Single-digit returns on equity are not sufficient for reinsurers given the amount of volatility they assume, according to industry executives.
Speaking on a panel at S&P Global Ratings’ Global Reinsurance Conference, Brian Young, president and CEO of Odyssey Group Holdings Inc., said that he thought a return on equity of between 7% and 9% was “realistic” and “achievable” for the reinsurance industry in 2021, assuming an average level of catastrophe losses. But the industry should “absolutely not” be happy with that outcome.
“That’s not acceptable,” he said.
A primary personal lines insurer may find a 7% to 9% return “perfectly reasonable,” but reinsurers “take the rump end of the exposures,” Young said. “We get all of the volatility.” As a result, reinsurers need to push for higher returns.
Fellow panelist Mike Sapnar, president and CEO of Transatlantic Holdings Inc., agreed. “You can’t be running the single-digit returns with the amount of volatility on the balance sheet,” he said. “It’s crazy.”
The reinsurance industry has struggled with profitability in recent years as a result of catastrophe losses, persistently low interest rates, adverse claims development in the U.S. casualty market and heavy competition. Panel moderator Taoufik Gharib, a senior director at S&P Global Ratings, said the reinsurance industry had failed to earn its cost of capital in 2017 and 2018 and “barely did so in 2019.” He added that the ratings agency’s expectation that the reinsurance industry would generate an underwriting profit in 2020, based on the market hardening that began in 2019, was now unlikely to be met because of the added pressure of the COVID-19 pandemic.
Young said that the reinsurance industry had made an underwriting loss for the three consecutive years of 2017, 2018 and 2019. It is now in line for a fourth year in a row in 2020. “At some point, we need to make money,” Young said.
While much of the focus is on price increases to restore underwriting profitability, Young said that one of his concerns was the level of commissions, which he said had increased to roughly 32% to 33% from 25% in the period from 2005 to 2019. “That is 7 or 8 [percentage] points as a market that we’re giving up,” Young said. “That’s a lot of margin in a business where we are fighting just to make a few pennies.”
He added that the reinsurance industry “really does need to get its head around the fact that commission levels are not where they need to be” and that “they need to come down.”