(Re)insurance ROE to rebound in 2021 after dip this year: Hyperion X

Although the proportion of Covid-19 losses taken by reinsurers may have been a surprise, the pandemic remains a manageable event for the overall P&C industry, whose return on equity (ROE) will rebound next year after a dip in 2020, according to Hyperion X.

The key finding of a second quarter update from the data and analytics division of broker Hyperion Insurance Group was confirmation that Covid losses are best described as an earnings event not a capital event for the insurance sector.

“Covid insured losses are significant and will likely add up to one of the largest insured loss events in history,” said David Flandro, managing director, analytics, Hyperion X, in a presentation. “This being the case, we can now say with increasing confidence what we have said from the beginning: these losses are manageable and are affecting earnings, not solvency.”

The update said that first half Covid loss estimates appear reasonable and under current assumptions there is no impact on sector capital in the aggregate.

“We think insurance companies have taken a relatively prudent and conservative stance,” said Flandro in a presentation. “Reinsurance companies have taken a larger proportion of Covid claims than perhaps was anticipated from some.

“The key point we want to make here is that Covid losses look manageable.”

Flando added that Covid losses in terms of the combined ratio look like a 4 or 5 percentage point hit on average.

He said it appears that governments are honouring contract law and that Covid losses will be within the parameters of current estimates. He noted that a District of Columbia judge this month ruled that direct physical damage is required for business interruption losses, which followed a similar ruling from a Michigan judge in July.

“That doesn’t mean there is not extreme uncertainty around the courts, there are risk premia that are increasing around Covid losses and that is still creating pricing pressure,” he said. “But the early signs are that contract law will be honoured and that no extracontractual claims are going to have to be paid.”

ROE to rebound next year

Hyperion X projects that composite forward ROE estimates are marginally, although not dramatically, lower in 2020 but will rebound in 2021. That would make this year the first dip in ROE since 2017.

“It looks like, if estimates are right, that we are going to see a dip in 2020 with a recovery in 2021 and 2022,” said Flandro. “This is based upon the composite we are using but it is indicative of the general trend in the sector.”

Flandro noted a number of drivers of the expected recovery in ROE. There is hardening in the P&C market, with rate increases accelerating in most commercial and reinsurance lines.

Another important factor is capital raising. Flandro said that some of it has been defensive but the majority has been opportunistic. New debt financing fell in the first half but new equity financing and new rounds of funding from start-ups were both up significantly.

“We’ve had about $16bn of new capital raising and that is roughly $10bn higher than we normally have in the first half of the year,” said Flandro. “This is significant and shows the sector is able to recapitalise quickly to take advantage of rising prices and to remain solvent during a big crisis.”

The first half of 2020 saw improved year-on-year underwriting results that were offset by lower investment returns. This drove diminished net income in the first half of 2020.

Hyperion X said that reserve releases re-emerged in the first half, although they were modest. This offset higher accident year losses compared with half year 2019.

Flando listed a number of ways that insurers have reacted during the crisis. This included new product design aided by better data, differentiation through service with focus on prevention, opportunistic new capital raising, the use of technology to lower administrative and acquisition costs, and strategic reinsurance purchasing.

On the latter point, he said: “Reinsurance is crucial, and strategic purchasing alongside contingent capital use is the new norm.”

Flandro concluded: “Going into the post-Covid era with higher pricing and opportunistic capital deployment, there are some positives for insurance companies to look to.”