AM Best
Limited claims activity amid inflationary pressures for Latin America reinsurers
Political risk remains a key factor for reinsurers domiciled in the region, say Eli Sanchez and Guilherme Monteiro Simoes of AM Best.
“Regional reinsurers with expertise outside Latin America have shifted to a wide array of non-cat lines.”
Eli Sanchez, AM Best
Latin America contains several markets—Mexico, Guatemala, Costa Rica, Ecuador, Chile, and Peru—that are vulnerable to numerous cat events in both magnitude and frequency. However, in the past three years, large severity events have been few and have not resulted in major insured losses, questioning the need for the market hardening that took place at the onset of the COVID-19 pandemic.
Reinsurers have adjusted their product offerings by raising deductibles, narrowing coverages, and pressing for exclusions (with different degrees of success), as they try to expand net profits by retaining more risks.
In addition, most of the region’s large insurers have ample amounts of available capital as a result of exceptional results in 2021 and redundant reserves, which have given them the ability to expand their risk appetites.
As market hardening diminishes, some global reinsurers have followed the mandate of their parents to exit or limit their business in Latin America, pressured by a more conservative risk appetite that is less focused on cat-prone areas, or to target their capital in regions that justify price increases. These conditions have opened opportunities for domestic reinsurers and reinsurers outside Latin America to participate in lower layers of programmes. We are thus seeing new names coming into large reinsurance programmes.
The strategies of the domestic and global participants in the region differ. The slowdown in hardening conditions should be viewed with some caution, especially by domestic participants trying to fill the gaps left by global reinsurers. These programme gaps are being filled by either a diverse group of reinsurers or other global reinsurers, but communications with brokers and further detailed analyses of probable maximum losses remain key to further developing efficient and profitable reinsurance solutions in a market that could quickly incur insured losses as a result of earthquakes, hurricanes, or other events.
Regional reinsurers with expertise outside Latin America have shifted to a wide array of non-cat lines both in and outside the region, mostly fidelity and some other low-exposure liabilities. Some are cutting back on their cat exposures in the region, while others are limiting their exposures by either using retro structures or demanding stricter terms and conditions.
Figure 1: Latin America reinsurance—change in capital & surplus*
Market dynamics
Direct business (opportunities found by reinsurers, which are then underwritten by primary insurers), captive solutions, and automated faculties for external underwriters such as managing general agents are gaining traction as ways not only to diversify revenue sources but also to address market dynamics.
For example, some countries in Latin America are considered tax havens by German regulations, which discourage German reinsurers from conducting business through incremental taxes. As a result, segregated cell companies domiciled in non-tax haven territories do fronting for those businesses. And, in Nicaragua, capital outflows are extremely limited, so insurance groups with a regional presence there are limited with regard to the fungibility of their resources; a way to access the market there is through fronting with foreign reinsurers that are already registered in the country.
Reserve development in the region has been positive, owing to the dearth of significant cat events the last couple of years. COVID-19-related coverages such as business interruption have not materially deteriorated the balance sheets of Latin American reinsurers. Some domestic participants built up reserves in 2020 and 2021, while others have started releasing reserves, given the lack of any significant increase in claims.
Claims activity has been favourable for reinsurers’ income, but pricing and claims costs are still pressured, due mainly to the global inflationary environment. Additionally, currency depreciation remains a constant across the continent. Although most contracts are in US dollars, a decline in purchasing power owing to higher prices could continue to soften renewals for primary insurers. Large contracts for government-related risks are particularly sensitive in this regard, given the growing prominence of leftist governments, which could press for flat renewals or better conditions for coverages.
Rising interest rates could help improve net income if portfolio durations allow, depending on asset-liability management. Traditionally, risks in the region could allow for shorter terms, but most large and experienced participants will opt to either take longer terms on investments over reserve requirements or deploy less capital for reinsurance activities. So far, available capital has increased (Figure 1) due to favourable results overall, but investment portfolios are shifting from fixed income—including real estate—to either higher credit quality instruments or alternative asset classes.
