Global reinsurers' very strong capital adequacy continues to provide the industry with a cushion against catastrophe risk exposure, despite insured losses from natural catastrophes being the highest on record in 2017, and fourth-highest on record in 2018, according to Swiss Re's Sigma. The magnitude of the 2018 losses--about 50% higher than reinsurers would expect in an average year--also helped push up prices at the 2019 April and June/July renewals. Property catastrophe rates increased by 15%-25% on loss-affected accounts.

S&P Global Ratings has noted that reinsurers' strategic reaction to the price uptick, amid heightened catastrophe activities, has diverged. Most of the top-20 reinsurers chose to increase their exposure relative to capital, to benefit from the slightly improved conditions. A few stuck with defensive measures, allowing their exposure to contract further, as they had in 2018. On average, reinsurers' property-catastrophe risk appetite at a 1-in-250-year return period rose to 29% of shareholder equity, but some reinsurers saw reductions of more than 5 percentage points.

Meanwhile, alternative capital growth seems to have paused, at least temporarily. This did not materially shift reinsurer's retrocession strategies.

The top-20 global reinsurers, which are listed in table 1, picked up about 20% of the total insured industry losses in 2018. We estimate aggregate losses in 2018 represent a level seen less than once in every 10 years (a 1-in-10-year loss) for the peer group. In aggregate, this peer group has budgeted catastrophe losses in 2019 of about $11 billion, or 7 percentage points of the combined (loss and expense) ratio. At this level, we forecast that this group would report pretax profits of about $22 billion in 2019, reflecting a consolidated buffer of about $33 billion before capital would be hit in a severe natural catastrophe stress scenario.

Chart 1

Chart 2

Although global reinsurers have maintained their underwriting discipline, we expect earnings volatility could be higher than historically observed, where exposure has increased. The 2018 natural catastrophe losses were 50% above the reinsurers' budgeted level, but slightly below the modeled annual loss expectation of $86 billion for the insurance industry reported by AIR Worldwide. We note that relative loss magnitude was closely aligned with the exposure riskiness ranking we developed for the top-20 global reinsurers.

The sector remains resilient to extreme events, but we expect a larger industry loss would hit more reinsurers. If a 1-in-100-year event hits, causing losses well in excess of $200 billion across the insurance industry, we expect only 12 of the 20 global reinsurers would maintain their current S&P Global Ratings capital adequacy level, as measured by our model.

2018 Event Losses Could Creep Into 2019

Claims following the costliest event in 2018--Typhoon Jebi--have seen significant unfavorable developments in 2019, which have affected reinsurers' earnings for this year. At the end of 2018, the industry had estimated losses from Jebi at $6 billion; by the first half of 2019, losses had been revised up to about $15 billion, making it the most costly Japanese typhoon on record, by insured losses.

Although the top-20 global reinsurers will likely be able to manage Jebi's loss creep, further material developments could yet occur. We already expect it to represent more than 15% of their catastrophe budget and estimate a return period of more than 1-in-40-years for the event (see chart 3).

Chart 3

Jebi is an important reminder of the significant uncertainty associated with early loss estimates. Although initial loss estimates for some large events in 2017 (such as Hurricane Harvey) proved conservative, other claims developed negatively (Hurricane Irma) (see chart 4). If the industry were to experience a mega event, beyond $50 billion loss, the risk and uncertainty stemming from substantial loss creep could be significant. A risk that we think the industry should better prepare for post an event.

Chart 4

Appetite For Catastrophe Risk Is Rising

More than half of the top-20 reinsurers are more exposed to property catastrophe risk than last year, partly because of exposure growth and partly through capital deterioration (see charts 5 and 6). Although some individual reinsurers made material exposure changes, across the peer group, we estimate that capital-at-risk exposure rose to 29% of total shareholders' equity exposed in January 2019 from 27% in the same period in 2018.

The positive price movements inspired about half of the top-20 reinsurers to increase their absolute net exposure to a 1-in-250-year aggregate loss by more than 10%. Meanwhile, as in 2018, some reinsurers chose to reduce their exposure to extreme events by more than 5 percentage points.

