Global reinsurers' direct asset exposure to Russia and Ukraine is limited enough, and their capital adequacy strong enough, to avoid credit quality deterioration as a result of the ongoing conflict, in our view. For most of the top 21 global reinsurers rated by S&P Global Ratings, asset exposure to Russia and Ukraine is not material, representing less than 2% of total adjusted capital and below 1% of total assets. However, on the liability side, we believe reinsurers are more exposed to the conflict, particularly in specialty lines, the industry segment that writes more difficult or unusual risks, such as war risk, political violence, and cyber risk.

Based on our conversations with many stakeholders over the past few weeks, we believe that there will be sizable losses on specialty lines, but the magnitude and impact for the reinsurance sector is so far uncertain. Given that the situation is fluid, we have therefore applied a scenario analysis approach to analyze the wider insurance market's potential exposure and, in particular, the impact for the top 21 global reinsurers.

In our view, the top 21 global reinsurers will likely assume about one-half of the potential losses in the insurance sector on aggregate. The losses assumed by reinsurers will vary by line of business because certain lines are more reinsured than others. For most reinsurers, the Russia-Ukraine conflict losses could be an earnings event. However, it could turn into a capital event for a few outliers given the large natural catastrophe losses already accumulating in the first quarter 2022 even before the Atlantic and Pacific hurricane seasons start. These negative outliers' profiles are likely to be more concentrated within the specialty lines with large market shares.

This bumpy start to 2022, as well as rising inflation that will hit both the asset and the liability side, means the industry is likely to find it difficult to meet its cost of capital (COC) once again in 2022. The year 2021 was the fourth in the past five years (2017-2021) in which the sector did not earn its COC (see chart 1). As a result, we maintain our negative outlook on the global reinsurance sector. This reflects our expectation of credit trends over the next 12 months, including the current distribution of rating outlooks, existing sector-wide risks, and emerging risks. As of March 31, 2022, 29% of ratings on the top 21 global reinsurers had negative outlooks, 57% outlooks were stable, and 14% were positive or on CreditWatch with positive implications (see table 5).

Over the past five years, elevated natural catastrophes and pandemic losses, adverse trends in certain U.S. casualty lines (general liability, professional lines, and auto liability), and a very competitive environment have driven weak underwriting results in the sector. In recognition of this, reinsurance pricing has been hardening over the past couple of years through to the January 2022 renewals, although the magnitude of these increases has varied by lines of business, loss experience, and regions. As a consequence of price rises, the accident year combined ratio (excluding natural catastrophe losses and reserve developments) of the top 21 global reinsurers has improved by about four percentage points since 2017. We expect this positive momentum in reinsurance pricing to continue throughout 2022, with tightening terms and conditions further influenced by the magnitude of the Russia-Ukraine conflict losses.

We could revise our sector outlook to stable from negative if we believed reinsurers could sustainably earn their COC. This will depend significantly on reinsurance pricing improvement through 2022 and the sector's discipline and preparedness in managing volatility from natural catastrophes and man-made losses, including the Russia-Ukraine related claims.

Chart 1

Specialty Lines Will Bear The Brunt Of Russia-Ukraine Re/insured Losses

We share the view of major market players that the ongoing conflict will represent a major claim to the market in 2022. We believe that specialty lines will be the most exposed, with aviation hardest hit (see table 1).

Table 1

Aviation insurance appears set to face a significant loss in 2022 following U.S. and European sanctions on Russia, and Russia's potential reaction of not returning leased airplanes that are currently grounded in Russia. For example, Dublin-based aircraft lessor AerCap Holdings N.V, the world's largest, states that it has submitted a $3.5 billion claim on its aviation insurance policy. We understand that Russian airlines had until March 28 to return planes to leasing companies (see "Leased Aircraft Stranded In Russia: The Focus Turns to Insurance," published on March 12, 2022, on RatingsDirect). In addition, according to aircraft fleets analyzer Cirium, 515 commercial aircraft had been leased to Russian airlines by international lessors as of the start of the military conflict. Russia is the fourth-largest international operating lease market, with about 4% of the global portfolio by indicative market value leased there by non-Russian lessors.

