The global reinsurance sector has generated weak underwriting results in the past four years (2017-2020), and 2021 is shaping up to be another below-par year. The industry continues to suffer from higher-frequency and -severity natural catastrophe losses, fueled by rapid urbanization and climate change. In addition, this year is likely to be the fifth in a row in which the top 21 global reinsurers rated by S&P Global Ratings exhaust their annual natural catastrophe budgets. The COVID-19 pandemic has further worsened industry losses, especially among these top reinsurers. Overall, this cohort of reinsurers generated more than 70% of the global net reinsurance premiums written in 2020.

Despite the elevated losses, the industry's capital adequacy has been robust and remains redundant at the 'AA' confidence level, aided by capital raises and financial markets' recovery. However, the industry still faces secular challenges and competitive market dynamics, remaining fragmented as it battles the commoditization of its business. Once a competitive advantage, capital now is viewed as a relatively cheap commodity because of the influx to the sector from nontraditional sources, sustained by dovish monetary policies.

Still, reinsurers have struggled to earn their cost of capital (COC), and 2022 could follow the same trend. As a result, we maintain our negative outlook on the global reinsurance sector. This outlook reflects our expectations of credit trends over the next 12 months, including the distribution of rating outlooks, existing sectorwide risks, and emerging risks. As of Oct. 25, 2021, 29% of ratings on the top 21 global reinsurers were assigned negative outlooks, 62% were assigned stable outlooks, and 9% were assigned positive outlooks.

Many reinsurers have adopted a hybrid model, writing both reinsurance and specialty insurance to hedge against the challenges of the reinsurance sector. Indeed, an increasing number of the top 21 global reinsurers are expanding their insurance more than their reinsurance business, taking advantage of better pricing on the primary commercial side while aiming to reduce volatility.

We believe reinsurance pricing momentum will firmly support premium rate increases during 2022 renewals, given the sector's recent underperformance, although the pace of rate increases may slow, in part due to ample capacity. While capital is not in short supply, reinsurers overall have shown discipline in capacity deployment so far, leveraging their alternative capital vehicles to manage their peak natural catastrophe zone exposures.

Reinsurers also continue to push for higher premium rates wherever they can take them in property/casualty (P/C) lines, with terms and conditions remaining in sharp focus, especially for the exclusion of pandemic and silent cyber coverage. However, reinsurers are only price-takers in this insurance cycle, since this time the primary market is leading pricing dynamics. While the recovery of economic and social activity has generated optimism, reinsurers remain cautious about reserve adequacy in view of casualty loss trends for business written during the recent soft cycle, as well as given inflationary pressures, potential COVID-19 loss developments, climate change, and the risks of investing in uncertain times.

Top 21 Global Reinsurers Bogged Down By Close To Half Of COVID-19 Losses

According to Johns Hopkins University School of Medicine, as of Oct. 25, 2021, global COVID-19 cases totaled about 244 million and had resulted in more than 4.9 million deaths. As a result, the global insurance industry suffered about $44.6 billion of COVID-19-related insured losses through 2020 and the first six months of 2021. The top 21 global reinsurers shouldered about $21.6 billion, or close to half, of the aggregate losses--82% from P/C re/insurance and 18% from life reinsurance. The outsize proportion assumed by this group of reinsurers reflects their triple exposure through P/C and life reinsurance as well as primary P/C commercial insurance.

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Unexpected lockdowns dramatically affected the economic and ultimately global pandemic insured losses. Of reinsurers' COVID-19-related booked reserves, 75%-80% are mostly incurred but not reported losses and include lines of business such as business interruption, event cancellation, credit (including trade credit, surety, and mortgage), mortality, professional liability, travel, and general liability.

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Most U.S. standard business interruption policies cover losses only from physical damage events and in the most part exclude communicable diseases. So far, insurers have been successful in U.S. federal courts in defeating COVID-19-related business interruption claims. However, outside the U.S., especially in the U.K., Continental Europe, and South Africa, the policy language wasn't clear, resulting in business interruption losses materially affecting re/insurers exposed to those markets.

The bulk of the total P/C reinsurance pandemic losses were booked in the second quarter of 2020, followed by an uptick in the fourth quarter and smaller amounts in the first half of 2021. Life reinsurance COVID-19 losses were first reported in second-quarter 2020 and continued to affect quarterly results through the second quarter of this year. We believe overall conditions are still fluid. COVID-19-related industry losses could further develop over the next few quarters, especially in the life reinsurance segment, given highly contagious variants of the virus.

