Tier 1 Reinsurers More Resilient than Smaller Firms in Current Market: Fitch

Major tier 1 reinsurers stand to benefit most from a changing reinsurance market and mounting competitive pressures, while small monoline companies will be the hardest hit, according to a reinsurance report published by Fitch.

Fitch’s Brian Schneider, one of the authors of Fitch’s “2016 Outlook: Global Reinsurance,” reports the conditions fueling M&A activity in the a separate article he authored for Carrier Management here.

Reported financial results confirm that major Tier 1 reinsurers with their strong franchises and market positions are well placed to adapt to the changing reinsurance landscape and make profits, said the report titled “2016 Outlook: Global Reinsurance.”

“The current macro operating environment is likely to extend beyond a normal soft market cycle, with the continued growth of alternative capital, changes in the purchase and distribution of reinsurance, and increased regulatory costs creating significant challenges,” said the ratings agency.

Conversely, small monoline property-catastrophe reinsurers, are most vulnerable to negative rating actions, during a protracted period of market price softening, Fitch continued.

Fitch said the sector outlook for the reinsurance industry is negative, with premium prices expected to fall further in 2016, while investment yields will remain close to historical lows.

Soft market conditions will prevail, the report continued, due to lower reinsurance demand and fierce competition, especially in areas where alternative capital and traditional reinsurers compete directly.

Editor’s Note: While Fitch has maintained a stable rating outlook for the global reinsurance sector, indicating that the majority of forthcoming rating actions are likely to be affirmations, since August 2014, Fitch has had a negative sector outlook for reinsurers. See related article, Upgrades and Negative Outlooks: What’s Wrong With This Picture?

Nevertheless, the rating outlook for the reinsurance sector is “stable,” which assumes a base case scenario that the majority of reinsurers over the next 12-18 months are able to maintain adequate profitability and strong capitalization, and that any decline in earnings will be within acceptable ranges, the ratings agency affirmed.

“We expect to affirm ratings for most reinsurers although a select group of smaller monoline companies could suffer downgrades or be moved to negative outlooks,” Fitch added.

The reduced pace of premium rate reductions reported for some bellwether lines in the June and July 2015 renewals do not represent a convincing signal that the bottom of the market has been reached, the report said, noting that it does suggest, however, that underwriting retains a degree of discipline.

In a separate late August report on midyear financial results for reinsurers, Fitch noted a midyear moderation of rate declines, mainly driven by increased demand for catastrophe risk cover in Florida, and speculated that cat pricing could be “nearing a bottom or at least no longer expected to suffer the double-digit declines of January and August.” In the more recent report, Fitch notes that the midyear signs of an approaching equilibrium could just as easily be a lull before another round of rate cuts.

“It remains unclear whether property premiums will stabilize, or if this is a lull before a more disorderly period of competitive rate cuts ensues,” the report went on to say.

It predicted that casualty rates will fall further next year as reinsurers look to non-catastrophe lines for profit.

Fitch expected further M&A activity into 2016, but emphasized it is not yet clear whether the recent round of mergers will deliver increased value.

“A protracted soft market increases the risk of ill-conceived mergers that offer little prospect of generating long-term value,” the report said, noting that high valuations for many companies are being fueled by the prospect of M&As, despite the difficult market conditions.

Fitch explained that reinsurance buyers may be reluctant to purchase cover from companies created by poorly constructed mergers.