‘ILS growth ahead’: S&P

S&P Global Ratings’ latest report claims that despite a recent slowing-down of interest in insurance-linked securities (ILS), recent pricing trends show an upturn ahead for the ILS market.

Titled For Global Reinsurers, 2019 Pricing’s Green Shoots Look Promising, the S&P report pointed out that following disappointing reinsurance pricing increases in 2018 and early 2019, it seemed that no amount of catastrophe losses would be sufficient to harden the overall market.

However, it then adds that during this year’s April and June renewals, reinsurers saw some green shoots, with property catastrophe rate increases in the 15 to 25 percent range on loss-affected accounts. At this stage in the cycle, S&P characterises the current global reinsurance pricing environment as a hardening market rather than a hard one.

According to S&P, reinsurers relied for many years on the profitability of the US property catastrophe market to subsidise other underperforming lines of business and regions. The recent underperformance of property catastrophe in combination with lacklustre performance in other lines of business posed a threat to the reinsurance sector’s underwriting margins, overall profitability, and ability to earn its cost of capital, thus forcing reinsurers’ hands to push for price increases.

The report states that overall, reinsurance pricing assumptions were challenged by continued loss creep from catastrophe losses in 2017 and 2018. Alternative capital, including ILS and collateralised reinsurance funds, was not spared.

According to Swiss Re estimates, alternative capital represented about 25 percent of total property catastrophe risk supply in 2018. In addition, alternative capital accounted for 25 to 30 percent of the insured losses from the 2017 North Atlantic hurricane season. However, its growth has slowed because of dismal returns and spread-widening in high-yield corporate bonds, exacerbated by governance issues at certain funds, which triggered investors’ redemption requests.

The flight to quality

The S&P report states: “This has caused a flight to quality, as investors shifted their attention to well-established sponsors/managers with a better track record. However, despite the recent developments, we still believe alternative capital backed by long-term investors remains committed to property catastrophe risk and is here to stay.

“We expect, once the recent bumps are smoothed over, growth will gather steam again.

“S&P Global Ratings maintains a stable outlook on the global reinsurance sector and on the majority of the reinsurers it rates, reflecting reinsurers’ still-robust capital adequacy, although it is below historic levels due to active catastrophe years in 2017-2018, unrealised losses on fixed-income securities because of higher interest rates in the US, and fourth-quarter 2018 stock market volatility.

“Thus far, strong enterprise risk management has helped reinsurers maintain relatively disciplined underwriting. We still believe the sector faces competitive business conditions as the influx of alternative capital, although at a slower rate, continues to challenge reinsurers’ business models.”

The report goes on to say that difficult market conditions have driven reinsurers to rethink their short- and long-term strategies. This has led many to pursue mergers and acquisitions (M&A), divest non-performing businesses, diversify into less-commoditised lines of business, and embrace the permanence of alternative capital.

They have also adjusted risk exposures, and are actively managing their capital structures through share buybacks and special dividends, and refinancing their maturing securities with more cost-effective ones.

According to S&P, reinsurers are exploring new opportunities for growth and ways to fill the protection gap. The top reinsurers in the sector have succeeded by focusing on client relationships and recognising the need to act as both capacity provider and risk partner, with the ability to offer customisable solutions to clients.

Key renewals

As the June renewals come to a close in Florida, S&P claimed that initial conversations with reinsurers are indicating a decent season in line with the industry’s experience during the Japanese renewals in April, with rate increases in the 15 to 25 percent range.

“It was another late renewal season, characterised as ‘reasonably orderly’,” the report said.

“The ongoing revisions to the losses from hurricanes Irma and Michael, driven by the assignment of benefits (AOB) and demand surge, are testing reinsurance pricing assumptions and the alternative capital resolve, which made it all the more important that reinsurers got double-digit rate increases this time around.

“Unlike in past years, reinsurance capacity was not plentiful, with the supply:demand equation fairly balanced.

“Alternative capital maintains its cautious stance after multiple catastrophe losses and loss creep during the past two-and-a-half years, seeking refuge with quality managers and thereby highlighting the flight to quality trend observed during the past couple of quarters.

“According to some reinsurers, the amount of alternative capital deployed/available limits are down about 20 percent because of trapped capital covering pre-existing catastrophe losses.”

S&P also claimed that helped by a tight supply of alternative capital, traditional reinsurers led the charge on pricing, as well as terms and conditions, which resulted in healthy increases which were not materially influenced by the recent AOB legislative changes in the US.

With 20 to 30 percent rate increases, retrocession pricing gains were higher than those on reinsurance, once again reflecting trends from the January and April renewal seasons. This further highlights the interplay between reinsurance and retrocession pricing.

“While Florida property catastrophe rate increases are in the low double digits, the market can’t be characterised as a hard one, but rate improvements are heading in the right direction, signalling momentum toward desired risk-adjusted pricing,” the S&P report concluded.