AM Best
US-Bermuda reinsurers in good shape
The US-Bermudian reinsurance composite’s 2021 combined ratio improved six points over the prior year, but inflation fears may put a wedge in various assumptions, says Greg Dickerson of AM Best.
“A significant amount of US and Bermudian COVID-19 claims reserves are still incurred but not reported.”
Greg Dickerson, AM Best
AM Best’s composite of US and Bermudian reinsurers contains 20 reinsurance groups domiciled in either the US or Bermuda, for which the reinsurance business accounts for a substantial portion of the underwriting portfolio. The composite’s profitability improved in 2021, driven by wider underwriting margins and a larger contribution from investment results.
Net premiums written (NPW) grew a robust 20 percent in 2021, benefiting from significant rate improvements in most of the key business lines. In most areas, rate increases continue to be driven by a recognition that further pricing gains are necessary in order to generate adequate risk-adjusted returns on capital. AM Best projects that premiums for the composite will further increase in 2022, as demand has proved resilient, and rates in most key business lines continue to rise, although the pace is slowing (Figure 1).
The 2021 combined ratio of 95.8 represented a six-point improvement over the prior year. Much of the improvement in underwriting margins reflected a larger benefit of prior year reserve releases, which trimmed 6.1 points from the 2021 combined ratio, compared to 3.3 points in 2020. Notably, $2.8 billion of the composite’s total $4.5 billion favourable development was reported by General Reinsurance Corp.
Gen Re’s reported reserve development was driven largely by changes in internal reinsurance contracts with other Berkshire Hathaway affiliates and does not reflect downward revisions in claims estimates for prior accident years. Excluding Gen Re’s favourable loss reserve development from both periods, the impact of favourable reserve development benefited the combined ratio by 2.3 points in 2021 and 1.7 points in 2020.
Figure 1: Global reinsurance—US & Bermuda market financial indicators
Reserve development remains favourable
Favourable reserve development may very well continue. COVID-19 claims development has been minimal. What’s more, a significant amount of US and Bermudian COVID-19 claims reserves are still incurred but not reported. The composite has consistently reported favourable development the past several years, a relatively small portion of which has come from casualty lines.
If frequency and severity trends for recent accident years continue to track with current trends, favourable reserve development would benefit. Any optimism regarding reserve redundancy for recent accident years must be tempered by recognising that the current spike in inflation could continue for a prolonged period, which could undermine current projections for severity trends in long- or short-tailed business lines.
In 2021, natural catastrophe activity was one of the worst on record for global insured catastrophe losses. Despite higher catastrophe losses, the composite’s 2021 accident year (excluding prior year reserve development) combined ratio of 101.9 was 3.2 points better than the 105.1 in 2020. The year-over-year improvement was due partly to the impact of a decline in COVID-19 claims in 2021. Because of the ongoing improvement in reinsurance pricing, terms, and conditions, as well as the quiet Atlantic/Gulf hurricane season thus far in 2022, the composite should be able to improve upon its 2021 accident year combined ratio of 101.9, assuming that catastrophe losses in the second half of 2022 are not excessive.
“The era of catastrophe-focused traditional reinsurers appears to be over.”
Significant improvement in ROE
Higher underwriting income and a growing contribution from net investment income generated significantly higher net earnings of $12.5 billion, well over double the $4.7 billion recorded in 2020. The resulting 10.8 percent return on equity (ROE) for 2021 is a significant improvement over the prior five-year average of 4.5 percent.
Net income in 2021 was bolstered by $6.6 billion of pre-tax realised/unrealised investment gains—$3 billion higher than in 2020. Otherwise, the composite ROE would have been cut roughly in half. Given the poor performance of the capital markets in the first half of 2022, investment performance will probably not match that of 2021, although net investment income will benefit from higher reinvestment rates on fixed-income asset classes. The composite will need to generate solid underwriting results in 2022 if it is to a post a double-digit ROE for the year.
Underwriting leverage up
Underwriting leverage rose for the US and Bermuda re/insurance composite, as NPW growth of 20 percent outpaced equity growth of 6 percent. The composite’s NPW to equity ratio nevertheless remains at a manageable 0.7x. Equity growth was constrained in 2021 by share repurchases, dividends paid, and a decline in accumulated other comprehensive income stemming largely from higher interest rates that depressed valuations on companies’ sizable fixed-income portfolios.
AM Best expects underwriting leverage to increase further in 2022, due to a mix of continued rate improvement, the likelihood that GAAP equity growth will continue to be pressured by unrealised losses on fixed-income portfolios, as well as rising interest rates, compounded by the recent sharp declines in equity markets. Most US & Bermudian reinsurers remain well positioned to withstand some degree of capital erosion while still maintaining solid risk-adjusted capitalisation.
AM Best further expects that these companies possess sufficient liquidity to pay claims without needing to sell invested assets.
Ample capacity, so diversification and consolidation to continue
Capacity remains ample in many business lines, despite constraints in certain areas, particularly in frequency layers of natural catastrophe programmes, aggregate covers, and peak catastrophe zones in the US. Underwriters remain particularly cautious about Florida exposure, due to concerns about long-term structural issues in the tort system that appear unlikely to be resolved in the near to medium term.
The pricing environment for property catastrophe risks is improving, with non-loss impacted programmes often seeing double-digit rate increases and impacted programmes seeing much higher rate hikes, along with limit compression and higher retentions. Regardless, US and Bermudian re/insurers are more focused on growing their specialty and casualty portfolios, particularly in the excess and surplus markets, where pricing is viewed as well in excess of loss cost trends. Several companies have publicly stated their intention to either cut back on their property catastrophe exposures or exit the property catastrophe reinsurance market altogether.
The era of catastrophe-focused traditional reinsurers appears to be over, although there is catastrophe-focused capacity in the insurance-linked securities reinsurance and retro markets. A decade ago, several US and Bermudian reinsurers had catastrophe exposures that were either their largest or their sole line of business. Most of these companies have either diversified their portfolios and are no longer dependent on property catastrophe business or have been acquired and now operate as part of a larger and more diversified franchise.
Diversified reinsurers have not been immune to consolidation, as acquirers have been willing to pay sizable premiums to purchase solid companies with established market positions in attractive business lines. Mergers and acquisitions over the next several years may be driven by re/insurers’ desire to strengthen their positions in the primary markets, especially in specialty areas, as long as the rate environment remains attractive.
Greg Dickerson is an associate director of AM Best. He can be contacted at: gregory.dickerson@ambest.com
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