Fitch: Latin American Reinsurance - Managing Through the Global Headwinds
Despite these conditions, the agency expects Latam reinsurers' ratings will remain stable. Our base case scenario is that over the next 12-18 months most Latam reinsurers will maintain overall adequate profitability and capitalization despite softening prices, and that any declines in earnings will be within the ranges that current ratings can tolerate. Fitch expects to affirm ratings for most Latam reinsurers, though a couple of highly leveraged companies could suffer downgrades or be given Negative Outlooks.
On the other hand, growth forecasts for some of the largest Latam economies have been reduced given their vulnerability to macroeconomic factors. Interest rates hikes due to inflation have been common, resulting in slower growth forecasts for the insurance market, which reduces reinsurance demand. However, a strong franchise, market position and deeper knowledge of regional markets have left the major reinsurers well placed to adapt and profit from the changing market.
In Fitch's opinion, soft market conditions in Latam reinsurance will continue to reflect global pricing conditions, with no convincing signs that a price floor has been reached. Given its small size in global terms, the Latam reinsurance sector tends to follow trends, and has no influence on international prices. In addition, 2015 insured global catastrophe losses decreased for a fourth consecutive year and were at their lowest levels since 2009, thus weakening reinsurance demand.
Fitch expects that while higher investment yields will favor profitability, the effect will be outweighed by adverse market conditions. Major Latam economies have raised interest rates as a means to offset high inflation levels. However, as these result in higher investment portfolio yields, they also reduce the value of fixed-rate securities. This could become a concern if reinsurers do not have sufficient liquidity to face a sizable loss event and need to sell investments at a loss.
Fitch's central scenario expects that Latam reinsurers' capital and liquidity will remain strong, but with profitability deteriorating in 2016 and 2017. This could be driven by further softening in pricing, low net financial income, unexpected shifts in loss ratios, reserve deficiencies, or if pricing proves inadequate to respond to a sizable loss event in the region.
According to Fitch, persistent increases in loss ratios from higher inflation levels, or a high-magnitude catastrophic loss event with significant unrealized investment losses from asset quality deterioration and/or restrictions on upstream dividend payments and other capital movements, could leave balance sheets more exposed to adverse events. It would also be a concern if reinsurers lack sufficient liquidity to pay claims and need to sell investments at a loss and/or raise new capital at a higher cost.