AM Best warns reinsurers to factor interest rate decline into underwriting

De-risking actions at renewals last year will support the sustainability of reinsurance underwriting margins in the short to medium term, AM Best directors told delegates during a market briefing at this year’s Rendez-Vous.

However, the rating agency warned reinsurers not to rest on their laurels as a potential decline in interest rates would impact rates, capital and competition across the segment.

Speaking at a briefing in Monte Carlo, Carlos Wong-Fupuy, senior director, global reinsurance at AM Best, noted that the upgrade of the sector’s outlook to positive in June had also taken de-risking into account along with pricing corrections.

“It’s not just about pricing, but mainly about de-risking,” he explained. “Changes in terms of conditions, increasing attachment points and tightening of wordings are as important, if not more important, than prices themselves. That’s why we believe that these underwriting margins are sustainable in the short to medium term.”

Wong-Fupuy added that this has enabled reinsurers to return to their historical role as protection for balance sheets, rather than earnings stabilisers.

“During the time of cheap capital and low interest rates, the allocation of capital was excessive and allowed reinsurers to offer capacity where they got involved in high frequency layers that they are now retrenching from,” he said.

Crucially, while there has been volatility in capacity, the global reinsurance segment has not seen capital depletion to the same degree as in previous hard market cycles. AM Best estimates all-time high capacity levels for 2024, with $515bn of traditional reinsurance capital and $108bn in alternative capital.

“The way that capital is being utilised has become more efficient as companies are being more cautious on how they deploy that capital,” Wong-Fupuy added.

“But, at the same time, we don’t see the need or pressure for new capital entering the market. We don’t think that that's impossible, but it’s unlikely to see disruptors in the market as we had seen in previous cycles.”

Previous hard market cycles have been characterised by a significant event – such as Hurricane Andrew in 1992, the 9/11 attacks in 2001 and Hurricane Katrina in 2005 – that eroded capital, thereby pressuring solvency and triggering sharp rate increases within a relatively short period of time.

With the last heavy cat year occurring in 2017, the gradual process of recovery in prices was stalled by the impacts of the Covid-19 pandemic, as well as unrealised losses that came through in 2022.

“We are seeing a market step change now on the underwriting side, not just the rates but the other actions that have been taken on terms and conditions, moving further up the structure in the reinsurance market, and the reinvestment rates improving as well. It’s a question of how long is this going to last,” added Mahesh Mistry, senior director, head of London analytics at AM Best.

Interest rates

The dynamic of hard cycles has also been impacted in recent years by interest rates, with Wong-Fupuy warning (re)insurers to factor this into underwriting strategies alongside maintaining discipline.

“Historically, what’s happened with the reinsurance industry is that there’s often been a correlation between the impact of interest rates,” said Greg Carter, managing director, analytics for EMEA and Asia Pacific.

“Higher interest rates historically encouraged cash flow underwriting, which actually led to softer market cycles. But this cycle is different – it’s important to flag that expectations of investors, driven by poor returns for so many years, is another one of the factors driving the hard market.”

Interest rates are expected to decline in the US this month, with persistent investor concerns around a potential slowdown in global economic activity signalling potentially looser monetary policy.

“That’s fine if it works, but if you look back at the history of the reinsurance sector and what ultra-low interest rates have meant, it’s meant excess capital, declining rates and increased competition,” Carter added. “Many of the problems through the long soft cycle have been exacerbated by low interest rates. That’s potentially not a good thing for the industry.”