A.M Best maintains negative outlook for reinsurance, expects slight recovery

A.M. Best is maintaining its outlook for the reinsurance market segment at negative but expects overall market conditions to actually improve slightly over the near term, following the catastrophic events that occurred in the third quarter of 2017. The main reason for maintaining the negative market outlook for the near term is the considerable uncertainty surrounding the level and sustainability of any improvement in the reinsurance market’s environment.

Earnings going into the third quarter had already been depressed compared to historical trends because of ongoing market challenges that suppressed current accident year underwriting performance, which, together with lackluster investment returns, has served to drag operating and overall performance for the sector to a level only marginally sufficient to cover the average cost of capital for many reinsurance-predominate companies.

The negative impact of catastrophe losses on underwriting earnings in 2017 has further eroded the segment’s historical earnings, although the market’s capacity to absorb these events has once again proven resilient, and balance sheets remain solid going into the critical January 1, 2018, renewal season.

At this point, A. M. Best estimates a combined ratio of approximately 110 percent and an ROe of -1 percent for the full year 2017 for the global reinsurance composite, and a meager ROe of approximately 8 percent based on a five-year average through 2017. This does not factor in the potential for further adverse loss reserve development (on top of the losses reported thus far from the recent catastrophes), a scenario that seems probable given the difference between insured losses reported and the various modeling firms’ estimates of what the reported insured losses should be. When considering recent years’ performance relative to the average cost of capital for the sector, we see a need for a sustained improvement in market conditions, and the events of 2017 should serve as a catalyst for that improvement.

A. M. Best is concerned that property catastrophe pricing is somewhat at the mercy of the alternative capital market and is not as heavily influenced by the traditional reinsurance market as it historically has been the case. This is an important distinction as regards current market dynamics.

Any near-term improvement in the market may be relatively short-lived given the current level of excess capacity in the overall market today.

This is compounded by the continued inflow of alternative capacity that was seen in the fourth quarter of 2017, which has helped offset the collateralized capacity that is currently trapped until losses from 2017 work their way through the settlement process.

Nevertheless, we see some potential positive factors that could favorably impact the reinsurance market over the near term, which may be sufficient cause to revise our market outlook from negative to stable.

The 2017 events have proven to be a significant test for alternative capital, which up to this point had enjoyed significant profits attributable to relatively benign catastrophe losses in the U.S.