S&P expects reinsurers to earn their cost of capital in 2024

Global ratings agency S&P Global expects the reinsurance industry to earn its cost of capital once again in 2024-2025, cementing its stable outlook view of the sector, but warns that discipline must be maintained amid casualty risks.

In 2023, the global reinsurance sector earned its cost of capital for the first time in four years, and S&P believes that companies are poised to earn their cost of capital again this year on the back of sustained favourable pricing and strong investment yields, as well as underwriting actions.

“Reinsurers’ earnings prospects are sound for 2024-2025 after strong operating results in 2023 and the first half of 2024, with the highest profit margins in many years amid favorable pricing in short-tail lines, healthy investment income, and strengthened capitalization with a buffer at the 99.99% confidence level,” says S&P.

According to S&P, the top 19 reinsurers produced a strong combined ratio of 91.5% in 2023, and this positive trend persisted into H1 2024 with reported undiscounted combined ratios in the low 80s to the low 90s.

The majority of global reinsurers now operate a hybrid model, benefitting from the diversification of their primary insurance operations, which has also helped to lower volatility in underwriting performance. This, combined with a reduced impact from natural catastrophe losses on the back of higher attachment points and a move away from frequency events, helped firms generate strong returns in both 2023 and the first half of this year.

“Given these strong returns, the reinsurance sector’s earnings exceeded its cost of capital in 2023 for the first time in the past four years and the second time in the past seven years. Last year, the return on capital was 14.4%, 6.5 percentage points higher than the 7.9% cost of capital. The last time the industry generated such returns was in 2009,” adds S&P.

The rating agency notes that full-year 2024 performance for reinsurers will largely depend on the Atlantic hurricane season, which ends on November 30th, with forecasts pointing to an above average season. Of course, for reinsurers it’s all about landfall and exactly where storms strike, and while firms can’t claim victory just yet, S&P excepts the sector to once again earn its cost of capital.

“Despite signs of moderation in property pricing, we think overall conditions are still favorable, and we expect the industry will continue to post strong results with a combined ratio of 92%-96%, including a catastrophe load of 8-10 percentage points and a return on equity (ROE) in the low to mid-teens in 2024-2025, barring any outsize catastrophe losses. We also forecast the sector will benefit from rising investment income, with expected net investment yields of 3.5%-4.0% in 2024-2025,” says S&P.

Despite the positive stance from S&P, analysts do warn that risks surrounding certain casualty lines’ loss reserves are looming for reinsurers.

S&P calls on reinsurers to remain disciplined and closely the watch the US casualty space and their reserves to avoid a repeat of the experience from 2002 to 2005.

Interestingly, fellow ratings agency Moody’s revised its outlook for the global reinsurance sector to positive from stable today, highlighting a combination of higher prices and tighter policy terms.

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