Hard reinsurance market may pressure insurers’ credit ratings
Rising reinsurance rates could result in adverse credit ratings for direct insurers, ratings agency Morningstar has warned.
In a commentary released yesterday, Morningstar said insurers that maintain their reinsurance allocations at higher prices when they cannot increase their own premiums and companies that risk greater earnings volatility by retaining more risk on their balance sheets both risk putting pressure on their credit ratings.
The commentary, headlined "Global Insurers Respond to Higher Reinsurance Costs by Retaining More Risk, Negatively Pressuring Credit Ratings", also said it expects high reinsurance rates to persist over the short to medium term but to moderate later, adding: "The soft reinsurance market is decidedly over and that insurers need to adapt to the changed market environment."
The commentary said; "Global property reinsurance prices increased sharply in 2023, driven by lower reinsurance capacity, above-average catastrophe losses, inflation, and financial and economic concerns. Higher attachment points, more exclusions, reduced coverage terms, and higher reinsurance prices have left many insurers with more risk on their balance sheet.
"We expect the tougher reinsurance market conditions to continue in the short to medium term, putting to the test insurers' risk management capabilities, which, if not adequate, could result in adverse credit rating implications.
"Insurers that maintain optimal risk retention but cannot increase premiums to keep pace with higher reinsurance costs will see their underwriting profitability deteriorate, while those who hold more risk on their balance sheet are likely to experience more earnings volatility. Both scenarios negatively pressure credit ratings."
The commentary noted that insurers who retain their reinsurance coverage will see profits decrease unless they can charge higher premiums to their policyholders or otherwise change the policy terms to reduce their exposure.
It added: "Premium increases running above inflationary trends have been especially evident for commercial insurance policies, which are in the midst of a hard insurance market that has been ongoing for several years.
"But price increases may not be a viable option for personal property lines, especially in jurisdictions where regulatory approval is required to implement premium increases. Furthermore, in some cases competitive pressures do not allow for a full pass-through of reinsurance costs. In such situations, insurers may see an erosion in underwriting profitability, which can have negative credit rating implications."
Morningstar said the most common response by insurers to rising reinsurance rates was to buy reinsurance rates at a higher attachment point which could lead to more volatility in the event of high frequency, low severity losses.
It said: "As an alternative to paying higher reinsurance costs, insurers may opt to change their excess-of-loss property catastrophe reinsurance programs. The most widespread response made by insurers to the 2023 reinsurance market prices and conditions has been to purchase reinsurance with a higher attachment point, which refers to the higher threshold value of loss before the reinsurance coverage engages.
"It means that more high-frequency, low-severity loss events are entirely covered by the insurer. During the 2023 reinsurance renewals, reinsurers had much more capacity for offering protection to the top layers of the reinsurance tower, allowing insurers to increase their upper coverage limits if they were looking to do so. However, some insurers have also reduced those upper limits to manage their overall reinsurance cost.
"Higher attachment points force insurers to bear more risk, which could increase income volatility and negatively pressure their credit rating."
Morningstar also said higher co-participation rates on existing reinsurance layers also added higher exposures for insurers, adding: "Some insurers have had to increase both their attachment points and co-participation as a way of attaining acceptable reinsurance protection at a reasonable cost. While these adjustments may be well within the risk appetite of some insurers, others may not be as well capitalised, which could lead to negative rating implications.
"Ultimately, reduced reinsurance coverage affects insurers' ability to tolerate higher earnings volatility, and it means that companies need to hold more capital to protect against higher exposure levels."
It concluded: "We expect the challenging reinsurance market conditions to persist over the short to medium term but to moderate with lower inflation and as reinsurance capacity increases, as seen in Q1 2023, including through alternative capital inflows such as cat bonds. However, we believe that the soft reinsurance market is decidedly over and that insurers need to adapt to the changed market environment."