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Loss Volatility In 2018 Matched Our Expectations

Industrywide, 2018 losses averaged about 0.8x of the annual normalized earnings and affected about 7% of shareholders' equity at year-end 2017. Reinsurers' individual experiences align well with our expectations, which we derive from our annually updated catastrophe exposure metrics. The most-exposed reinsurers in 2018, in terms of both earnings and capital, appear on the right hand side in chart 7.

Earnings-at-risk exposure remains flat, at 0.55x profit before tax in 2019 (0.56x in 2018). We estimate that a 1-in-10-year aggregate loss would be equivalent to global insured losses of about $100 billion. Although the industry would likely report profitable results under this stress level, an aggregate loss of this magnitude would be a capital event for a few of the global reinsurers. This was demonstrated in 2018, when aggregate losses were less severe. Losses from natural catastrophes wiped out earnings for five of the top-20 reinsurers last year.

Chart 7

Retrocession Retains A Vital Role

Retrocession remains a flexible way to shift exposure quickly. Although the market for retrocession has also shown signs of price hardening, with significant rate increases, reinsurance utilization by primary reinsurers has been flat. As of Jan. 1, 2019, insurers were choosing to reinsure about half of their 1-in-250 exposure, on average. We consider reinsurers typically take a strategic view of cover, over the medium term. Nonetheless, we now see less arbitrage opportunity in buying retrocession than two or three years ago. At that time, reinsurers were seizing the opportunity to access alternative capital, which offered a good spread against the inward exposure. Consequently, further rate hardening could lead global reinsurers to gradually cede less of their exposure in the future.

The average utilization conceals a wide spectrum of coverage (see chart 8).

Chart 8

Buffers Remain Sufficient, For Normal Years

Given the catastrophe losses of the past two years, we examined the sector's earnings and capital resilience to assess what effect further losses might have, at an aggregate level. Based on data from the top-20 reinsurers, we estimate that the sector would post profits before tax of about $22 billion in 2019 if natural catastrophe losses were at the budgeted level of about $11 billion. This represents about 7 percentage points of the sector's combined ratio for 2019.

In a severe stress scenario, this implies that the sector has a buffer of about $33 billion ($22 billion plus $11 billion) before its capital would be depleted, assuming no dividends or other shareholder returns. For reference, the top-20 companies paid out about $9 billion in dividends and share buybacks in 2018. An earnings or capital event at an individual company could be triggered earlier, depending on its relative exposures.

An aggregated loss experience equivalent to 1-in-10-years is likely to be about $19 billion for the peer group. This is well above the $11 billion natural catastrophe budget for the year, and so would hit the sector's earnings. That said, most insurers would not see this as a capital event.

By contrast, an aggregated loss experience equivalent to 1-in-50-years, implying losses of around $35 billion, would probably imply a capital hit. It would exceed both the annual catastrophe budget and the assumed earnings for 2019 (see chart 9).

Chart 9

Based on their average loss market shares for the past two years, we expect profit before tax, including the catastrophe budget, at most reinsurers would be sufficient to absorb industry losses up to an aggregate of $150 billion, or roughly 1-in-30 to 1-in-40 years loss (see chart 10). That said, reinsurers with higher risk appetites and subdued returns would likely see their profit before tax depleted more quickly than peers.

Chart 10

Capital levels at individual reinsurers also vary. In line with our aggregate view for the sector, we expect more than half of reinsurers to sustain their S&P Global Ratings capital adequacy in a 1-in-100 year aggregate loss. That said, eight reinsurers could experience a deterioration in their S&P Global Ratings capital adequacy in such a scenario, unless they took action to manage capital levels (see chart 11).

Chart 11

What If The Market Turns?

If reinsurance markets get firmer, the temptation to expand exposure will strengthen. Reinsurers' attitudes to catastrophe risk are already diverging. Some reinsurers have reacted to the improved premium rates by taking on increased catastrophe risk, while others appear to be more defensive. Combined back-to-back record years for natural catastrophe losses may have caught them off guard. We expect this divide could widen if rates harden.

Although indications that reinsurers are relaxing their underwriting discipline remain weak, reinsurers will face difficult strategic decisions if the cycle starts to turn. Overexposure risks their balance sheet and earnings, but underexposure will cause them to miss out on the higher returns that the property catastrophe space might offer. Reinsurers will need to find the right balance.

Table 1

GRH2019