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Reinsurance Pricing: Onward And Upward!

This year renewals have again shown rate increases across most lines, spurred by casualty loss cost trends, natural catastrophe losses, and uncertainty about COVID-19 losses (even though P/C pandemic losses in 2021 remain contained). During January renewals, the reinsurance supply-demand equation was mostly balanced. Prices for U.S. excess-of-loss P/C loss-affected reinsurance policies were up by 5%-30%, and those for European business were positive as well although less pronounced.

However, the pace of rate increases has slowed through the year, in part due to excess reinsurance capacity. In general, terms and conditions tightened as well with a push for clarity on communicable disease and silent cyber exclusion. Reinsurers have had mixed results with that effort outside of North America, and business remains challenged in Asia-Pacific. Retrocession and aggregate cover capacity remain constrained, though catastrophe bond issuances have somewhat mitigated these constraints, with spreads tightening compared with 2020, indicating active investor interest.

During April renewals, rates were flat to up in Japan amid stable supply. Property catastrophe coverage including wind was up by 5%-10%; for earthquake exposure, flat to 5%; and for liability, flat to modestly up. There has been a growing trend among multinational Japanese insurers to combine covers for nondomestic regions as well, which typically pressures rates. However, reinsurers have tried to reflect the pricing dynamics of the non-Japanese regions to some extent. Furthermore, with rate increases, the proportion of multiyear programs has been falling.

Rate momentum during June-July renewals was somewhat subdued as Florida saw lower demand for property catastrophe reinsurance. Florida-focused cedents looked to restructure their programs in view of higher prices at the lower layers and ample capacity at mid to higher layers as reinsurers shifted their capacity, although rates were differentiated based on cedent performance. U.S. casualty continued to show robust rate increases of 5%-25%. Ceding commissions on quota-share P/C policies fluctuated by a couple of percentage points both up and down, depending on the line of business, but the overall decreases were small as cedents pushed back.

Property catastrophe rates have strengthened less during 2021 renewals than reinsurers hoped for, and downward rate pressure started to build in the first half of this year. Major catastrophe events in the third quarter remind reinsurers of the need for further rate strengthening, considering risks from climate change and model limitations. On the casualty side, significant underlying rate increases taken by primary insurers have aided reinsurers' proportional business, but pricing adequacy remains at the fore. Therefore, we believe sentiment in support of additional rate increases has gained strength through the third quarter, and we expect positive rate momentum to last through 2022.

Capital Strength Remains A Safe Harbor

Despite COVID-19 and high-frequency natural catastrophe losses, the reinsurance sector ended 2020 with very strong capital adequacy, which remains a pillar of the industry. The very strong capitalization was aided by the financial markets' recovery and the $23.6 billion of fresh capital raised by the sector in 2020. This newly raised capital comprised $15.4 billion of equity, including a few start-ups, and $8.2 billion of incremental debt to shore up balance sheets and capitalize on firming reinsurance pricing.

This strength softens the potential blow from the severity risks that reinsurers face, such as natural catastrophes, long-tail casualty reserves, and pandemics, just to name a few. The reinsurance industry often serves as a backstop for the primary insurance market. Therefore, to cope with these severity risks and the ensuing volatility, global reinsurers tend to be strongly capitalized with generally conservative investment strategies. Nevertheless, some reinsurers are slightly increasing their allocations to risky assets (for example, structured products and private equity and debt) to enhance returns.

Capitalization for the top 21 global reinsurers in 2020 was 7% redundant at the 'AA' confidence level, down from 8% in 2019. This cohort lost its capital redundancy at the 'AAA' confidence level in 2017 and hasn't recovered since then because of natural catastrophe and pandemic losses, adjustments to the large global reinsurers' asset-liability management and longevity risk capital charges, share buybacks, and special dividends. We believe capital adequacy will remain a strength of the sector and resilient to moderate stress as we enter 2022.

