De-risking & underwriting profits propel reinsurers above cost of capital in 2023

According to a new report from AM Best, reinsurers met their cost of capital for the first time in four years in 2023, driven by a rebound in capital gains and underwriting profits.

The rating agency observed that rising interest rates, stock market volatility, weather events, and inflation have raised the cost of debt and equity in recent years.

“The reinsurance industry’s weighted average cost of capital had decreased from 9.5% in 2010 to 6.25% in 2019, before spiking up to 7.31% in 2021. After falling in 2022, it rose again in 2023 to 8.12%,” AM Best explained.

However, in 2023, reinsurers generated returns well above the cost of capital due to positive underwriting results, driven by repricing and de-risking of reinsurance portfolios.

AM Best continued, “The current hard market came about due to prolonged underperformance and economic and social inflation and despite a relative abundance of capital, due to the prolonged low-interest rate environment.

“Rate increases are slowing down, but reinsurers have also implemented thorough de-risking measures such as tightening terms and conditions and sharply increasing attachment points, which are unlikely to be relaxed.

“The hardened market has led to more sustainable pricing momentum, enhancing reinsurers’ ability to meet their cost of capital over the medium term.”

AM Best’s report also noted that most reinsurance players had an excellent ROE in 2023, with a median of 10.41%, the highest in 12 years by a margin of about 3.7 percentage points.

These returns were again attributed to the ongoing positive underwriting results and the recoupment of unrealized investment losses from previous years thanks to higher reinvestment rates.

“The exceptional ROE in 2023 is unlikely to be repeated, although reinsurers are expected to maintain underwriting discipline over the near term,” the rating agency added.

AM Best went on, “Sound risk management, strategic use of technology, and a maturing partnership with alternative capital have subdued the cyclical nature of the reinsurance market by narrowing the extremes.

“To meet or exceed the cost of capital, reinsurers must remain flexible with regard to market conditions and balance opportunistic moves (taking advantage of market conditions, retreating when pricing is not right) over the short term, with strategic long-term goals (maintaining relationships, building expertise, and being relevant and dependable over the long run).”

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