Reinsurers’ returns just 1.2% above their cost of capital

In the first half of 2017, the reinsurance sector generated returns only 1.2 percent above its cost of capital, according to a new report by S&P Global Ratings.

Excluding heavily catastrophe-exposed years, this is the lowest excess in more than a decade, the rating agency said.

The report, called Global Reinsurers' Returns Dwindle Ever Closer To Their Cost Of Capital, proved that the lengthy period of low investment returns, combined with further softening of the property/casualty (P/C) underwriting cycle, is eroding reinsurers' profitability.

It said that while global reinsurers' cost of capital has consistently fallen in recent years, it appeared to have reached a floor at end-2016. Meanwhile, operating conditions for the global reinsurance sector remain difficult.

“In our view, reinsurers' ability to earn returns above their cost of capital has declined significantly,” S&P said. “The sector's return on capital stood at 8.6 percent in 2016, and we expect it to drop to around 5 percent -7 percent by year-end 2017.

“Meanwhile, the sector's cost of capital stood at 6.5 percent at the end of 2016. We anticipate that the sector's cost of capital will increase marginally throughout the rest of 2017 and in 2018. These trends indicate that, even if prior-year reserve releases remain favorable for the next two years, reinsurers are likely to barely cover their cost of capital under a normalized level of natural catastrophe losses.”

The rating agency also noted that it is seeing signs that prior-year reserve releases could decline; some reinsurers have already demonstrated this during 2016 and after the lowering of the UK's Ogden discount rate during the first quarter of 2017.

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