Reinsurance
A Complex Situation

• Meg Green
• October 2020
• 

Despite the long, dark shadow cast by the pandemic, AM Best continues to maintain a stable outlook on the global reinsurance industry. Associate Director Scott Mangan and Senior Director Carlos Wong-Fupuy discussed the rationale behind the outlook and other issues as detailed in the Best's Market Segment Report on the global reinsurance industry, Global Reinsurers Maintain Equalibrium Through COVID-19 Turbulence.

Following is an edited version of the transcript.

A number of insurance segments globally have seen their outlook revised to negative since the start of the pandemic, but not the global reinsurance segment. What are the leading factors behind AM Best maintaining its stable outlook?

Wong-Fupuy: Yes, you're correct. There are some insurance segments that we have on a negative outlook. That's the case of commercial insurers in the U.S., for example, and the life and annuity insurers. The main concerns are not just associated to impact on claims due to COVID, but mainly because of the macroeconomic environment, a very depressed economic situation, and historically low investment rates.

In the case of the global reinsurance market, we are talking about a more complex situation, where we can see some negative and positive factors interacting. Probably the best way to explain this is trying to remember what the situation was when we were keeping the global reinsurance market on a negative outlook.

At the time, the main issue was a very overcapitalized market, which we still see that excess capacity, continued influx of third-party capital, companies really struggling to meet their cost of capital in soft market conditions.

Obviously, we've had increased loss activity in 2017, '18, and, '19. By 2018, we changed the outlook from negative to stable. This wasn't because we were overly optimistic about the main indicators in the market. It was simply that what we saw was stabilization on performance indicators which were below historical levels.

What we were seeing was an environment which we were calling a new normal, where we would all have to get used to this lower performance. In 2019, we've started to see some positive movement in pricing terms and conditions, initially driven by the primary sector and the retrocession markets, with the early signs on the reinsurance side.

We've seen that actually being reinforced during the first half of the year with the renewals and with this COVID situation. All in all, what we see is this interaction of positives and negatives leading us to a stable outlook for the global reinsurance sector.

What positive factors are out there?

Mangan: The biggest positive that we're seeing is the pricing environment. Reinsurance is seeing improvement. I don't think we are quite ready to call it a hard market, but we're seeing hardening conditions, and it's across numerous geographies and lines of business. Again, not completely across the board yet, but certainly has momentum.

The [Jan. 1] renewals will be very telling in terms of how sustainable that pricing improvement is. Also, we're seeing pricing improvement at the primary level, and this should benefit reinsurers that have quota shares. Frankly, a lot of the reinsurers that we follow do, to some extent, write some of those primary specialty-type classes of business.

Maybe not necessarily a significant amount, but enough to maybe gain some extra benefit as well as reinsuring that.

I also think some of the positives are that the COVID losses haven't been as big, or at least are manageable. It's still an ongoing catastrophe, so we can still see the other shoe drop and more losses come in, but so far, it seems to be manageable. The way the claims will pay out will be different than what we see in a typical catastrophe, but again, I think it's been manageable up until this point.

For a number of years, we were talking about the excess capital in the industry, and how well reinsurers' balance sheet strengths are and how well capitalized they are. Now they're finally going to be able to deploy some of that capital to gain some opportunities and take advantage of these market conditions.

Given the recent years' catastrophic events and market volatility, what are you seeing in regard to third-party capital?

Wong-Fupuy: We believe that definitely, third-party capital investors are reassessing their positions. There is a bit of a change in attitude. This doesn't mean that we are going to see a drastic decline in capacity from third-party capital. We're actually estimating a slight decline this year. In terms of transactions, we saw actually a relative recovery during the first half of the year, but mainly driven by renewal of maturities.

Obviously, we've had three years of increased claims activity both from the cat side and from man-made losses. I think that from the third-party capital investor side, there has been some concern about the robustness of pricing and reserving modeling. The fact that we've had a number of events for which reserves had to be reassessed several times, for example, Japanese typhoons.

The second assumption about the short-term, the ability of entering and exiting the market swiftly has been put into question as well, because of the claims settlement process taking much longer than expected, the issues related to collateral trapped.

Finally, the assumption about the lack or perceived lack of correlation with the rest of the economy. Obviously, COVID is a vivid example that correlations tend to increase significantly in times of crisis. We think that added uncertainty is making third-party investors reassess their positions, to be more careful.

If not to shrink capacity dramatically, at least to be much more selective. Flight to quality is definitely a significant factor in how capital is being allocated.

What unknowns do you think may be keeping reinsurance CEOs up at night?

Mangan: I think certainly one thing that might be keeping reinsurance CEOs up at night is reserve development. There have been about 10 years or so of really challenging, soft market conditions. Those years are starting to run off. We're seeing a diminished benefit of reserve releases that have all been favorable on a net basis if you look at it in aggregate across the industry.

It went from about 6% on a combined ratio to just about 1% as of the year in '19. If that starts to turn to adverse development, I think it dovetails with the other thing that I think might be keeping CEOs up at night, is the interest rate environment and what the future holds for that.

It looks like it's going to be a low interest rate environment for the foreseeable future, but it's very hard to predict about what central banks and governments will do in terms of how they're viewing interest rates and what actions they can take to push them upward, which isn't always a good thing in certain cases.

If you have reserve development and you're unable to get the investment income that you've gotten in the past, reserve development will take away from the current underwriting year. Then if you're not getting as much investment income as you have in the past, it's going to be hard to maintain strong earnings over time.