Fitch: Reinsurance Outlook Weakens; Small Firms' Ratings Exposed
These tough market conditions could lead to rating pressure on smaller, less diversified firms that are reliant on business lines that have seen profit margins diminish. Thinning underwriting margins will also leave the industry as a whole more exposed to an uptick in major loss claims.
We see profit deterioration as the key risk for reinsurers in 2017 due to the combination of excess capacity and the low investment yield environment. Reinsurers' investment portfolios often have an average duration of less than three years, so the need to regularly reinvest at lower yields can weaken investment returns significantly.
At the same time, competition means prices will continue to fall. While the rate of decline in some bellwether sectors such as Florida wind reinsurance has slowed to low single-digits, we believe this just reflects that cost of capital returns have fallen to virtually breakeven. Reinsurers are therefore likely to divert more of their underwriting capacity to those sectors where margins are currently more attractive, such as casualty. But this will lead to pricing pressure in these sectors, pulling down margins and contributing to lower profits for a significant number of reinsurers in 2017.
The majority of our reinsurance Rating Outlooks are Stable. This reflects our expectation that, despite pressure on earnings, most reinsurers will be able to maintain credit metrics commensurate with their current rating over the next 12-18 months. However profits at several companies have fallen considerably since 2012 and a further deterioration could result in downgrades or Negative Outlooks.
Thinning underwriting margins over the last four years have also made reinsurers' earnings more sensitive to even a modest uptick in major claims losses; we expect this to continue in 2017. An increase in 1H16 major losses led reinsurers to release prior-year reserves to supplement income. We believe the ability to generate a reserve surplus from earlier underwriting years will become ever more important and increasingly difficult. Surpluses will provide the flexibility to supplement future results, while a need to top-up reserves would be very difficult in a competitive and highly price-sensitive market.