What AM Best Says
AM Best: Dedicated Reinsurance Capital Growth of 2021 May Not Continue
Traditional reinsurance capacity projected to fall as third-party capital holds steady.
- October 2022
Editor's Note: The following is an excerpt from the Best's Market Segment Report: Dedicated Reinsurance Capital Growth of 2021 May Not Continue. Visit www.ambest.com to access the full report.
For the past 10 years, AM Best and Guy Carpenter have jointly estimated the amount of global capital dedicated to support the reinsurance market, with AM Best determining traditional reinsurance capital and Guy Carpenter determining third-party capital.
The global reinsurance market has evolved over the past decade, as has the capital supporting it. Third-party capital and large commercial lines capacity are more closely aligned with reinsurance business models, which has impacted not just the levels of capital, but also their utilization. The majority of reinsurance market participants now have primary insurance operations as well as third-party capital capabilities, blurring the lines between reinsurance capital and other activities and business lines at individual organizations.
AM Best's estimate of dedicated reinsurance capital is derived from incisive analysis and consistent aggregation methods, resulting in a more accurate picture of capital backing the reinsurance market. Pure reinsurers with a global reach are rare, as “global reinsurers” are engaged in business other than reinsurance, covering specialty areas, large commercial lines, surplus lines, and other interests. Typically, not all of a company's capacity is allocated to its reinsurance business.
AM Best's estimate of traditional reinsurance capacity takes into account the allocations by business classification. Since year-end 2018, our estimate has been less than 60% of total shareholders' equity of the consolidated figures for groups identifying as reinsurance writers. As reinsurers expand further into other primary insurance lines and other activities, more in-depth analysis will be needed to determine these estimates.
Traditional Capital Up in 2021
Traditional reinsurance capacity increased 10.7%, from US$429 billion at December 31, 2020, to US$475 billion at December 31, 2021 but is projected to fall to US$435 billion at year-end 2022. The increase from 2020 to 2021 was due primarily to the rise in shareholders' equity among market participants as a result of substantially improved underwriting returns and strong equity market growth. The AM Best Global Reinsurance Composite reported its lowest combined ratio in five years in 2021 (96.4); equity values grew roughly 17%, partially countered by anemic fixed-income investment returns.
Rates hardened in many reinsurance lines in 2021, boosting underwriting performance. An improvement in reserve development was driven by the generally conservative COVID-19 reserves recorded in 2020, as well as a slowdown in U.S social inflation, which may be transitory in nature as U.S. courts catch up on their backlog and entertain civil case activity again. The increase in frequency and severity of catastrophic events, including Winter Storm Uri and Hurricane Ida in the United States and the Bernd floods in Europe, partially counterbalanced the impact of the strong investment gains, the improvement in underlying underwriting performance, and reserve releases throughout the year. The final reason for higher traditional reinsurance capital levels at year-end 2021 was the persistently low interest rate environment, which allowed companies to access affordable debt financing and use the capital to support growth and financing objectives, including lowering the cost of capital.
Third-Party Capital Reallocates
Guy Carpenter estimates relatively stable third-party capital for 2022, despite notable shifts in the insurance-linked securities (ILS) market. The downturn in the US equity market has posed capital supply challenges for some ILS funds, given investor portfolio allocation percentage caps. The muted returns of aggregate-focused covers are another pressure point for investors. However, the pullback of traditional reinsurance in catastrophe-exposed markets such as Florida has created opportunities for ILS funds. By taking advantage of the lack of capacity, some ILS funds have been able to capitalize not only on significant price increases, but also tighter terms and conditions.
Reinsurers with third-party capital facilities generally are supported by large, long-term institutional investors seeking diversification and higher yields. The higher yields in the ILS market are a function of (1) higher interest rates and (2) higher risk premiums in the natural catastrophe reinsurance market due to uncertainty caused by climate change (which translates into modeling risk), ultimately leading to higher rates on line. However, the geographic diversification of these investors is growing, with a significant portion originating outside the United States.
ILS investments have benefited from a lack of correlation with the financial markets. Despite the possibly greater correlation of casualty-focused ILS, there are signs of early but growing market interest in non-catastrophe exposed transactions. Some deals have addressed investor concerns about the liquidity lockup of the longer-tail casualty business, while the relative absence of volatility has been an appealing offset to natural catastrophe business.
2022 Estimates Very Uncertain But Generally Unfavorable
The rising underwriting rate environment and improving terms and conditions of the past five years have been accretive to capital levels. These favorable market conditions have been partially counterbalanced by elevated catastrophic losses that have been detrimental to operating returns, although the losses have been characterized as “earnings events,” rather than capital-deteriorating events. Although underwriting returns for many companies have been close to break even in recent years, capital levels grew through investment gains and inexpensive debt financing. However, the start of 2022 has seen a reversal of most of these conditions.
Underwriting results for the first half of 2022 have been generally favorable, aided by rate increases in prior years. Accurately resolving losses associated with the Russia/Ukraine conflict will take some time, although reinsurers are cautiously optimistic about insured loss development in the region. Market conditions for reinsurance—in both the property and casualty lines (except workers' compensation)—continue to improve, which has resulted in compounding rate activity year-over-year and more favorable terms and conditions.