Charles-Marie Delpuech London +44-20-7176-7967
Johannes Bender Frankfurt +49-693-399-9196
Global reinsurers are of two minds about the natural catastrophe business this year. S&P Global Ratings finds that only half of the top 21 global reinsurers are growing their natural catastrophe exposure in 2022. The other half are taking a more cautious and defensive stance by reducing their exposure. This divergence in strategy reflects the growing cost of natural catastrophes: they have topped loss expectations in the past five years despite increases in reinsurers’ budget. This year, the top 21 on average increased budgeted loss expectations by almost 20%.
For the top 21 overall, property catastrophe prices this year rose again, and more capital is at work against natural catastrophe risk. Net exposure for a 1-in-250-year return period grew a slight 4%, with average capital at risk increasing to 28% from 27% in 2021.
Rapid rises in interest rates, financial market volatility, inflation, and increasing climate variability are large risks for the industry. However, global reinsurers' very strong capital adequacy continues to cushion them against exceptional shocks--such as from natural catastrophe events. If a severe 1-in-100-year event hits, causing annual losses in excess of $250 billion across the entire insurance industry, we expect 14 of the top 21 global reinsurers would maintain a buffer at their current S&P Global Ratings capital adequacy level, as measured by our model. In this scenario, we anticipate the reinsurance sector on aggregate would be capitalized just slightly below the ‘AA’ confidence level.
This year, the top 21 on average increased budgeted loss expectations by almost 20%
For 2022, we expect the natural catastrophe business to contribute about 2.5 percentage points to return on equity (ROE) for the top 21 if losses remain within the annual budget. That remains to be seen, given that exposure growth, inflation, and elevated losses from midsize perils (like flood, convective storms, and wildfire) are contributing to the long-term trend of rising insured losses from natural perils.
The contribution to ROE was marginal for the top 21 global reinsurers from 2017-2021 based on our estimates, showing that the natural catastrophe business underperformed in the period. In those five years, losses were at or above budget for the group (see chart 1). We estimate that the top 21 aggregate ROE would have been on average about 2.5 percentage points higher every year since 2017 had catastrophe losses been in line with budget expectations. In terms of combined (loss and expense) ratio, companies experienced 10 points of natural catastrophe losses over the last five years. That’s 3 points more than budget expectations.
The year 2021 was the fourth costliest year on record for annual global insured losses, with Hurricane Ida one of the largest insured losses in U.S. history, Uri the biggest U.S. winter storm in history, and the low-pressure weather system known as Bernd leading to the largest European flood on record.
Chart 1 | Catastrophe losses at the top 21 global reinsurers were beyond budget in 2021
Source: S&P Global Ratings.
Chart 2 | Cumulative excess natural catastrophe losses reduced ROE by about 2.5 percentage points on average annually compared with companies' budgets
ROE--Return on equity. Source: S&P Global Ratings' estimates.
The top 21 now budget about $15.5 billion for natural catastrophe losses in 2022 (versus $13 billion in 2021). If losses remain in line with budgets, we forecast the group will post pretax profit of about $22.5 billion in 2022. In a severe stress scenario, this implies a buffer of about $38 billion ($15.5 billion plus $22.5 billion) before capital depletion. That assumes companies take none of the actions we would typically observe in a stress scenario, such as suspending share buybacks or other shareholder returns, and investment performance remains in line with our base-case assumptions (see chart 3).
The top 21 have markedly increased their natural catastrophe budgets in 2022 compared with those in recent years. We think that many reinsurers, in addition to allowing for exposure growth, have factored greater climate variability into their forecasts this year.
This budget would broadly translate into an annual insured loss for the whole industry of about $75 billion, which aligns with the historical 10-year average, based on loss market share (see table 1). It appears that reinsurers will fully use their insured loss budget in 2022, according to our half-year estimate of $35 billion-$40 billion (based on Munich Re, Aon, and Swiss Re).
The top 21 now budget about $15.5 billion for natural catastrophe losses in 2022, versus $13 billion in 2021
Table 1 | Average global insured loss estimates are on the rise Expected annual loss from natural catastrophes (bil. $)
Source
Scope
2021 Insured
2022 Insured
Comment
Swiss Re Sigma
10-year average
79
74
Aon
21st-Century average
69
Gallaghar Re
Average 2011-2021
66.5
71
Published under Willis Re in 2021
AIR
2020 annual aggregate
100
106
Stochastically modeled by AIR
S&P Global Ratings' estimate
2021 catastrophe budget
65-70
~75
From budget estimate based on 20% market share for top 21 reinsurers
We think that reinsurers will continue to limit their appetite for frequency risk and exposure to midsize events and expect them to reduce quota share and aggregate cover offering. For the second consecutive year, the loss share of 18% for top 21 was slightly below our estimate of 20%. Similar to the 2020 experience, the frequency of losses and occurrence of only one very large event meant that pure primary insurers supported a significant amount of the losses.
