Despite the global reinsurance sector’s “robust capital position” and “very high rate rises,” which are expected to “carry on for the remainder of year, and continue for major renewals in 2021,” S&P Global Rating’s credit outlook for the sector will remain negative this year.

“We expect more negative rating actions over the next 12 months,” S&P director and lead analyst Ali Karakuyu told journalists during the ratings agency’s virtual 2020 Monte Carlo Global Press Briefing, held on Tuesday.

“The negative outlook is also because, in the last couple of years, the sector’s underwriting performance, even excluding natural catastrophe events, has been deteriorating,” Karakuyu said. “COVID-19 added pressure, and the impact of lower-for-longer [interest rate policy] placed more pressure on investment yields, and for reinsurers to produce underwriting profits.”

Karakuyu said S&P believes that, once again in 2020, the global reinsurance sector won’t earn its cost of capital. “For 2020, we expect the sector to post an underwriting loss, with a combined ratio between 103% and 108%, and a very low return on equity for this year, from 0% to 3%.”

Reinsurers ‘Proactive’ on COVID-19

The negative outlook remains in place despite several positive judgements S&P made about the sector during what was an otherwise upbeat briefing. On COVID-19 claims, for example, “the reinsurance sector has been proactive” in its reserving, with 70% to 80% of recent reserves posted for incurred but not reported (IBNR) claims, Karakuyu said.

With the worst of COVID-19 now behind it, S&P expects the sector to deliver a 2021 combined ratio of 97% to 101%, and a return on equity of between 5% and 8%. “We appreciate there’s a lot left to happen on COVID-19,” Karakuyu said, “but year to date, based on what we have observed for the wider insurance sector, it is reasonable to assume the industry loss estimate is $35 to $50 billion, for a combined-ratio contribution of 6 to 8 percentage points.”

Excluding COVID-19’s impact, S&P’s 2020 combined ratio forecast falls to the narrower, profitable or break-even range of 97% to 100%.

Robust Capitalization

“Mitigating the pressures the sector is facing is its capitalization,” Karakuyu said. “The global reinsurance sector’s capital remains robust, although for some players, with COVID-19 and financial markets volatility, losses have hovered near a hit to capital. But the sector really benefitted from entering the year with a robust capital position.” The reinsurance sector includes “well diversified companies in terms of lines of business and geography,” he added.

Reinsurers are aware that investment “will be a pressure point on profitability,” the analyst said, before praising reinsurers’ remedial actions on reinsurance pricing. “2017 and 2018 were very heavy natural catastrophe years. 2019 was loss creeps and the lower-for-longer theme.” The sector “had to do something about it,” Karakuyu said, “and to the extent that it has been possible, has been putting through price increases.”

Rates ‘Catching Up’

He revealed that S&P’s discussions with reinsurance company managements show them to be “quite comfortable with the increases,” which they believe are “catching up with pricing inadequacies” of the past several years.

“We have seen very high rate rises on the back of COVID-19… and hardening in reaction to the natural catastrophes, and capacity constraints,” he said. “When we form our view on earnings projections, we think this will carry on for the remainder of year, and continue for major renewals in 2021.”

The consensus among reinsurance companies is that the sector needs to continue to push through rate increases. Asked about the quantum of these expected rate rises, Karakuyu said, it is “difficult to say in terms of a generic rate rise.” Those seen so far have been “quite regionalized.”

He expects price increases “in the low or mid single digits for the upcoming major renewals, but in loss-affected areas we could see substantial rate rises still, depending on the COVID claims, and what happens for the remainder of the year.” He noted that some loss-hit areas have attracted rate increases “as high as 80%.”

Negative Outlook

This success and continued resolve notwithstanding, “rate rises are still catching up with historical pricing inadequacies,” Karakuyu told the virtual press conference. “If rates had not gone down as much as they did, it would be difficult to justify a negative outlook.”

He explained that the reason for the negative outlook is: “We think that the level of rate rises may not be sufficient, one, for the catching-up, and two, for the U.S. casualty situation and the even lower interest rate environment.” Uncertainty remains over the extent to which the sector will navigate this combination of factors to eliminate the threat, and take action to protect capital and ratings, Karakuyu said.

S&P takes a prospective view on what could happen, he explained, considering the uncertainty over how its rating levels could move. “We are not saying the sector will find it difficult to pay its claims, but that there is potential pressure that these ratings could drop.”

Regardless of the reinsurance sector’s performance, S&P’s negative outlook will not be revised this year. “If we see signs that the sector is going to meet its cost of capital on a sustainable basis through good earnings, we may revise our outlook back to stable, but this will not happen until 2021,” Karakuyu said, reiterating: “The sector is not going to meet its cost of capital in 2020.”

Buffer Depleted

Further explaining the negative outlook, S&P Global Ratings Associate Director Charles-Marie Delpuech said: “A lot of the reinsurance sector’s buffer to absorb catastrophe losses has disappeared.” He said “any loss event [in 2020 in addition to COVID-19 losses] above $55 billion will become a capital event for many.” Clarifying this, he said, if a loss event of between $60 and $70 billion were to occur, “some reinsurers would post a loss, and the wider reinsurance sector would face pressure.”

“A big hit to capital means the big players will automatically face pressure,” Karakuyu said, “but we don’t want to be fixated on one year. We need to take a step back. We want ratings to add value and be prospective,” he said, adding: “The sector has been quite disciplined in doing what they need to

*This story ran previously in our sister publication Insurance Journal.