S&P Global Ratings has revised its view of the global reinsurance sector to stable from negative. We'd had a negative view of the sector since May 2020 (see "COVID-19 Pushes Global Reinsurers Farther Out On Thin Ice; Sector Outlook Revised To Negative"), but structural changes that emerged in underwriting during the 2023 reinsurance renewals have changed the outlook.

We expect these green shoots will take root and help address industry challenges. Reinsurers have had to quickly adapt to evolving conditions amid more frequent and severe natural disasters and an abundance of unprecedented economic and geopolitical events. High inflation, COVID-19, and the Russia-Ukraine conflict have had untimely negative effects on an already overburdened sector.

Reinsurance pricing is the most obvious recent improvement for reinsurers and has been on the rise for a few years now, especially this year in short-tail lines. These increases in reinsurance pricing, along with enhanced underwriting measures such as stricter terms and conditions (T&C), increasing attachment points, scaled-down limits, and fewer aggregate covers, together with increasing investment income and life reinsurance earnings at pre-pandemic levels, instill some confidence that the sector will effectively tackle its still-plentiful challenges and earn its cost of capital in 2023-2024.

Our stable view of the global reinsurance sector 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 Aug. 28, 2023, 90% of the top 20 global reinsurers were assigned stable rating outlooks, 5% were assigned positive rating outlooks, and 5% were assigned negative rating outlooks.

Sector Performance Is Improving

Underwriting results are beginning to improve in the global reinsurance sector. The combined ratio of the top 20 global reinsurers was 96.0% in 2022, better than the five-year average of 99.7%. This positive trend continued in the first half of 2023, with combined ratios ranging from the mid-80s to the low 90s. The improving results have come in response to changes in reinsurers' strategies, increases in pricing, and tighter T&C.

Hybrid business models are common nowadays as reinsurers expand into primary specialty insurance, including U.S. surplus lines, to diversify their books and reduce volatility in their underwriting results. Reinsurers have also remained disciplined regarding the business they write, avoiding or at least reducing their exposure to certain problematic contracts such as aggregate covers and causing primary insurers to retain more risk.

Meanwhile some reinsurers see pricing adequacy within the property catastrophe segment as a profitable opportunity, while for others it's a stark reminder of the inadequate returns of the past several years. Some reinsurers have grown their natural catastrophe exposure, while others have reduced it or even completely exited the property catastrophe business.

We think the overall favorable reinsurance pricing, and particularly the hard market conditions in the short-tail lines, will prevail, and we expect the industry will post more favorable results with a combined ratio of 92%-96%, including a catastrophe load of 8 to 10 percentage points (ppts), and a return on equity (ROE) of 9%-12% in 2023-2024, barring any outsize catastrophe losses.

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Economic Slowdowns And Persistent Inflation Are Crimping Growth

Economic outlooks have slightly improved from a year ago, with most economies now expected to face slowdowns in GDP growth rather than recessions. However, economists are still debating whether the U.S. economy will experience a soft or hard landing. Since the first quarter of 2022, most central banks globally have aggressively raised interest rates; for instance, the U.S. Federal Reserve raised them by 525 basis points to tame inflation.

Yet labor markets have been resilient and demand remains strong. Headline inflation is starting to ease, but core inflation is stubbornly high, which will likely lead to higher-for-longer interest rates or even further rate hikes, depending on how economic conditions progress.

Inflation is a key risk because it drives claims costs and could damage existing loss reserves and reinsurance price increases, especially for long-tail casualty lines. While the property/casualty (P/C) re/insurance industry is familiar with the effects of social inflation, especially in U.S. casualty lines, consumer price index (CPI) inflation is a newer risk with far-reaching effects for many lines of business.

Persistent inflationary pressure could create shortfalls in the current loss reserve provisions, particularly for the soft-cycle accident years of 2015-2019. Reserve releases have been declining in the past five years and aided the top 20 reinsurers' combined ratio by 1.7 ppts in 2022. We expect favorable reserve developments to remain modest at 1%-2% in 2023-2024.

S&P Global Ratings economists expect inflation to continue to moderate over the next couple of years as the lagged effects of rate hikes play out, though it's too early to declare victory as central banks keep rates high. The reinsurance sector can mitigate the risks associated with higher inflation with stronger investment income, which is already becoming apparent in companies' financial results.