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In aggregate, reinsurers have not generated an underwriting profit since 2016, and 2021 could follow the same trend. According to Swiss Re Sigma, natural catastrophe insured losses reached $40 billion in the first half of 2021--the second highest on record for a first half after 2011. February's major winter storm in North America (unofficially referred to as Winter Storm Uri) caused an estimated $15 billion in insured losses in the U.S., marking the highest total ever recorded for this type of peril in the country. In the third quarter, which is usually more prone to natural catastrophes, results will take a hit from the category 4 Hurricane Ida, which caused about $30 billion in insured losses, and European floods, which added $13 billion to the reckoning.

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Moreover, 2021 could be the fifth year in a row in which the top 21 global reinsurers deplete their natural catastrophe budgets. As a result, reinsurers' strategies, given the improving risk-adjusted pricing, have diverged, with some increasing their property catastrophe risk appetite while others maintain a defensive stance. We believe capitalization will remain a strength for the sector in the next two years. However, it could be tested again by above-average natural catastrophes and capital markets' volatility.

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Reinsurers' 2021 Earnings Outlook Doesn't Look Promising

The global reinsurance sector's history of earning its COC is weak. Reinsurers have struggled to earn their COC since 2017, and 2021 looks set to continue this trend. In 2017 and 2018, the reinsurance sector generated returns on capital (ROCs) of only 3.2% and 1.7%, below its 7.6% and 8.0% COCs (defined as the weighted average cost of capital), respectively. Natural catastrophe losses, loss creep, and investment market volatility in fourth-quarter 2018 all played significant parts in these results.

However, the improved investment returns in 2019 helped the sector earn its COC. This meant that the gap between the sector's actual ROC and COC was positive at 2.9 percentage points. In 2020, the sector took a major hit from COVID-19 and natural catastrophe losses, as well as significantly lower net investment income relative to the previous year. As a result, the sector did not earn its COC.

In the first half of 2021, ROC improved to 7.4% but remained below the 9.6% COC as February's winter storm and pandemic losses hurt reinsurers' performance, particularly in the life reinsurance segment. At the same time, the 9.6% COC in the first half was up from 7.7% in the prior year, boosted by higher equity and credit risk premiums. Given the elevated natural catastrophe losses in the third quarter, it's unlikely that the sector's earnings will be sufficient to meet its COC in 2021. Therefore, 2021 would be the fourth year in the past five years in which the sector failed to meet its COC.

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Alternative Capital Market Resumes Growth

As estimated by Aon PLC, global reinsurance capital increased by $10 billion, or 1.5%, in the first six months of 2021 and reached a record $660 billion. This increase stemmed from growth in both traditional and alternative capital. Traditional equity capital grew by $7 billion, or 1.3%, to an all-time high of $563 billion, thanks to retained earnings benefiting from improving pricing and strong returns from equities and alternative investments.

Alternative capital, which includes collateralized reinsurance, catastrophe bonds, sidecars, and industry loss warranties (ILWs), grew by $3 billion, or 3.2%, in the first six months of 2021, matching the $97 billion peak from the end of 2018. Most of this growth resulted from collateralized reinsurance, catastrophe bonds, sidecars, and, to a lesser extent, ILWs. It seems the alternative capital market has recovered from the impact of recent natural catastrophe losses and uncertainty about the potential for COVID-19-related business interruption to leak into property coverage.

Alternative capital plays an important role in the global reinsurance market. Its share of overall global reinsurance capital continues to hover around 15%, but it accounts for a significantly larger proportion of retrocession capacity. Therefore, it continues to exert its influence on reinsurance and retrocession pricing. The pullback of 2019 and 2020 was temporary amid a prolonged period of more inflow and influence from nontraditional third-party capital sources.

According to Swiss Re ILS Market Insights, 2020 was a record year of new catastrophe bond issuance, with $11.3 billion, more than double the $5.5 billion issued in 2019. At the end of 2020, the outstanding notional amount of the catastrophe bond market increased to $31.7 billion, up 5.3% from 2019. The momentum has carried into this year, with 2021 shaping up to reach another record. Existing and new issuers, along with an increase in annual aggregate coverage given the reduced capacity in the traditional aggregate retrocession market, have supported this growth.

Collateralized reinsurance still represents the largest share of alternative capital. We expect collateralized reinsurance to grow as funds are deployed in the reinsurance and retrocession markets. Sidecars have also resumed growth in 2021 with increasing demand from cedents, reversing the previous declining trends because of natural catastrophes and COVID-19 losses. ILW capacity has been mostly flat in 2021 as demand has declined with catastrophe bonds' spreads tightening, which has made them an attractive substitute for ILWs.

