Dedicated reinsurance capacity is expected to drop for 2022 after a changing environment that has reversed the factors that had made it grow, a new report from AM Best has warned.

Last year, capacity increased to $568 billion, driven by an increase of nearly 11 per cent from traditional reinsurance capacity providers.

But the spike may be short-lived given expectations for depressed investment markets, continued geopolitical turmoil and a potential decline in global gross domestic product.

Best’s market segment report Dedicated Reinsurance Capital Growth of 2021 May Not Continue is part of AM Best’s look at the global reinsurance industry ahead of the Rendez-Vous de Septembre in Monte Carlo.

The total amount of capital supporting the reinsurance industry is estimated by AM Best working in conjunction with Guy Carpenter.

AM Best determines traditional reinsurance capital; Guy Carpenter determines third-party capital.

According to the report, the expectation for 2022 is that total dedicated capital will slide back after a decade of year-over-year increases, driven by reductions in traditional reinsurance capital.

It said that although underwriting returns for many companies had been close to break even in recent years, capital levels had grown through investment gains and inexpensive debt financing.

But the start of 2022 has seen a reversal of most of these conditions.

Dan Hofmeister, senior financial analyst at the rating agency, said: “Although AM Best expects headwinds in the capital and investment markets to continue in 2022, dragging down traditional capital levels, some of these losses likely will be offset by underwriting gains.

“The historical lack of a strong correlation between underwriting and asset returns may indicate relatively flat capital levels but the repeat of a severe property catastrophe season in 2022 could prove to be adverse for reinsurers.”

The report notes that many reinsurers substantially decreased property exposure through the last renewal cycle.

Those still exposed to material amounts of multiyear reinsurance contracts or that did not manage risk exposures prudently could be exposed to material capital deterioration should they suffer underwriting losses, especially if coupled with adverse investment market returns in 2022.

On the third-party reinsurance capacity side, the pullback of traditional reinsurance in catastrophe-exposed markets such as Florida has created opportunities for insurance-linked securities funds.

By taking advantage of the lack of capacity, some ILS funds have been able to capitalise on not only significant price increases, but also on tighter terms and conditions.