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Eroded Capitalization Is Set To Improve

For the industry, capital adequacy remained robust at year-end 2022, though lower than in the previous year because of unrealized losses on fixed-income securities. Last year shareholders' equity dropped by about 13%, on average, for the top 20 reinsurers, with the big four European reinsurers dropping about 32%, given their longer fixed-income portfolio durations due to their exposure to life reinsurance or their primary insurance business. Unrealized losses began to unwind in the first half of 2023 as bonds pulled to par or matured, but recovery will take longer for some reinsurers, depending on their portfolio durations.

Meanwhile investment income is on the rise, and reinsurers can reinvest into higher-yielding investments that will be accretive to capital. While further interest rate increases are not off the table and could lead to more fixed-income losses, overall the top 20 reinsurers have well-diversified investment portfolios that are conservatively managed, except for a few outliers.

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In aggregate, the top 20 reinsurers' capital adequacy, per our risk-based capital model, was redundant at the 'AA' confidence level by less than 1% at year-end 2022, compared with 6% at year-end 2021. Rapid interest rate hikes caused $43 billion of unrealized losses on bonds backing P/C liabilities and shareholders' equity, which ultimately wiped out about $15 billion in 2022 capital redundancy, nearly pushing the cohort below the 'AA' confidence level.

However, higher P/C reserve discounting credit (about $21 billion in 2022) and lower investment market values have helped soften the impact of dampened shareholders' equity. We expect the top 20 reinsurers, in aggregate, will maintain their capital adequacy redundant at the 'AA' confidence level as bonds pull to par and mature and as strong underwriting earnings and investment income take effect.

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Natural Catastrophes Aren't Letting Up

According to Aon PLC, in 2022 global natural disasters resulted in $132 billion in insured losses, which is 57% above the 21st century average and marks the fifth-costliest year on record. Hurricane Ian alone accounted for $50 billion to $55 billion in insured losses and became the second-costliest insured loss event on record, surpassed only by Hurricane Katrina in 2005 with $99 billion in insured losses (2022 dollars). The first half of 2023 followed the same trend and was the fourth-highest first half on record, after 2011, 2021, and 2022.

It remains to be seen whether pricing increases are enough to draw back certain reinsurers that have exited the property catastrophe business over the past several years after the heightened natural disasters, including secondary perils such as severe convective storms, wildfires, and floods. It's also too soon to tell if the pricing improvements are enough to withstand the more frequent and severe natural catastrophes.

Tort reform in Florida, which is a major property catastrophe market, may bring players back to the Sunshine State. While the effectiveness of the legislation is undetermined, the reform is targeted at abuses of the legal system, which should improve operating conditions for re/insurers in the state.

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In addition to elevated natural catastrophes, the sector has suffered other unexpected losses from COVID-19 and recently the Russia-Ukraine conflict. The top 20 reinsurers reported $25 billion in pandemic losses from both P/C and life re/insurance in 2020-2022 ($19.1 billion in 2020, $4.6 billion in 2021, and $1.6 billion in 2022). In addition, they reported $3.6 billion in losses, mostly incurred but not reported, from the Russia-Ukraine conflict in 2022. The situation is fluid, and further losses may materialize.

Property Catastrophe Pricing Is At A Multidecade High

In 2023, pricing has continued its upward trajectory, especially in short-tail lines. According to Guy Carpenter, during the January 2023 renewals, the global property catastrophe Rate on Line (ROL) Index increased 27.5%, primarily driven by pricing and attachment point adjustments in the U.S. and Continental Europe: The U.S. ROL Index increased 31.3%, and the Continental Europe ROL Index increased 30%. In addition, the U.S. ROL Index increased 35% between the January and July 2023 renewals. These significant ROL increases represent a multidecade high.

Indeed, 2023 renewals rival those of 2006, in the aftermath of hurricanes Katrina, Rita, and Wilma. However, unlike in 2006, when increases were mostly in the U.S., the 2023 renewal price increases were global and covered both loss-impacted and non-loss-impacted accounts.

Nonetheless, in our view, price increases are more effective this time around because of the fundamental underwriting changes: Reinsurers have tightened policy wording for exclusions for certain risks (such as cyber, war, and terrorism), raised their attachment points, scaled down limits, and offered meaningfully less capacity to lower layers and aggregate covers, thereby hedging against the increasing frequency of natural catastrophes and high inflation.

In some instances, reinsurers have walked away from business that didn't fit their new view of risk. Overall, reinsurers' revised risk appetite indicates a distinct shift toward taking on severity exposure rather than frequency.

Casualty reinsurance markets were tamer during recent renewals, with flat to moderate pricing increases after these reinsurers, like their cedents, enjoyed compounded rate increases over the past few years. The sustainability of pricing will be tested in future renewals, but casualty reinsurers remain adamant about the necessity of increases, given the loss cost trends of the past several years.

