Reinsurers will have to “push back” on pricing if returns continue to dwindle towards unsustainable levels.

That is the view of Taoufik Gharib, senior director, North America insurance ratings for Standard & Poor’s Global Ratings, who will be speaking on a panel at a conference in Hamilton today.

Returns on equity have fallen substantially from the levels of five years ago and even this year, after the industry soaked up $135 billion in catastrophe losses in 2017, reinsurance price increases were more modest than carriers had hoped for.

In an interview, Mr Gharib said one of S&P’s triggers for action on a company’s credit rating was the relationship between cost of capital and return on capital.

“Last year the industry did not earn its cost of capital because of the catastrophe losses,” Mr Gharib said. “This year return on equity has been declining because of the catastrophe losses.

“From our perspective, if the return on capital does not cover the cost of capital on a sustainable basis, then we will change our sector outlook to negative, which means that potentially we could have more negative rating actions on reinsurance companies.

“So far, we have kept the outlook stable because of the strength of capital and ERM [enterprise risk management], but if the trend continues then we will change the outlook.”

Some of the more diversified companies were delivering stronger returns, helped by profitable lines of business such as mortgage insurance and reinsurance.

Rising interest rates should boost returns from reinsurers’ large fixed-income portfolios, but Mr Gharib said the benefits would take a couple of years to work through to the balance sheet.

“At some point, the industry has to push back and ask for more reinsurance price increases,” he said.

S&P forecasts a reinsurance sector return on equity of 7 to 9 per cent for this year and 2019, a combined ratio of 96 to 99 per cent, assuming catastrophe losses amounting to 8 percentage points and reserve releases of 5 percentage points.

US corporate tax cuts kicked in this year, eroding the island’s tax advantage, as the US rate fell from 35 per cent to 21 per cent. Excise tax on premiums transferred to a Bermuda affiliate through a reinsurance agreement are also increasing and are due to climb further.

“For the last 12 to 18 months, we’ve seen Bermudian companies changing up their quota shares. Many used to have quota shares of 80 or 90 per cent of premiums being sent back to Bermuda from US operating companies.

“Given that the excise tax is going up, gradually, over the next few years, ultimately reaching 12 per cent or so, some have them have reduced those quota shares down to 50 per cent, or even cancelled them.

“In other words, a lot of the risk that used to be transferred to Bermuda now stays onshore in the US.”

Bermuda’s advantage goes beyond the tax and includes talent, regulation and proximity to the US, he added.

“If you want to get a licence, it takes weeks here. It takes months in other jurisdictions. Also you have the local expertise — Bermuda has become a centre of excellence when it comes to property-catastrophe risk and now ILS.

“If you’re a cedant, there is also the proximity of the reinsurers, so it’s easy to visit them all in one trip.”

Mr Gharib says there are several reasons why the trend of consolidation is likely to continue, including a lack of organic growth, customers’ preference for dealing with larger reinsurers, and fragmented regulation around the world that generates extra costs that larger players can more easily absorb.

Mortgage insurance and reinsurance has been a growth area for many of the island’s companies, including Arch Capital, Everest Re, PartnerRe and RenaissanceRe, Mr Gharib said.

However, he added that pricing was probably past its peak, as underwriting of mortgages had strengthened since the global financial crisis of ten years ago.

“There is pressure on mortgage reinsurance,” Mr Gharib said. “We still view it as an attractive line of business, but there are more competitors coming to the market.”

Munich Re has entered the market for the first time, he added, partnering with Arch.

From a credit rating standpoint, S&P applies a hefty capital charge to such business, he added, to capture its risk.

“If exposure becomes significant, and it becomes a quasi mortgage insurer, then we have a separate capital model for mortgage insurers, which involves doing a deep dive for additional data and treating it like a mortgage insurer,” he added.

S&P’s Bermuda Reinsurance Conference will take place at the Hamilton Princess and Beach Club today. Mr Gharib will moderate a CEOs panel featuring Scott Carmilani of Allied World, Kevin O’Donnell of RenaissanceRe and Mike Sapnar of Transatlantic Holdings.

For more information, visit http://ratings.spglobal.com/18Q4-NAM-US-INS-Conf-BermudaReInsurance-Bermuda-7-Nov_BermudaLayout.html