Moody’s warns of 2020 ‘headwinds’ as it hails stable reinsurance sector outlook

Global reinsurance can expect to face market “headwinds” in 2020, despite strong capitalisation and rising pricing, credit ratings agency Moody’s has said.

In its outlook report, published September 3 2019, the agency gave global reinsurance a “stable” outlook.

But it warned that headwinds in 2020 will come from persistent low interest rates, which will dampen investment income, as well as weaker reserve releases.
While market conditions are favourable, profitability will be heavily influenced by catastrophe losses, with climate change, growing cyber exposure and rising asset risk further sources of uncertainty.

Brandan Holmes, VP senior credit officer at Moody’s and outlook co-author, said as a result of the headwinds, there was “some migration to higher risk assets or more illiquid assets classes to try and support investment yields, which is a theme we will probably see more of.”

However, he added that it was fairly limited for reinsurers, compared to life insurers, and that analysts didn’t expect to see a significant move for reinsurers as they are mainly focused on taking the risk on the liability side.

However, weaker reserve releases leave casualty insurers more vulnerable to a potential rise in claims inflation. Moody’s added that this line has “reported declining reserves in recent years”.

Looking at the key drivers for a “stable outlook”, the report identified strong capitalisation and pricing improvements, which firm up profits.

“Capitalisation has come off a little bit since 2016 but the sector is still very well capitalised and came through the significant cat events of 2017/18 very well,” Holmes said

He explained that this was down to companies generally adopting a more conservative stance.

“They were focused on preserving capital and, for the most part, not returning a lot of capital to investors in response to a soft market and not taking outsized risks to try and boost return.”

The agency also saw “quite a lot of discipline" over 2017/18 with companies reducing their nat cat exposure. The increased use of alternative capital has also helped reinsurers, particularly when taking on property cat risk.

“Over the last five to seven years, concurrent with price softening, we’ve also seen peak cat risk being spread more broadly with capital market participants. We saw this helping the sector in 2017 and 2018, so capitalisation remains strong.”

But, Holmes added: “For some reinsurers we’d probably say where there is excess use of retro in the capital structure that has probably weakened the quality of capital a bit, particularly where they are dependent on annual renewals of that retro and may be susceptible to dislocations of capitcity of pricing in that market. But by and large overall it is strong.”

Moody’s analysts said they had seen two consecutive years of pricing improvements. “The extent of price increases is likely to be dampened compared to what you would have seen in a previous hard market because of the shift in the structure of the industry and the established content of capital," Holmes said.

“Nonetheless prices are increasing. We’ve seen it largely constrained to loss affected property risk but it is spreading further into other lines.”

The report’s co-author said Moody’s had seen some of the changes being made at Lloyd’s filtering through into more buoyant specialty prices. “There are indications of output pressure on casualty prices, so the pricing environment is positive and that will start feeding though into profitability.”

M&A has been largely positive for the sector. Moody’s outlook said that over a number of years through the softening cycle analysts saw a lot of smaller maybe more vulnerable reinsurers being absorbed into larger groups. Holmes added: “So the average credit quality of the population was supported by that.” He said that the sector has been fairly proactive in adjusting to structural shifts, technological changes and shifting the business model.

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