Rates may rise, but reinsurers still can’t meet cost of capital: S&P

Global reinsurers might enjoy mid-single-digit average rate increases in excess of inflation moving forward through the 1.1 renewals, excluding some of the more dramatically loss-impacted lines, but still without hope that earnings can catch up with a rising cost of capital,  S&P analyst and director Ali Karakuyu (pictured) has said.

“We do expect the rate rises to continue,” Karakuyu told reporters. “Depending on the segment, rate rise will vary for an average of mid-single digit.”

Inflation remains a wildcard that can potentially undermine sector fundamentals. The market shows no shortage of reinsurers who have had to double the inflation forecasts they are baking into their rate calculus, Karakuyu noted.

“The speed at which inflation is changing is quite rapid,” Karakuyu said. Given the volatility in readings, it might take “several years” before S&P is comfortable saying if countermeasures taken today were sufficient to meet the currently unknown challenges of claims inflation. No sign yet that reserves are weak, but releases could halve.

Reinsurers are showing exceptional attention to loss-makers for outlier pricing action and Karakuyu was quick to make an example of lines impacted by the Russian invasion of Ukraine.

“Reinsurers have been asking for very substantial amounts of rate rises,” Karakuyu said of lines hit by the conflict. It's a slow-cooking story: very little has been reported, initial IBNR's have been written, but even that will “more likely spread over the next two to three years.” Final tallies could be a decade or more away.

Pricing adjustments have been key in helping the industry push away from the worst of the losses recorded in recent years. S&P believes the industry is on track to hold combined ratios to a range of 95-98 across 2022 and 2023, largely matching the 2021 score, but well improved from the spattering of over-100 readings seen since 2017.

“Despite the lackluster underwriting performance in the past five years, the underlying metrics have improved in the past 18 months (2021 through first half of 2022) owing to favorable reinsurance pricing,” analysts said in their latest report on the sector.

With caveat for natural catastrophe, where S&P pencils in 8 to 10 percentage points of combined ratio impact over the period.

But pricing adjustments, no matter what type of line they are taken from, will still not be enough to cover the cost of capital, a cost which is rising hand in hand with the same interest rates that hopes for improvement investment earnings are also pinned on.

On conviction that earnings will continue to fall short of that bar, S&P is standing by its negative view to the global reinsurance sector.

The industry has earned its cost of capital only once since 2016 and even managed to post a return on capital below ten-year US Treasuries twice: in 2018 and over the twelve months to end-June 2022.

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