Dedicated reinsurance capacity continues to grow

Reinsurance available capacity and excess capital are the most useful measures of the segment’s capital. Our estimate of available capacity is not a simple aggregation of the shareholders’ equity of all companies that write reinsurance.

Pure reinsurers are a relative rarity, as most global reinsurers are engaged in business other than reinsurance, such as specialty insurance or other outside interests. Thus, not all a company’s capacity is allocated to its reinsurance business.

AM Best’s estimate of available capacity considers these allocations by line of business. Since year-end 2018, AM Best’s estimate of available capacity has been less than 60 percent of total shareholders’ equity, based on consolidated figures for groups identified as reinsurance writers.

As reinsurers continue to expand into primary lines, more in-depth analysis is required to determine these estimates.

Available capital increased in 2020

AM Best estimates that total dedicated reinsurance capacity increased by $35 billion (or 7 percent) from $482 billion on December 31, 2019, to $517 billion on 31 December 2020 (Figure 1). The increase is wholly attributable to the rise in traditional reinsurance capital, from $394 billion at year-end 2019 to $429 billion on December 31, 2020.

Figure 1: Global reinsurance–estimated total dedicated reinsurance capacity

Capital levels were influenced by events throughout a tumultuous 2020, a year that was punctuated by a pandemic still raging in many places during the second half of 2021.

The onset of COVID-19 brought significant volatility to the reinsurance segment in the first half of 2020, due mainly to equity market fluctuations and conservative initial incurred but not reported (IBNR) margins for COVID-19 losses. However, as 2020 progressed and countries implemented stimulus and economic-relief programmes, the equity markets rebounded, and interest rates decreased. This was particularly notable for the Top 10 reinsurers, which saw a 9 percent increase in fixed-income market values and a 19 percent increase in equity market values. These increases and other factors resulted in a growth in available capital of roughly 12 percent for the Top 10.

The influx of new capital into the reinsurance segment was widely publicised, but the overall impact of these new ventures was relatively restrained given the lag required to deploy the capital, along with relatively more attractive opportunities on the primary side. Market volatility stemming from the pandemic in 2020 had a significant impact on our biannual estimate of available capacity. At mid-year 2020, reinsurers’ investment portfolios were still in the process of recovering from the mark-to-market unrealised losses on both fixed income and equities in the second quarter. However, by year-end 2020, balance sheets had largely recovered with some of the larger reinsurers having significant unrealised gains.

The year-end 2020 increase in total dedicated reinsurance capacity is noteworthy given the loss-affected operating results across the industry. However, this is an absolute measure of total capital and not relative. Thus, given the size and diversification of segment investment portfolios (roughly 60.7 percent fixed income, 7.8 percent equity, 10.9 percent cash and short-term investments, and 20.6 percent other at year-end 2020), values can be driven heavily by investment markets.

Furthermore, the largest reinsurers generally have sophisticated and time-tested enterprise risk management (ERM) programmes in place to function in adverse conditions, such as the COVID-19 pandemic.

Our previous estimates for 2020 were relatively flat year over year, given the general uncertainty in underwriting results and investment market volatility throughout the year. The same applied to our original expectations as to capital utilisation, which approximates how much of the market’s available capital is required to maintain the risk-adjusted capitalisation at the strongest Best’s Capital Adequacy Ratio (BCAR) level of 25 percent at a value at risk (VaR) level of 99.6 percent.

We also track how much capital depletion is needed to reduce BCAR to 10 percent at 99.6 percent VaR. This measure approximates the tolerance afforded companies in extreme stress scenarios. Increases in the capital depletion buffers demonstrate the segment’s proactive management of tail-risk exposures, despite the ongoing deterioration in capital utilisation metrics for standard BCARs.

Capital depletion

A close look at the calculated available capital, relative to increases in required capital for the same segment, paints a much clearer picture as to how capital is being deployed (Figure 2). In 2018, capital utilisation rose to 80 percent from 75 percent in 2017, the result of a $4 billion reduction in traditional reinsurance capacity. In 2019, capital utilisation was flat at 80 percent, despite a $53 billion increase in traditional reinsurance available capital.