Aviation insurance policies usually cover hull and liability on the main policy, which covers damage to the aircraft, including theft. Policies are usually cancellable at 30 days' notice. These policies usually do not cover war. Separately, aviation insurance war policies cover hull and liability and loss of the aircraft through war, terrorism, and confiscation. These are usually cancellable at seven days' notice.

In our scenario analysis, we have aimed to capture the following uncertainties:

• Definition of insurance trigger events, such as sanctions versus confiscation;
• The different sums insured on main aviation policies versus war policies;
• The potential for recovery of some of the approximately 515 aircraft affected; and
• The timing of the insurance event and cancellation possibilities.

We believe it may take many years to settle the ultimate losses incurred by aircraft leasing companies, insurers, and reinsurers. By way of comparison, a New Jersey court earlier this year ruled in favor of the U.S. pharmaceutical company Merck & Co. for a $1.4 billion claim against its insurers under its all-risk property insurance policy following the 2017 NotPetya cyberattack.

Our analysis has considered three scenarios of insured losses from specialty insurance. All scenarios carry significant uncertainties but, in our view, give an indication of the potential exposures for the global insurance industry and the share that may be assumed by the top 21 global reinsurers. In all scenarios, we assume the top 21 global reinsurers would take about 50% of these insured losses. This compares to these reinsurers' share of COVID-19 losses and is higher than their typical share of natural catastrophe losses, where alternative capital providers take a sizable share of losses. By way of reference, the market share of the top 21 global reinsurers' historical natural catastrophe losses was around 20% on average over the past five years. Although we acknowledge there is a high degree of uncertainty over the magnitude of specialty insurance losses, we believe they could reach the level of a sizable natural catastrophe event. For example, Winter Storm Uri in the U.S. in February 2021 had insured losses of about $15 billion and was among the most severe events in 2021 for the sector.

Table 2

Under Scenario 1, which is our base-case assumption despite the high degree of uncertainty surrounding potential losses, we assume global insured aviation losses from airplanes currently in Russia of about $6 billion. This assumption reflects indications from Cirium that about 39 of the 515 aircraft leased to Russian airlines were outside of Russia before the conflict, and another 39 have been safely recovered since it began (totaling 78 aircraft). From discussions with market participants, we understand that the appraised insured value of all the 515 aircraft is about $12 billion. In this scenario, however, we believe the insured loss will be lower because we take into account the 78 aircraft that are outside and recovered from Russia. We also assume that some coverage has been cancelled and some potential court decisions do not foresee the highest sums insured and coverage. In Scenario 1 we also add about $10 billion in other specialty lines insurance losses. Marine hull war, political risks, and political violence usually have explicit war coverage, and we assume a high reinsurance coverage for these lines of business. This scenario assumption also includes trade credit losses that can emerge from increasing credit losses from Russia and other affected regions, although we believe the reinsurance share to be lower compared to other specialty lines. Lastly, we also believe there could be increasing cyber insurance losses following the increase in severity and frequency of cyberattacks even prior to the current conflict. The reinsurance sector plays a critical role in the cyber insurance market, taking on about 35%-45% of global premiums from insurers. We now see a hybrid cyber kinetic form of warfare, where cyber assaults can precede or be accompanied by military operations. For example, in December 2021 Lloyd's of London announced that it would introduce a new framework to cyber war exclusions, applying different levels of exclusion. Challenges are likely to arise because cyber war is not clearly defined and the attribution of attacks to nation states could also be difficult.

Under Scenario 2, we assume global insured aviation losses from the airplanes currently in Russia of about $12 billion. This reflects broadly the appraised insured value of the 515 aircraft, that most policies are not cancellable, and that a majority of potential court decisions fall in favor of lessors versus insurers in terms of sums at risk. In this scenario we also add about $15 billion of insured losses from specialty lines.

Under Scenario 3, we assume total insured aviation losses of $15 billion, reflecting even higher losses compared to the appraised insured value. This reflects potential uncertainties surrounding the exact insured value, the assumption that the vast majority of policies are not cancellable, and that the vast majority of potential court cases rule in favor of lessors with the highest possible insured sums at risk (if, for example, the insured event is classified as theft instead of an act of war). Moreover, we assume additional other specialty lines insured losses of about $20 billion.