We saw a large reduction in natural catastrophe exposure in January 2022 for about half of top 21 reinsurers, after they reassessed their risk exposures in certain markets and geographies. We believe this is explained by uneven pricing adequacy across the globe, despite years of improved pricing. The average contraction was 20% for those reinsurers that opted to reduce absolute net exposure to a 1-in-250-year aggregate loss. To us, this suggests a clear, strategic derisking.
By contrast, the other half increased absolute net exposure by close to 20% on average. The change is also pronounced relative to shareholders’ equity (see chart 6). This indicates that the reduction in risk exposure has largely exceeded movements in shareholders’ equity for some reinsurers. As a result of these changes, we estimate that average capital at risk has increased across the top 21 group of reinsurers. On average, total shareholders’ equity exposed in January 2022 stood at 28%, compared with 27% one year before (see chart 7). Note: Earnings at risk is defined as a 1-in-10-year modeled annual aggregate net loss, compared with normalized expected profits before taxes and net catastrophe claims. Capital at risk is defined as a 1-in-250-year modeled annual aggregate net loss against shareholders’ equity as reported (including preference shares).
We expect underwriting margins to improve in 2022, which would add resiliency to the sector. Increases in pretax profit (including the catastrophe budget) for most reinsurers, based on their average share of market losses over the past five years, should provide some cushion against sizable insured industry losses (see chart 8). Of course, reinsurers with higher risk appetites and subdued returns would likely see lower pretax profits quicker than peers.
Chart 8 | Scenario impact on expected 2022 PBT
PBT--Profit before tax. Source: S&P Global Ratings.
Capital levels and risk appetite for individual reinsurers do vary. We expect 15 reinsurers to sustain their S&P Global Ratings capital adequacy, if aggregate losses are at the 1-in-50-year level in 2022. That said, such a scenario could lead six reinsurers to experience a deterioration in their S&P Global Ratings capital adequacy, unless they take action to manage their capital levels (see chart 9).
We have not reflected in these metrics any mark-to-market investment losses for reinsurers’ fixed-income portfolios following the rapid rise in interest rates in 2022, especially in the U.S. Although these losses could be for the most part temporary, they may take three to five years to mature and unwind, depending on the duration of the assets. During that time, we would adjust our view of capital adequacy depending on changes in asset-liability mismatch positions and the speed at which fixed-income instruments may be reinvested at higher yields, among other factors.
Retrocession, including use of third-party capital, remains a flexible and key strategic way to manage tail risk. Data at Jan. 1, 2022, suggest that reinsurers have largely maintained their use of retrocession since 2021. Nonetheless, rates in the retrocession market continue to increase. This means reinsurers may have to cede proportionally less of the risk if it becomes too expensive. We think those reinsurers that will aim to further derisk in 2023 will need to find the right balance of gross exposure and use of retrocession.
As of Jan. 1, 2022, reinsurers ceded about slightly above half of their 1-in-250 exposure, on a simple average basis. That said, average utilization rates mask a wide range of coverage. Large global reinsurers typically retrocede less risk, for example (see chart 10).
The global reinsurance sector is more optimistic about risk-adjusted pricing during the upcoming renewals, and hopes to forget the poor experience of the past five years--if 2022 turns out to be within budget. The temptation may increase in 2023 to further deploy capital into the property catastrophe line business as demand continues to rise.
Cedents will continue to shy away from volatility, and more reinsurers may decide to reduce their exposure to property catastrophe while diversifying into lower-severity lines. Reinsurers that have been more cautious during the recent turbulent times may decide to follow a more opportunistic trend. On the other hand, an active second half of 2022, coupled with additional inflationary pressure, would call into question the strategy of those reinsurers that have maintained or increased exposure to natural catastrophes.
Table 2 | Top 21 global reinsurers
Group 1: Large global reinsurers
Group 2: Midsize global reinsurers
Group 3: Other reinsurance groups
Hannover Rueck SE
Alleghany Corp.
Arch Capital Group Ltd.
Lloyd's
AXIS Capital Holdings Ltd.
Ascot Group Ltd.
Munich Reinsurance Co.
Everest Re Group Ltd.
Aspen Insurance Holdings Ltd.
SCOR SE
Fairfax Financial Holdings Ltd.
China Reinsurance (Group) Corp.
Swiss Reinsurance Co. Ltd.
PartnerRe Ltd.
Fidelis Insurance Holdings Ltd.
RenaissanceRe Holdings Ltd.
Hiscox Insurance Co. Ltd.
Lancashire Holdings Ltd.
Markel Corp.
Qatar Insurance Co. Q.S.P.C.
Sirius International Group Ltd.