Reinsurers Narrowly Earned Cost Of Capital In The First Half Of 2023

The industry has struggled to earn its cost of capital because of heightened losses. Moreover, inflation can affect reserves from the soft underwriting years and result in higher-than-anticipated claims cost trends.

These negative factors over the past several years have fueled higher pricing. Even though pricing sustainability is uncertain, current prices are helping reinsurers overcome their challenges: At the end of the first six months of 2023, the top 20 reinsurers had narrowly earned their cost of capital.

Full-year 2023 results will largely depend on the Atlantic hurricane season, which runs from June 1 to Nov. 30. Reinsurers can't claim victory yet, but we expect the sector will earn its cost of capital in 2023-2024.

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Alternative Capital Is Filling The Gaps

Despite the impairment in traditional reinsurance capital (which somewhat recovered in the first half of 2023) due to unrealized investment losses, alternative capital is charging ahead and providing additional capacity to the sector. Alternative capital hit a high of $100 billion as of March 31, 2023, according to Aon. Catastrophe bonds are the primary contributor to the growth, reaching $37.8 billion in total outstanding bonds in the second quarter of 2023, and the more than $8.6 billion issued in the first half of 2023 suggests another record year.

Catastrophe bonds are offering attractive floating rates to investors. We expect investors will continue to favor them because they have better structures, clearer coverage, and more liquidity than other vehicles, such as collateralized reinsurance, sidecars, and industry loss warranties.

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But all is not well in alternative capital, especially when it comes to collateralized reinsurance and sidecars. Investors in the recent past have taken hits from elevated losses and the resulting trapped capital in these vehicles, which have created doubts about the sponsors' (reinsurers') risk-modeling capabilities. As a result, there has been a flight to quality, with investors seeking to deploy capital with well-established and sophisticated risk managers.

Yet alternative capital is still poised to serve an important need for the re/insurance market. With traditional reinsurance capacity coming at a high price tag, alternative capital, notably catastrophe bonds, can provide extra relief to buyers of protection. Alternative capital provided aid to the supply-demand equation during the 2023 midyear renewals, and we expect this dynamic will continue.

Life Reinsurance Earnings Look Promising

We expect the global life reinsurance sector's operating performance in 2023 and 2024 will be favorable with an ROE of 8%-10%, providing meaningful earnings diversification for those reinsurers writing life and P/C reinsurance.

Since 2020, the life reinsurance sector had suffered from COVID-19-related losses due to rising mortality rates. As a result, its ROE dropped to about 4% in 2020 and 2021, compared with the historical average (2015-2019) of about 10%. We estimate the pandemic losses represented 3%-8% of life reinsurance gross premiums written from 2020 through the first half of 2022.

However, this sector remained profitable, benefiting from other sources of income, including investments as well as longevity and morbidity businesses. With the significant decrease in COVID-19 fatalities and rising interest rates, we expect operating performance will improve to pre-pandemic levels, given this sector strengthened its underwriting controls to reflect lessons learned from COVID-19.

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This expectation is backed by our view that the fundamentals of life reinsurance have remained intact through the pandemic. The sector maintains high barriers to entry and is less price sensitive than P/C reinsurance, with significantly fewer market participants. 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 with primary writers seeking capital relief.

The U.S. remains this sector's biggest market, with about 40% of global premiums and stable cession rates from primary insurers. Longevity business also continues to show strong demand in markets such as the U.K. and the Netherlands. Moreover, we believe the industry will benefit from growth in some 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 life reinsurance. Therefore, we think competition will remain largely stable over the next few years.

Still Room To Grow

Our revised view of the reinsurance sector comes in response to this year's structural changes and the resulting repricing of risk. Reinsurers have remained adamant in pursuing pricing adequacy as heightened losses have battered their underwriting profitability. It is now a hard market, at least in the short-tail lines, and reinsurers are remaining disciplined.

Nonetheless, it's important to remember that these improvements came in response to difficult operating conditions that resulted in inadequate returns for several years amid heightened catastrophe losses. While we believe the recent structural changes should allow the industry to better earn its cost of capital, reinsurers must navigate complex and increasingly unprecedented conditions to sustainably post returns that exceed their cost of capital.

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Related Research

• Global Cyber Insurance: Reinsurance Remains Key To Growth, Aug. 29, 2023
• Catastrophe Risk Appetite Varies Among Global Reinsurers, Aug. 24, 2023
• Top 20 Global Reinsurers Can Ride Out Unrealized Losses, Aug. 17, 2023