Global reinsurers may be emerging from the economic crisis with relatively strong balance sheets and operating performance, but a number of issues may impact the sector’s ability to remain viable, such as a convergence of market pressures, low interest rates and tightening financial and market regulations.
According to a report issued by Standard & Poor’s Rating Services, life reinsurers in particular will face numerous challenges that may erode the health they’ve enjoyed. The report, "The Sluggish Economic Recovery and Emerging Regulatory Changes Are Reshaping The Life Reinsurance Landscape," maintains that a slow economy is forcing life reinsurers to deploy limited capital resources cautiously.
"In addition, the uncertain implications of emerging accounting and solvency standards around the globe for both direct companies and life reinsurers are keeping the industry from venturing too far from familiar, traditional risks," notes Standard Poor's credit analyst Robert Hafner.
Hafner points to market dynamics that reduced direct insurance sales as eroding life reinsurers' pricing power slightly, “contrary to our expectation last year that their pricing power could improve and meaningfully expand available opportunities.” According to S&P, life reinsurers' pricing power on traditional risks will not change substantially—favorably or unfavorably--during the next year. However, these same circumstances reinforce a long-held belief that life reinsurers will likely expand into new markets and new products to maintain growth opportunities as the global economy stabilizes.
The ratings agency blames a sector under-prepared to cope with the effects on their variable annuity exposures from an equity market decline as severe as actually occurred because the possibility of such an event was not considered sufficiently plausible. Reinsurers, notes S&P, fared better than direct writers because reinsurers accepted relatively limited amounts of variable annuity risk. "As the industry moves in other new nontraditional directions, we believe that the more successful players will learn from their missteps in taking on nontraditional variable annuity risks and exercise appropriately high levels of prudence and caution," Hafner added.
The issues facing global reinsurers (sluggish economy, low interest rates and regulatory compliance pressures) may be exacerbated by any significant catastrophes, including hurricanes that develop in what’s predicted to be an active season in the Atlantic basin.
“Prudent reinsurers are looking at every aspect of their operations’ capital management, underwriting discipline, the size of their balance sheets and even their countries of domicile,” notes A.M. Best Co., which listed the following predictions for the global reinsurance market:
-- Insurers and reinsurers continue to prepare for Solvency II, the European Union¹s new solvency directive, which A.M. Best Co. believes will drive business to highly rated reinsurers.
-- The implications of Solvency II are expected to extend beyond the European Union to jurisdictions such as the United States, Switzerland and Bermuda, which will seek equivalency in their solvency regimes.
-- Bermuda also faces U.S. government scrutiny of perceived tax advantages for subsidiaries of offshore companies--a perennial debate that could lead to limits on the tax deductibility of reinsurance premiums that U.S.-based, foreign-owned insurers pay to non-U.S. affiliates.
-- Despite seemingly ripe conditions for consolidation--excess capital and a soft market--the bleak outlook for profitability has reinsurers across the board trading near or below book value, which constrains the market for mergers and acquisitions.
-- New private equity investment in the sector has been slow, and the next market moving event may trigger an altered cycle of capital infusion marked by the use of temporary capital such as sidecars.
-- Uncertainty over prospects for inflation or deflation is challenging insurers in their capital management to bet on one scenario or the other.
A.M. Best says that despite these challenges, the reinsurance industry remains well capitalized, noting that underwriting discipline and the ability to maintain pricing integrity will likely be factors in reinsurers’ success at managing current market conditions. The rating outlook for the reinsurance segment, which remains stable, indicates that A.M. Best continues to anticipate that the majority of reinsurers¹ ratings will likely be affirmed over the next 12 to 18 months.
Moody's Investors Service, however, says in its recently published “Global Reinsurance Outlook” that fundamentals for the sector are more likely to weaken than improve in the next 12 to 18 months as the sector will be challenged by soft pricing, overcapacity, and low investment yields. However, Moody's notes that this view is already reflected in the ratings and outlooks assigned to individual firms.
In 2009 reinsurers' book value increased due to the recovery in the capital markets and low catastrophe losses, and balance sheets have remained strong despite much higher losses this year related to events such as the Chilean earthquake and the Deepwater Horizon oil rig disaster. At the same time, however, demand is sluggish, reflecting slow global economic growth.
"With premium volumes drifting lower and equity positions holding steady, we believe the industry has too much capacity, which is likely to manifest in increased price competition going forward," says Moody’s VP, Sr. Credit Officer James Eck, the lead author of the report. He adds that renewal prices continue to decline for most property and casualty lines, and that the path of least resistance will lead to even lower pricing in the absence of a transformational catastrophic event.
While the U.S. remains an important market, Europe and Bermuda continue to vie for the top spot among reinsurers that are launching their businesses or considering a change of address, notes an article published by Standard Poor's Ratings Services, titled "Choosing A Domicile Remains A Hot Topic For Global Reinsurers.” From the mid-to-late 1990s through 2007, Bermuda was the location of choice for reinsurers that were setting up new businesses, notes Standard & Poor's credit analyst Laline Carvalho. “Start-up activity on the island was particularly strong in 2001 to 2002 following the Sept. 11, 2001, terrorist attacks, as well as in 2005 to 2006 after Hurricanes Katrina, Rita, and Wilma. However, the number of reinsurers—many of which offer a combination of insurance and reinsurance products—that are moving to establish their business in Europe has risen over the past few years. Europe historically has been home to some of the largest and most well-established reinsurers in the world. And though Bermuda had gained prominence as a domicile of choice, we are now seeing a significant shift back toward Europe."
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