By year-end 2020, capital utilisation had increased to 82 percent following another year of strong available capital growth ($35 billion).

Figure 2: Global reinsurance–capital utilisation

Overall, available capital has grown approximately 24 percent since 2017, even though the buffer between available capital and risk-adjusted capitalisation levels has shrunk.

The smaller buffer is due to the increase in required capital stemming from hardening market conditions (such as increases in estimates for catastrophe exposures and loss reserves), plus asset volatility over the three prior years.

Required capital, as measured in BCAR, can be broken down into eight separate factors: fixed income securities, equity securities, interest rate, credit, net loss and loss adjustment expense (LAE) reserves, net premiums, business, and catastrophic—with an additional covariance adjustment to reduce the total level of required capital.

In 2020, the segment’s largest increase in risk (7 percent) was from catastrophes. This increase is largely model-driven, as most companies incorporate AIR, RMS, or internal model results into their capital models. Additionally, the segment realised a 3.8 percent increase in required capital from fixed income and 5 percent from equity securities.

Persistent volatility in both the fixed income and equity markets could further pressure capital, as risk factors adjust to the latest trends. The last factor of note is a 5.4 percent increase in net loss and LAE reserve risk. This figure is driven by numerous items, including US social inflation, declining redundancy levels globally, and uncertainty about COVID-19 claims.

The increased risk and associated required capital for traditional reinsurers continues to drive up capital utilisation levels. Although the largest reinsurers continue to find ways to expand the overall capital base with diversification strategies and access to cheap debt financing, hardening market conditions continue to stress overall risk-adjusted capitalisation levels. This is consistent with AM Best’s view that the segment is in the early stages of a hard market cycle.

As pricing conditions continue to improve and underwriting results become more favorable, we expect the required capital burden to diminish and capital utilisation levels to begin to fall.

Estimated available capital also up in 2021

AM Best’s estimate for available capital in 2021 includes a 3 percent increase in traditional reinsurance capital, to $441 billion, driven primarily by anticipated improvements in underlying (ex-cat) performance by many companies in 2020, which is expected to continue during 2021. This is a result of the ongoing rate increases in both primary and reinsurance lines since last year.

Although these pricing developments are a direct response to continued heightened catastrophic activity, coupled with adverse loss cost trends in casualty lines, the net effect is favourable (and more stable) underwriting results, a trend that AM Best expects will continue at least for the next couple of years.

Since 2012, AM Best has estimated the amount of global capital dedicated to supporting the reinsurance market. This estimate is a joint effort between AM Best and Guy Carpenter, with AM Best providing an estimate of traditional reinsurance capital and Guy Carpenter providing an estimate of third-party capital.

How we calculate total dedicated capacity

The data in the report is obtained through analysis of the BCARs of the Top 50 reinsurers. These BCARs are used to measure an individual company’s available capital and required capital. To adjust for organisations that provide capacity in both primary and reinsurance markets, we apply a haircut based on a company’s split of business and net premiums earned.

The haircuts for all 50 companies are then consolidated and grossed up by 10 percent to account for organisations that are not in the Top 50. The consolidation of these numbers results in AM Best’s estimation of traditional reinsurance capital, which we then combine with Guy Carpenter’s estimate of third-party capital, for the total dedicated reinsurance capacity. In addition to this process, AM Best estimates excess capital in the market.

The estimation of excess capital is similar to that of traditional reinsurance capital. The difference is that BCARs incorporate the impact of a catastrophic event at the company level. We then apply the same haircut, consolidation, and grossing-up procedure to the catastrophe-stressed BCARs. Finally, the consolidated figures are examined to determine how much available capital must fall before the market’s BCAR ratio falls below 25 percent at the VaR level of 99.6 percent, the strongest measure of BCAR in AM Best’s criteria.

This article is an excerpt from an AM Best market segment report “Global Reinsurance Outlook Remains Stable in a More Uncertain World”, published August 31, 2021.

Dan Hofmeister is a senior financial analyst at AM Best. He can be contacted at: dan.hofmeister@ambest.com Clare Finnegan is a senior financial analyst at AM Best. She can be contacted at: clare.finnegan@ambest.com