Most global reinsurers have been able to maintain underwriting discipline despite the ongoing soft market, but there is a danger that their profits could be hit if the current benign period of natural catastrophes returns to normal levels, according to a report published by S&P Global Ratings.

“As margins compress, the more frequent catastrophe losses will become more visible,” exposing the sector to higher earnings and capital volatility, S&P said.

“Reinsurers that are overexposed are likely to be caught if claims revert to more normal levels and they will need to review their risk appetite for these high-probability events to sustain their earnings and defend their competitive positions,” S&P cautioned, noting that technical profitability is deteriorating to the point that “reinsurers are now twice as likely to fail to break even in a calendar year as they were in 2012, due to their exposure to catastrophe risk.”

“We consider the chance of the combined ratio being above 100 percent as a result of catastrophe exposure as being 12 percent in 2015 (5 percent in 2012),” said the report titled “Global Reinsurers May Reassess Their Exposure if Annual Losses from Catastrophes Rise to Normal Levels.”

Of the 21 global reinsurers under review by S&P, 15 are likely to maintain a capital adequacy of at least “BBB,” following a one-in-250 year aggregate loss from natural disasters.

The ratings agency said some of the Bermudian reinsurers are more at risk “because their underwriting results are slightly weaker as they have a higher appetite for property catastrophe risk than their peers.”

“The big winners would be those that have taken action earlier to improve their profitability outside the catastrophe space and reduce their exposure to the sort of high-frequency, high-probability events that recur every 10 years or so…,” S&P’s report continued.

S&P expects to see reinsurers reallocating more capital away from catastrophe-exposed lines, as they seek to improve their risk-return profiles, which could offset some earnings volatility over time.

Indeed, S&P noted that its capital model results for rated reinsurers indicates that the property catastrophe risk charge has been declining against the premium risk capital requirement.

“Nevertheless, we consider that reinsurers that are overexposed to the more-frequent events could see their competitive position and earnings deteriorate if they do not take further action to protect themselves.”

Managing Cat Exposures

The report emphasized that reinsurers are generally remaining cautious in this soft market by managing their peak exposures and constraining their growth in property catastrophe lines.

Citing a confirmation of this trend, S&P said its analysis shows that relative exposures on Jan. 1, 2016 remained flat on average at around 33 percent of common shareholders’ equity, compared with last year.

“Some reinsurers have nevertheless observed material movements in their exposure of about 6 percentage points in either direction.” S&P attributed this movement to currency fluctuations, rebalancing of peak exposure appetites and active retrocession management.

U.S. Opportunities

Some reinsurers find attractive business opportunities in the U.S. on a risk-adjusted basis, the report said, noting that most of the increase in net relative exposures came from the U.S.

“We saw a 9 percent increase, on average, across the six reinsurers that reported an increase in exposure to U.S. windstorm.”

Retrocession Demand Is High

Most reinsurers have taken defensive actions by retroceding more of their high-frequency risks, S&P confirmed, explaining that the purchase of retrocession cover explains much of the reported reduction in exposure for some reinsurers.

“We expect demand for retrocession to remain high as reinsurers remain committed to maintaining their risk tolerances and limiting their solvency capital requirements.”

S&P said an influx of third-party capital is helping reinsurers adapt their risk transfer strategy. As competition for high-layer exposure is keeping prices low, “reinsurers have seized the opportunity to offset certain risks while improving their risk-adjusted return.”

The ratings agency said Bermudian reinsurers and mid-sized global reinsurers have been the biggest purchasers of retrocessional protection in the past two years.

Source: Standard & Poor’s

*This story appeared previously in our sister publication Insurance Journal.