Reinsurance capacity grows despite low yield, competition

A return to an underwriting profit in 2012 enabled the global reinsurance market to continue its growth trajectory despite significant challenges.

Deterioration in investment yields seems to be the greatest immediate concern, as depressed interest rates have persisted longer than most market observers predicted. Near-term improvement on that front appears unlikely, unless companies choose to stretch for yield, taking greater risk on the asset side, according to a new special report by AM Best Co.

The overwhelming market response to this issue has been to keep fixed income duration short in an effort to insulate against interest rate risk and what appears to be an inevitable decline in market values. The segment has benefited from a run-up in market values on fixed-income holdings, associated with the previous decline in interest rates.

Reinsurers have harvested some capital gains over the period and have increased holdings of cash and short-term investments to maintain flexibility to reinvest easily at higher yields once more favorable interest rates return. How long that wait will be remains the question. Meanwhile, management teams have to plan and prepare for inflationary and deflationary environments.

In the interim, the weakened yield environment has increased pressure on underwriters to find better margin business while staying within their stated underwriting risk tolerances. This is difficult, considering the current view that the reinsurance and broader property/casualty markets are overcapitalised. The industry as a whole has recognised that achieving a 15 percent or even a low double-digit return on equity is challenging when the risk-free rate is in the low single digits.