In all three scenarios, we consider that specialty insurance losses would be an earnings event for the global reinsurance sector. In chart 2, we show that the sector's annual expected pre-tax profit of about $22.5 billion, coupled with the natural catastrophe budget of about $13 billion, should provide a sufficient buffer to absorb these losses. However, we believe that for a few reinsurers with a large aviation market share or aviation losses in combination with other losses stemming from the Russia-Ukraine conflict, it could become a capital event.

Chart 2

2022: Another Costly First Quarter

The year 2021 was an active natural catastrophe year, the fourth-costliest on record, with insured losses of $119 billion, according to Swiss Re. Not least, winter Storm Uri caused $15 billion in insured losses for the sector. First-quarter 2022 has now also provided a volatile environment for the sector, even before the Atlantic and Pacific hurricane seasons start.

As indicated in our base-case Scenario 1, specialty insurance losses can add about $16 billion of insured losses in addition to winter storms in Europe (Germany, U.K., and the Netherlands), which could add between about $3 billion and $5 billion, and the earthquake in the Fukushima region of Japan with an estimated industry loss of between $2 billion and $4 billion. Furthermore, the Australian floods in Southeast Queensland and New South Wales are expected to be around $2 billion. The ongoing wildfires in Texas could add to the industry losses.

While these aggregate losses are material and the global reinsurance sector will take a share of them, we do not believe the sector is immediately facing a capital threat when comparing 2022 to annual natural catastrophe budgets and other historical large tail events. However, the first-quarter losses will reduce buffers that would have helped bring more stability to the sector going into this year's hurricane season. As a result, we believe these large losses this early in 2022 will further harden upcoming reinsurance renewals in 2022, and potentially into 2023.

Table 3

Rising Inflation Adds Challenges For Long-Tail Lines

In addition to these sizable first-quarter losses, the global reinsurance sector is also facing increasing inflation and, notably, claims inflation. S&P Global Ratings economists expect world inflation of 6.0% for 2022. For short-tail lines of business, we believe the sector has sufficient measures, particularly through ongoing pricing increases at renewals, which are typically adjusted annually. Longer tail lines within casualty insurance are more sensitive to inflation considering the longer duration of these lines. We have already seen in prior years reserve-strengthening measures in certain U.S. casualty lines such as general liability, professional lines, and auto liability. That said, the sector recently continued to benefit from prior-year reserve releases when considering the overall loss reserve developments. However, the amount of favorable development has gone down to about one to two percentage points in 2021 of the combined ratio of the top 21 global reinsurers, versus four percentage points in 2017. On the flip side, reinsurers may benefit from rising interest rates for their investment portfolios, as central banks try to curtail rising inflation. We will continue to carefully watch claims inflation versus general inflation, which could create some additional volatility for long-tail reserves for reinsurers' earnings in 2022.

Capital Remains A Key Strength Of The Sector

The global reinsurance sector entered 2022 with robust capitalization. Capital adequacy for the top 21 global reinsurers in 2021 was about 7% redundant at the 'AA' confidence level and we believe the sector has maintained this buffer entering 2022. This is further backed by sound regulatory solvency ratios of the large global reinsurers of above 200% (see table 4). We believe capital adequacy will remain a key strength of the sector and resilient to moderate stresses.

Table 4

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets--notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks. Note that the timing of publication for rating decisions on European issuers is subject to European regulatory requirements.

Table 5a

Table 5b

Related Research

• Leased Aircraft Stranded In Russia: The Focus Turns to Insurance, March 22, 2022
• Bulletin: Credit Quality Of Insurers Is Weathering The Geopolitical Storm, March 4, 2022
• 28 Ratings From Seven Aircraft ABS Transactions Placed On Watch Negative On The Russia-Ukraine Conflict, March 15, 2022
• Global Reinsurance Highlights 2021: Navigating Uncharted Waters, Nov. 17, 2021