KBW: Reserve surpluses are falling and inflation already a factor

Reserve adequacy has declined across multiple business lines as inflationary pressures continue to erode surpluses, KBW’s insurance equity research director Darius Satkauskas has warned.

“According to our calculation, European reinsurers’ reserve surplus amounted to 4 percent at the end of 2020. When we last did this study in 2018, this number was at 5 percent,” he said.

“Four percent is really the lowest level it has been since we started measuring it in 2008.”

Satkauskas spoke with The Insurer TV in the context of a recent KBW report examining the largest European reinsurers’ reserves.

The report points to signs of inflationary pressures and, in some cases, inadequate provisions across specific subsectors.

Satkauskas said inflationary pressures – both structural and social – have been “eroding” European reinsurers’ reserve adequacy for a few years.

“It’s clearly visible in the ultimate loss ratio development triangles disclosed by the companies but younger years of origin have been exhibiting negative development,” he added.

Loss development triangles are a methodology actuaries use to compare loss development for a specific period of time.

“And because the market has not seen negative developments for more than two decades until now, it could be underestimating this risk,” Satkauskas added.

In addition, the fact that valuations are not attractive enough is also contributing to KBW’s “underweight” view on the European reinsurance market.

Decelerating CR growth

During the interview, Satkauskas also warned that the challenging interest rate environment would make it difficult for European reinsurers to deliver on “normalised combined ratio targets” their investors are expecting.

Satkauskas said KBW’s view on the European reinsurance market remains “underweight” as rising interest rates could put a lid on capital returns and add pressure to pricing momentum.

There have recently been no signs of significant improvement on these metrics so far this year.

“If you look at Q1 2022 large losses reported by the companies [European reinsurers], this was not a good start to the year for most.

“I think that, considering that structural inflation is accelerating, which should increase loss costs, we think it’s likely that 2022 is going to be another difficult year for the industry,” Satkauskas said.

Structural inflation relates to inflation that results from structural changes in supply and demand, while social inflation is associated with claims-related losses and insurance costs.

As analysed by The Insurer, European reinsurers were forced to apply double-digit rate increases to their clients – against wide expectations of rises in the mid-single digits – amid an increase in loss frequency.

These increases in losses were mainly driven by macro trends in the cyber space, as well as losses related to climate change.

Satkauskas continued: “Now it is debatable whether the last five years is the new normal or if the industry simply underestimated global warming or simply mispriced this big risk in secondary perils. But I think companies need to be prudent and consider that higher large loss frequency could be here to stay when pricing for this risk.”