Future proofing in Latin America

Fitch’s Eduardo Recinos says a resilient reinsurance sector in Latin America will help buffer uncertainty, but challenges remain.

Eduardo Recinos – Fitch

The past nine months have been difficult for everyone, with uncertainty at every turn. While many parts of our sector have suffered at the hands of the coronavirus pandemic, the significance of reinsurance has shone through.

The facility offered by this important sector may be the key to helping business and economies come through some of the toughest times in a generation. Without reinsurance protection, insurers run the risk of collapsing after a catastrophic event – and we seem to be having more of them.

Nowhere is this more apparent than in Latin America, which operates a relatively compact insurance sector. As a region, it has had more than its fair share of catastrophes, even before the pandemic hit, and having a back-up to insurers is becoming increasingly important.

In 2019, insured losses in Latin America hit $2.7bn, adding to the $500mn in 2018 and the disastrous $36bn in 2017. However, these figures are significantly lower than the actual economic losses to hit the region, mainly due to the low insurance penetration levels in its constituent countries.

While primary insurance premiums have shrunk in the current financial year, at Fitch, we expect increased demand for reinsurance coverage from primary insurers facing pandemic-related claims for losses.

“Climate change may be a double-edged sword, as along with regularly occurring natural disasters, increasingly violent and unpredictable weather could prove a boon to reinsurers”

Climate change may be a double-edged sword, as along with regularly occurring natural disasters, increasingly violent and unpredictable weather could prove a boon to reinsurers in the region. Record natural catastrophe losses from the past three years have motivated further coverage acquisitions in affected countries, and competition from ILS in the region is scarce.

Fitch data shows that many insurance companies operating in the region would not have the ability to offer catastrophe risk coverage if it were not for their reinsurance protection.

With the exception of Brazil, the region’s reliance on reinsurance is high. The weight of reinsurance recoverable is also considerable in most countries, meaning non-payments would have a material negative impact on insurers’ balance sheets.

However, that is not to say Latin America does not face its challenges.

Investment portfolios held by reinsurers in the region are commonly limited to sovereign bonds, which, in the sustained low-interest-rate environment, produce little yield. Additionally, when a sovereign comes under pressure, any negative credit rating affects the strength of the bondholder, too.

This means in the short term, we expect pricing will maintain its current positive trend, given reinsurers’ higher focus on technical profitability that is aimed to offset low financial income. Yet, despite these higher prices, reinsurance demand in the region will benefit from global conditions, as we consider primary insurers hit by pandemic-related claims will increase reinsurance coverage.

This phenomenon is not constrained to Latin America; rather, it reflects a relatively small market following global trends.

Global competition, on the other hand, forces local reinsurers to focus their efforts on regional insurance sectors. We expect this behaviour to continue, since the region’s largest and best-positioned competitors possess strong franchises and deep knowledge of regional markets. Accordingly, they are well-placed to adapt to and potentially profit from the changing global reinsurance market.

Looking forward, in the medium-term, pricing may return to flat levels, as seen a couple of years ago, and we may perhaps see M&A activity, given the contraction on global reinsurance capital from pandemic-related losses. But for the long-term, the ultimate implications of the pandemic on the reinsurance market are uncertain and it is difficult to see where, how and when this story ends.

But it is clear the support of reinsurers in the region is key – and looks to be sustainable.