Political risks remain a significant factor for reinsurers domiciled in Latin American countries, which are pressured by investment requirements in sovereigns with deteriorating credit quality. Although there has not been a flight of companies to less risky domiciles as yet, it is a constant in companies’ internal risk assessments.
Brazil’s reinsurance industry
In Brazil (which other than flooding has no significant natural catastrophe exposures that would be covered by re/insurance), domestic reinsurers with international catastrophe exposure are trimming their property catastrophe exposures, in line with global trends. However, their actions have yet to translate into meaningful underwriting profits or capacity growth.
Domestic reinsurers have been focusing on specialty lines (such as surety, oil and gas, marine, agricultural) and property and still have room to grow due to the relatively low insurance penetration in the country. The profitability of Brazil’s primary insurance industry is still higher than that of the reinsurance industry. Still, the largest player in the country, which accounted for 50 percent of domestic gross written premium in 2021, is dedicated exclusively to reinsurance; almost all of the remaining domestic reinsurance companies have a presence in the primary insurance market.
In Brazil, inflation is high at 12 percent (10 percent at the end of 2021) and continues to fuel loss costs, but incurred but not reported reserves increased 3 percent from 2020. Net premiums grew significantly, by 16 percent, with premium retention rising to 48 percent (after a significant decline to 44 percent in 2020), contributing to the increase in underwriting leverage of 104 percent, from 78 percent in 2020 (Figure 2).
Figure 2: Latin America reinsurance—local Brazilian reinsurers’ NWP leverage and premium retention
“Brazil’s regulatory framework continues to evolve towards a more open and less restrictive reinsurance market.”
Guilherme Monteiro Simoes, AM Best
The 42 percent jump in investment income over 2020 was not enough to offset the underwriting losses that have been incurred the past two years. Net premium retention and the increase in underwriting losses resulted in a double-digit decline in surplus in the domestic industry, down 12 percent in 2021, in Brazilian reais. This decline becomes even more significant when converted to US dollars: 18 percent.
For the domestic Brazilian reinsurance industry, surplus growth and the retention of profitable business remain key. Pricing remains favourable, with the help of the hard global reinsurance market and inflation, and despite the Central Bank of Brazil’s hawkish interest rate hikes, these have not been enough to generate profitable results for the industry. In a year of presidential elections aggravated by global instability, reinsurance groups are likely to find attracting capital from investors and increasing capacity difficult.
The most significant lines of business contributing to annual growth in 2021 were property, automobile, and agricultural reinsurance. Agricultural re/insurance can be considered natural catastrophe-like exposure, but innovative techniques are being used to monitor climate risks to which the sector is vulnerable. New technologies may help improve the operating performance of the agricultural line, which continues to incur underwriting losses.
As the industry continues to evolve, insurers and domestic reinsurers gross premium cession limits to occasional reinsurers skyrocketed at the end of 2019, to 95 percent from 10 percent. As a result, occasional reinsurers have posted significantly higher growth in the past two years, with a 94 percent compound annual growth rate, compared with 58 percent for the admitted reinsures and 17 percent for the domestics. Occasional and admitted reinsurers have had another tailwind in their favour: the Brazilian real was devalued further, strengthening their US dollar capacity versus the real.
Brazil’s regulatory framework continues to evolve towards a more open and less restrictive reinsurance market, allowing occasional and admitted global participants to access the market with greater efficiency, while maintaining strict regulatory metrics to protect policyholders.
Types of reinsurers in Brazil
Domestic: Fully compliant with local (re)insurance rules; partial right of first refusal in local primary business; a minimum mandatory percentage of business is ceded to them. Admitted: Domiciled abroad; files local financial statements; representative office. Occasional: Domiciled abroad (except for tax havens); recent regulatory change makes practically equal to admitted.
This article is an excerpt from an AM Best special report “Limited Claims Activity Amid Inflationary Pressures for Latin America”, published September 20, 2022.
Eli Sanchez is associate director at AM Best in Mexico City. He can be contacted at: eli.sanchez@ambest.com
Guilherme Monteiro Simoes is senior financial analyst at AM Best in Oldwick, NJ, US. He can be contacted at: guy.simoes@ambest.com
