ILS likely to contribute to reinsurance pricing drop: Fitch
The growth of insurance-linked securities (ILS) – capital market investment vehicles backed by insurance policies – will contribute to a further decline in reinsurance pricing during 2018, according to Fitch Ratings. ILS and other sources of reinsurance capacity have already dented pricing in the sector. The decline may lead to rating downgrades for some reinsurance companies, Fitch said. Conversely, the ratings firm predicts the market for catastrophe bonds will remain favourable as investors look to diversify risk. 

Pricing in the global reinsurance sector will continue declining throughout 2018 as competition from alternative sources of reinsurance capacity intensifies and margins across the sector deteriorate further, according to analysis by Fitch Ratings.

The current low-interest rate environment is expected to remain, dampening returns on the investment side of the balance sheet as underwriting profits come under increasing pressure from falling rates and intense competition.

Fitch expects pricing in the reinsurance industry to deteriorate in 2018 as alternative capital, or insurance-linked securities (ILS) intensifies the competition for reinsurance business.

“This will mainly be driven by the collateralised reinsurance segment, where funds are likely to expand their reinsurance capacity at lower pricing margins,” explains Fitch.

Furthermore, Fitch expects that market conditions will likely remain favourable for catastrophe bond issuance in 2018 as investors look to diversify risks, on the back of what’s set to be a record year for cat bond issuance after an impressive Q2 for the expanding sub-sector of the broader ILS arena.

Fitch warns of “shrinking headroom” for global reinsurance companies, exacerbated by the impacts of hurricane Harvey and further deterioration of pricing metrics. However, the ratings agency doesn’t expect any substantial impact on ratings over the next 12 to 18 months, but warns that the deterioration of the pricing environment beyond its expectations, could lead to some negative actions.

Discussing hurricane Harvey, Fitch notes that a relatively light opening six months for catastrophe losses across the industry should assist companies’ as they absorb losses from the event, which brought record-levels of flooding to Houston, Texas.

Fitch doesn’t expect the losses to be enough to turn the market from its soft state and have any impact on pricing outside of the directly affected regions, and overall, expects much of the loss to be retained by primary insurers and be more of an earnings event for the reinsurance sector.

However, Harvey does leave some companies with perhaps a smaller catastrophe budget for the remainder of the year than desirable, which suggests that above-average catastrophe losses for the remainder of the year could push some firms into a very challenging position, to say the least.

“Combined with low investment yields, which are likely to persist in 2018, the significant decline in premium rates over the last few years has made it harder for reinsurers to write business at a profit margin that exceeds their cost of capital. Their ability to use prior-year reserves to mitigate the pressure on operating profit is also dwindling, and we do not expect firms to be able to maintain reserve releases at their current levels in the medium term,” warns Fitch.

For the reinsurance companies that Fitch monitors, it expects the group to report a combined ratio of 96.9% in 2018, and an operating ratio of 89.9%. However, should these ratios rise to above 100% and 90%, respectively, in the mid-term, Fitch could revise its rating outlook for the sector to negative.