk.
Mr Gharib noted: “There has been a flight to quality in alternative capital. Investors are becoming choosier.
“Companies such as RenRe, because of their strong track record and the way they manage alternative capital — it seems that they’re able to raise more capital.”
He noted a significant increase in ILS related to mortgage coverage and pointed to the ILS unit being set up by global fixed-income investment giant Pimco, complete with a Bermudian-domiciled reinsurance vehicle Newport Re Ltd, as evidence that alternative capital would resume its growth trajectory.
Mr Gharib said the industry remained vulnerable to potential dislocation in the event of a megacatastrophe.
“It’s not a question of if, but rather when, it happens,” he said. “If a Category 5 hits Miami, then that’s at least a $100 billion event automatically. The industry is well capitalised, at a AA level in our view, but in terms of a major cat, the industry could be disrupted especially if alternative capital were to take a major hit.”
Many Bermudian reinsurers had ceded peak-zone exposures to alternative capital, he said. Of the roughly $93 billion of alternative capital, some $15 billion was already “trapped” after losses suffered over the past two years.
Another hefty loss after the poor returns of the last two years could put off investors, he warned, potentially limiting capacity.
In terms of capital management, Mr Gharib said share buybacks among Bermudian reinsurers had largely dried up. “One reason is because operating earnings fell because of the catastrophes and companies wanted to shore up their capital.
“Another factor is that pricing is improving, so instead of buying back their shares, they see more attractive ways to deploy capital.
“Also companies are trading at a high multiple — as of October 31 the Bermudian group were trading at 1½ times book value — so that’s not an incentive to buy their own shares.”
Those multiples had also dampened merger and acquisitions activity, he said. However, he expected consolidation activity to resume.
“Beyond the top ten in property and casualty, you have many smaller reinsurers,” he said. “For them to compete globally, they need to be a certain size with a certain capital base and a financial strength rating and to be able to deal with increasing regulation.”
There were similar consolidation pressures in the life reinsurance sector, with a big five dominating the market, he added.
Today’s conference runs from 8am through 4pm, featuring Brian Duperreault, chief executive officer of AIG, as keynote speaker, and including sessions on climate change, the future of alternative capital and environmental, social and governance investing.
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