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Willis Re analysis lays bare eroding profitability at reinsurers

Underlying profitability at global reinsurers has deteriorated by more than 5 points on the combined ratio since 2005, according to Willis Re's latest Reinsurance Market Report.

The broker’s analysis of a subset of 23 global reinsurers found the average ex-cat accident-year (AY) combined ratio for 2017 was 94.6 percent.

This was 5.4 points worse than the same metric in 2005, and 4.4 points worse than in 2011, the last two years which also suffered severe catastrophe losses.

The 2017 ex-cat AY combined ratio was also a 10 basis point deterioration on the previous year.

The numbers demonstrate the extent to which underlying profitability has been eroded since these two previous heavy cat years.

Speaking to The Insurance Insider, Willis Re International chairman James Vickers said: “These numbers show the trend which has been talked about for a long time, where the benign cat experience of the last few years has covered up a lot of the underlying deterioration.”

The 2017 reported combined ratio of 107.4 percent was lower than the 2005 and 2011 results of 112.8 percent and 108.2 percent, respectively. However, in both 2005 and 2011, the cat loss ratio was significantly higher, at 25.8 percent and 24.8 percent, respectively.

In 2017, reserve releases accounted for 5.3 points of the reported combined ratio, compared to 2.2 points in 2005 and 6.8 points in 2011.

Vickers added that in 2017, reinsurers were operating in a very different market to 2005 and 2011.

"In 2005 we were still recovering after 9/11," he said. "What people also forget is that 9/11 wasn't only a single large loss event but the underlying business had been performing very badly, and the market was [already] starting to turn – 9/11 turbo-charged that."

In 2005 there had been capital constraints, and the ILS market was less developed, Vickers noted.

Therefore, it would be "very difficult" for reinsurers to get back to an ex-cat AY combined ratio similar to 2005 in today's market, he added.

"Reinsurers who have incredibly cost-effective models might get to that. But I think the majority will struggle," he said.

Rising expenses have been a major factor in the deterioration of reinsurers’ underlying profitability.

The Willis Re analysis shows that if the subset of studied reinsurers had been able to maintain an expense ratio at 2007 levels, the aggregate return on equity of 2.8 percent would have been 2.2 points higher.

Commenting on expenses, Vickers pointed to a recent observation by Axis CEO Albert Benchimol, who said the composition of a 95 percent combined ratio needed to shift from a 65 percent loss ratio and 30 percent expenses to something more like a 70 percent-25 percent split.

“I think that is fair but that will be difficult,” he said. “Of course there are initiatives like PPL [the London market electronic placing platform] which have been very much welcomed, but we still don’t know how much they will deliver and how long the impact will take to come through.

“What we are seeing at the moment is more drastic actions in cutting headcounts.”

Vickers also warned that the market may not yet have seen the last of the 2017 cat losses, with loss creep something that may impact reinsurer results for years to come.

“Cat losses are never quite as short tail as people think and there have been quite complicated losses, like the mudslides in California. It wouldn’t surprise me if there was some movement in the next year or two,” he said.

Vickers said the 2017 cat losses had been the first real test for the ILS market, and it had “passed with flying colours”.

“All the ILS funds we speak do not have a problem in raising money,” he said. “There seems to be no slowdown in that [market], at all. Their challenge is putting it to work.”

The Willis Re reinsurance index subset comprises: Alleghany, Arch, Argo, Aspen, Axis, Beazley, Everest Re, Fairfax, Hannover Re, Hiscox, Lancashire, Markel, Munich Re, Navigators, Novae, PartnerRe, RenaissanceRe, RGA Re, Scor, Swiss Re, Validus, WR Berkley and XL Catlin.

The entire Willis Re reinsurance index is comprised of 36 global reinsurance companies. Shareholders' funds for the index rose 7.8 percent year on year to $371bn at the half year.

Aggregate net income for the index fell to $12bn from $26.6bn a year earlier, due to substantial catastrophe losses. Profitability in 2017 was heavily reliant on realised investment gains of $9.7bn, which were up 39 percent year on year.

Notably, $15.6bn of capital was returned by reinsurers through dividends and share buybacks, far exceeding the aggregate net income of $12bn.

Vickers said: “For us the good news in is analysis is that the industry remains extremely well capitalised. It has sailed through a difficult year and is able to perform.”

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