The pandemic remains an earnings event for reinsurers, but why?

Pandemic-related losses are large but reinsurers look to have avoided the worst. Will efforts to inoculate themselves against the pandemic in H1 continue to be effective into H2, and how will it affect the wider market? Intelligent Insurer speaks to Robert Mazzuoli, director at Fitch Ratings, to find out more.

As talk of imminently available COVID-19 vaccines grows louder, the results of the big four insurers offered another opportunity for longer-term optimism.

That’s not to say the results for the first half of 2020, the period hardest hit by the pandemic, were all sunshine and rainbows.

Reports from Munich Re, Swiss Re, Hannover Re and SCOR all revealed substantial additional claims related to the coronavirus pandemic. But the hit was not as bad as it could have been.

Capital remained resilient and all four reinsurers reported increasing price momentum for June and July 2020 renewals.

Robert Mazzuoli, director at Fitch Ratings, says: “Fitch believes that the pandemic remains an earnings event despite the high degree of uncertainty on ultimate losses.

“The underlying financial performance of the four major reinsurers remains strong, as does their capitalisation.”

Part of the reason for this is a “widespread desire” among the big four to protect earnings from pandemic-related claims and lower investment income, according to Fitch’s market analysis headlined “Pandemic-Related Losses Are Increasing for European Reinsurers” published on August 14, 2020. This desire led to an ever more disciplined approach among the reinsurers.

The report tempers its praise, adding: “Even before the pandemic, price adjustments were needed to reflect higher natural catastrophe claims and concerns over reserve adequacy and loss severity in casualty business lines.

“Any additional large losses in H2 2020, whether caused by manmade catastrophes, such as the explosion in the harbour of Beirut, or natural catastrophes, such as a hurricane hitting the US coast, will erode profits even more and as a consequence accelerate price improvements further.”

Reasons to be cheerful

Even with the high volume of claims that have been booked already in the first half of 2020, the profitability of at least three of the four has remained positive so far.

“They’ve been able to generate some profit so the losses have not yet eaten into the capital position of the reinsurers,” Mazzuoli tells Intelligent Insurer.

“This is also true for the investment impact, this means when you look at what rates have done, what volatility in financial markets has done, they have taken away a bit of the capital position—but the big four European reinsurers remain solidly inside their risk appetite framework.

“They are not constrained to raising capital, they’re not forced to cut back on business. That’s why I say this is an earnings event.

“Earnings are impacted but capital is not—or at least not to the extent that the companies or management teams would have to do something about it.”

The big four European reinsurers remain solidly inside their risk appetite framework.”
Robert Mazzuoli, Fitch Ratings

Capital status quo

Between them the big four reinsurers have raised $15 billion in capital, according to an estimate from Fitch Ratings, with more to come “as long as favourable market conditions persist”. But capital in the reinsurance industry remains basically unchanged despite COVID-19.

“For many years we talked about the market not really getting out of this soft market phase where there was one constraint or another,” says Mazzuoli.

“So capital raises this year under normal circumstances wouldn’t have happened to the same extent and certainly not added any capital to the market.”

He explains that what is new is that the market has, for technical reasons, alternative capital that does not provide any additional capital to the market.

“The arrangers of alternative capital have a hard time replacing maturing programmes, so alternative capital cannot be the answer at the moment for an increased need for additional reinsurance coverage,” he says.

He says there has been an element of decline in traditional capital because of lower interest rates in particular and higher volatility of credit spread and equity markets.

“That has consumed an estimated 3 to 4 percent of the traditional reinsurance capital. This includes the COVID-19 related claims.”

What has happened is that these gaps are now filled, Mazzuoli explains, so traditional capital including the capital raises remains where it was at the beginning of this year. This situation is linked to capital raises in the market.

“It also means that the hard market we see, which is not due to a constraint in capital, it is due to uncertainty related to your profit in the industry,” he adds.

Mazzuoli says it’s important to note because there was a risk back in the spring that financial markets would close down on the re/insurance sector.

“On the contrary—it has been very easy for them to place additional capital at very favourable conditions, so financial markets keep functioning.”

“Alternative capital cannot be the answer at the moment for an increased need for additional reinsurance coverage.”

COVID-19 claims shift

Pandemic-related losses vary between the big four insurers highlighting different business portfolio structures and methodologies to estimate incurred but not reported reserves. Fitch expects that additional claims will be booked in the quarters to come, with the focus moving away from event cancellation claims to credit and surety losses.

To get an idea of what to expect, Mazzuoli says probably the best reference would be to look at the 2009/2010 financial crisis.

“It’s the last big event when we had lots of bankruptcies and were seeing that the combined ratio in the credit and surety industry moved up to about 110 percent. That could give you an indication.

“History doesn’t always repeat itself and it remains to be seen what will happen this time.”

In 2020, he says, event cancellations happened fairly quickly but when the policies are renewed for 2021, pandemic cover will be taken out of this coverage. This is when losses are expected to switch to credit and surety.

When a recession happens, bankruptcies normally follow with a time delay as businesses try to survive for a quarter or two quarters.

“For the coronavirus recession the delay in bankruptcies is even more pronounced because governments have, in countries such as Germany, given companies more time to file for bankruptcy,” he says.

The extra time for struggling companies has been recognised in national governments’ legislation. “This will delay the surge in bankruptcies we’re going to see because of the recession.”

History doesn’t always repeat itself and it remains to be seen what will happen this time.”

The influence on the wider industry

Before COVID-19 the industry had already seen the start of a hardening market in commercial primary insurance because of increased losses in natural catastrophes and in US casualty. There had already been problem areas when huge underwriting losses forced insurers to take action to turn businesses around.

“Reinsurers are playing catch-up at the moment with primary insurers that, in principle, already have better technical margins in the business when you exclude the COVID-19 effects.”

Other than that there will be policy exclusions going forward, but that is probably something reinsurers have to discuss with their clients because reinsurers are not willing to keep pandemic exposure to the same extent as they did this year.

Mazzuoli says one thing that will affect primary insurers a bit more than reinsurers is the question around what the recession will do to premium volumes. Lower economic activity means falling premiums.

“This is something we will see over the next few quarters, and that might hit primary insurers a bit more than the reinsurers,” he says.

Like the news about potential vaccines, the outlook for the industry remains uncertain—even though the market is heading in the right direction.

Images (from top): / Montri Thipsorn, minicase