The reinsurance sector’s focus on strong enterprise risk management (ERM) frameworks is helping them weather the many headwinds hitting both the asset and liability sides of their balance sheets, according to a report issued by S&P Global Ratings.
These headwinds include lower reinsurance prices in the property-catastrophe and specialty market; competition from alternative capital sources; lower investment income; and emerging risks including more volatile and extreme weather and evolving regulations, said the S&P report.
Reinsurers must deal with complex, higher volatility risks across many regions and are typically one step more removed from these risks than their cedents, said the report titled “For Global Reinsurers, Stronger Enterprise Risk Management Is the Key to Success and Survival.”
In response to these risks, global reinsurers have invested heavily in various models, tools and methodologies, which enable them to act as proactive partners to insurers in their management of risk through risk transfer, S&P said.
ERM frameworks have “led to an increased focus on disciplined risk selection,” as well as conservative underwriting and investment asset allocation, despite the lower returns.
“We view reinsurers as well equipped to weather the headwinds they face, as reflected in our broadly stable outlook on the sector,” said S&P Global Ratings credit analyst Sridhar Manyem in a statement issued with the report.
Over the past few years, S&P said it has observed “significant improvements in global reinsurers’ ERM capabilities, especially in the area of risk/return optimization, capital modeling and understanding of catastrophe risk and its aggregation.”
Risk Models Differentiate Reinsurers
S&P affirmed that reinsurers are leading in their use of risk models “and have a longer track record for their use than in other sectors.”
“Reinsurers need to manage concentrations of risk that could creep up from various sources and prepare for stress scenarios that are typically at high confidence levels, which requires more reliance on statistical extrapolation than empirical data,” the report continued, noting that modeling therefore takes on more significance for reinsurers’ risk selection.
S&P noted that confidence and experience in using models is a key differentiator for reinsurers, which have seen their benefits as well as shortcomings over the years.
“Given that reinsurers are exposed to extreme tail risks, dealing with aggregate risks becomes more important—and extreme weather losses in particular could morph into capital events very easily,” the report went on to say. “Therefore, sophisticated modeling becomes a key survival tool.”
As these risk issues are more pronounced for reinsurers than for primary carriers, “reinsurers have led the way in risk modeling.”
Rapidly Changing Risks
ERM practices must be adapted as uncertainty and volatility become the norm, the report stated. “Some risks are accelerating, such as the potential for extreme weather events related to climate change; cyber risk and the ability of controls to keep pace with technology; capital market volatility; and evolving regulations reflecting various interests and differences among jurisdictions.”
The reinsurance industry’s ERM practices compare “very favorably to those of their primary insurance counterparts…,” added the report.
“We assess 33 percent of global reinsurers’ ECM as good or superior, compared to 5.3 percent of insurers in EMEA and 1.5 percent of North American and Bermudian insurers.”
In its ERM industry assessments, S&P assigns “very strong” scores to re/insurers with positive ERM subfactors such as risk culture, risk controls, emerging risk management, risk models and strategic risk management. Companies in this category also must have good or superior economic capital models (ECM).
S&P noted that primary insurers’ ERM frameworks are becoming more sophisticated, which means the gap between their capabilities and those of their reinsurers may narrow.
Although S&P views the developments in ERM favorably, “we are aware that these frameworks and new techniques have not been tested in recent years by historically stressful events, the likes of Hurricanes Katrina, Rita and Wilma in 2005, the reserve strengthening in the late 1990s, or periods of high inflation,” Manyem added.
“It remains to be seen how well these frameworks have prepared the industry for the hurdles that are sure to come.”