Investors continue to express reservations about model credibility, including unmodeled losses and models for secondary perils, such as severe convective storms and wildfires; risk selection and underwriting; loss reporting; reserve setting; and climate change's impact on the frequency and severity of natural catastrophes. In addition, investors in collateralized reinsurance and sidecars are more sensitive to losses than those in catastrophe bonds because of their exposure to event frequency. This has caused a flight to quality as investors become more selective and shift their attention to well-established sponsors or managers with better track records and modeling capabilities, clearer underwriting strategies, and stronger reserving practices and governance--while asking for higher returns.

Despite the freezing of the catastrophe bond market in March-April 2020 because of the pandemic, the case for investing in low-correlated insurance-linked assets--to diversify amid low interest rates--remains valid. As a result, we believe alternative capital backed by long-term institutional investors remains committed to property catastrophe risk and is here to stay, supported by hardening reinsurance pricing. Furthermore, alternative capital has expanded to lines of business such as in-force life and annuity blocks and has become a vital risk transfer instrument for U.S. private mortgage insurers.

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Life Reinsurers Suffered Higher Mortality Losses

Life reinsurance continues to face increased mortality losses due to COVID-19. In the first half of 2021, mortality losses represented about 77% of the reported pandemic losses by the top 21 global reinsurers, while 23% were P/C-related claims. The life reinsurance sector's return on equity (ROE) dropped to 4.1% in 2020, compared with a five-year average (2015-2019) of about 10%. This follows the increase in mortality losses above historical levels mainly in the U.S., which is the sector's largest mortality market.

This trend continued in the first half of 2021, with more reported deaths from COVID-19 in the U.S., the U.K., India, and South Africa. The effect on life reinsurance pandemic losses from higher mortality is mitigated by the age structure of most fatalities being outside the insured cohorts, and to some extent by the sector's diversifying longevity portfolios. We have observed a decreasing trend of COVID-19-related mortality losses since the first quarter of 2021, but the sector is still experiencing losses, and potential delays in medical care during the lockdowns could affect the sector's disability and morbidity exposures. However, mortality rates have decreased since the end of March 2021, alongside progress on global vaccinations. We therefore believe the life reinsurance sector will be able to post an ROE of 4%-6% in 2021 and 8%-10% in 2022, assuming a declining pandemic mortality rate.

In general, with its high barriers to entry and fewer global players, life reinsurance is less price sensitive than P/C reinsurance. Reinsurance buyers are sophisticated, precluding the need for intermediaries, and demand is driven less by available capacity and more by balance-sheet management. Demand has also been increasing by life insurers seeking capital relief, amid the hike in reserve provisions caused by low interest rates.

The U.S. is the sector's biggest market, with about 40% market share of global premiums with stable cession rates from primary insurers. The U.K. longevity business also continues to see strong demand. However, we believe the industry's future growth will come mostly from Asian markets--specifically, emerging markets, which are experiencing increased insurance penetration, supporting robust growth of primary life business. Mergers and acquisitions and alternative capital aren't transformative in the life reinsurance segment. Therefore, we think competition will remain largely stable over the next few years.

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Navigating Uncharted Waters

Reinsurers are navigating uncharted waters with uncertainty galore on both sides of the balance sheet. While reinsurers are price-takers in this insurance cycle, the winners will be those that combine underwriting discipline with innovative risk solutions while enhancing their value proposition to cedents and insureds. Our negative outlook could improve if we come to believe the sector may earn its COC, but we don't expect this will happen before 2022, at the earliest.

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Related Research

• Reinsurers' Use Of Insurance-Linked Securities Is Set To Increase Amid Rising Catastrophe Losses, Oct. 27, 2021
• Five Years Of Over-Budget Catastrophe Losses Test Global Reinsurers' Discipline, Oct. 14, 2021
• S&P Global Ratings Top 40 Global Reinsurers And Reinsurers By Country: 2021, Sept. 30, 2021
• Cyber Risks In A New Era: Reinsurers Could Unlock The Cyber Insurance Market, Sept. 29, 2021
• Global Reinsurers Grapple With Climate Change Risks, Sept. 23, 2021
• Reinsurers Left Wanting More Despite Global Reinsurance Pricing Gains At January Renewals, Feb. 26, 2021