Reinsurers generated returns well above the cost of capital in 2023 due to positive underwriting results, driven by repricing and portfolio de-risking, a report by ratings agency AM Best has revealed.

The Best’s Market Segment Report, Reinsurers Meet Cost of Capital for First Time in Four Years, is part of AM Best’s look at the global reinsurance industry ahead of the Rendez-Vous de Septembre in Monte Carlo.

The agency said the turnaround was also due to a rebound in capital gains.

AM Best said: “To meet or go above 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.”

The agency said the reinsurance industry’s weighted average cost of capital had fallen to 6.25 per cent in 2019 before spiking up to 9.31 per cent in 2021. After falling to 7.35 per cent in 2022, it rose again in 2023 to 8.12 per cent – but reinsurers generated returns well above the cost of capital due to positive underwriting results.

At the same time, the industry’s return on equity reached a 12-year high in 2023, AM Best said, with a median of 16.41 per cent.

AM Best said 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.

It added that 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 the agency said 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,” said Sridhar Manyem, senior director, Industry Research and Analytics, AM Best.

The report said reinsurers look to optimise their cost of capital and maximise their returns while taking risks commensurate with their risk appetites. Significant and unexpected volatility in returns can indicate inefficiencies with regards to managing risk, resulting in a higher cost of capital.

During the prolonged low interest rate environment, AM Best said, investors’ interest in reinsurance through traditional equity, third-party capital and insurance-linked securities grew, as investors diversified their portfolios.

“Reinsurers’ failure to meet their cost of capital consistently in recent years has tested investors’ risk appetite,” said Helen Andersen, industry analyst, AM Best.

For reinsurers that take on high severity risks, the agency said, meeting their cost of capital during years of severe catastrophe losses is a challenge.

It added: “The years when returns exceed the cost of capital are generally the ones with a lower frequency and severity of natural disasters. According to Swiss Re, 2023 marked the third year in a row in which global insured losses exceeded $100 billion.

“However, the insured losses were due mainly to numerous small to medium-sized events and, owing to higher attachment points, most of the impact was retained by primary insurers.”