Dear shareholders:
World Economic Outlook
2020 was marked by the dramatic slowdown of the world economy. According to data reported by the economic agencies of each country, the contraction to a greater or lesser extent is widespread and growth forecasts for 2021 remain conservative.
Lingering GDP declines are a serious setback to living standards against expectations prior to the COVID-19 pandemic, which has claimed more than two and a half million lives and counting. A critical aspect of combating the health crisis is to ensure that all innovations, whether in terms of screening tests, treatments, or vaccines, are produced on a scale that will benefit all countries. Globally, economies will face an uphill struggle to return to pre-pandemic levels.
On the bright side, the prospect of interest rates remaining at low levels for longer, coupled with the projected pickup in growth in 2021, could ease the debt service burden of many countries. According to the short-term projections of the World Economic Outlook, global growth for 2021 is expected to be around 5.5 %, which implies a limited improvement in economic activity projected for 2020 - 2025, both in advanced economies and in developing and emerging market economies.
Mexico's credit ratings for 2021 are 'BBB' with negative outlook by S&P; 'BBB-' with stable outlook by Fitch, which since March 2020 as well as S&P cut by one notch, followed by Moody's, which maintains a 'Baa1' rating with negative outlook. The adjustment is mainly due to the downgrade of PEMEX's credit rating and the country's sovereign debt, in view of the deterioration in investor confidence and the economic outlook, as well as the risks to public finances derived from the energy policy.
Insurance Market
In the insurance industry, many expect the current economic backdrop to bolster a market that was already transforming, albeit at a slower pace. However, today the insurance industry is accelerating its digitalization process, in some cases redefining its business model and, on top of that, the pandemic also stressed the need to offer new tailor-made products: cyber insurance, insurance based on automobile mileage, life insurance and medical expenses with specific coverage, among others.
On the other hand, the historical behavior of claims in segments such as medical expenses and automobiles shifted, the former due to a lag in the attention of medical consultations, treatments, and surgeries for non-COVID related illnesses and the latter due to the sudden change in the use of vehicles due to quarantines.
In the opposite direction, we had to face new claims caused by the pandemic across multiple business lines such as life, medical expenses, interruption of economic activities in some markets, cancellation of events, unemployment, among others. These claims are estimated at more than US$105,000 million and if we consider the investment losses that the sector has incurred, it is estimated that the total loss will be approximately US$203,000 million.
In Mexico, the loss due to the pandemic has already been ranked as the second worst in history, amounting to US$1,279 million at the end of February 2021, only surpassed by the losses compensated for damages caused by Hurricane Wilma in 2005 (US$2,325 million). Overall, however, the global industry will be able to endure the impact on profits caused by the crisis.
Moreover, the pandemic has hit the industry at a time of tightening property and casualty rates, a trend that is expected to continue, particularly in commercial risk portfolios, as capital becomes scarcer. This, and the expected rebound in insurance demand, should raise profits over the long run.
In this regard, current trends in the global insurance industry include:
- Increased risk awareness:
Although pandemics are known to be a peak risk, the crisis is increasing awareness of the value of different insurance lines and customer groups globally. Pandemics will not be fully insurable, but the health crisis will raise awareness of the associated financial risks and spur innovation of new coverages.
- Accelerating digital transformation:
Quarantine and the implementation of social distancing measures have underscored the importance and value of digitalization across the entire value chain. Distribution models must digitize in order to maintain sales. Usage-based insurance products are likely to become more attractive as they adapt quickly to changes in behavior or business volume. In addition, digital claims management and damage appraisal methods will become more important, as they allow claims to continue to be settled efficiently in a mobility-restricted environment.
- Globalization and parallel supply chains:
The pandemic has spotlighted the risk of undiversified supply chains. While the redundancy of supply chains, their offshoring and relocation will lead to higher costs, these changes will also offer insurance growth opportunities in countries where new production is located, including property, casualty, engineering, and surety.
Reinsurance Market
2020 will be remembered as another challenging year for the global reinsurance industry, due to significant pandemic-related losses, natural catastrophe claims and lower investment returns, so again, the industry will not be able to cover its cost of capital.
This follows three previous years in which the industry has struggled to cover its cost of capital due to large natural catastrophe losses, adverse loss trends in certain U.S. liability coverages, and fierce competition among reinsurers, creating difficult business conditions for the industry but at the same time posing new challenges and opportunities.
As 2020 began, expectations were that reinsurance was on the right track and reinsurers would improve their results. However, the COVID-19 losses and the resulting market volatility became, in this instance, the main factor dragging down results, so that once again, the industry’s expected performance was negatively impacted.
The market headed into the December 2020 and January 2021 renewal season with a sense of fear from cedents and a sense of opportunity from reinsurers, which prompted a number of capital increases by both existing and new reinsurers.
Poor underwriting results in previous years, compounded by interest rate reductions and emerging COVID-19 losses, suggest that reinsurers were indeed able to quietly push pricing and improve terms and conditions in the 2020 year-end renewals. Negotiations centered on the fact that while some business lines and regions have shown poor results, other markets have generated consistent profitable returns for reinsurers.
Global reinsurance capital also recovered quickly during 2020 from a combination of improving investment markets, retained earnings and new capital inflows, finishing 3% higher than at the end of 2019, giving cedents and brokers hope that there is a tougher, but thoroughly solid market to support them today.
Reinsurance has been focused on seeking adequate margins for its capacity in short-tail covers, resulting in a reluctance to back operating or working covers. Conversely, pricing pressure and the availability of loss-free high layer capacity decreased and became easier for cedents to underwrite.
The worsening environment and low interest rates have impacted pricing in all long-tail lines, particularly for excess of loss due to their higher exposure to claims inflation, with reinsurers seeking substantial price increases.
Reinsurers pushing for improved terms and conditions in these contracts have met with increased confidence from cedents to retain more of their own portfolios, now that many insurers believe they have reached an adequate level of rates. At the same time, brokers are increasingly attracting additional new capacity from inside and outside the market to long-tail portfolios, and these, by generating competition, of course improve initial rates and terms. This has put further pressure on established reinsurers who have weathered several years of a weak market but were largely unable to reduce ceding commissions as they had planned prior to the renewals.
A major concern has been the lack of clarity around COVID-19 losses that were only reported at the end of the renewal process or not reported at all in an increasing number of reinsurance programs. The technical issues around primary policy coverage and the wording of reinsurance contracts are complex and, in many cases, still in the early stages of deliberation.
Reasonably, rather than trying to solve complex problems in tight renewal deadlines, most programs renewed without considering any potential COVID-19 losses, freeing time for more thoughtful discussions to take place over the next 12 months and for negotiations to be postponed for subsequent renewals, where reinsurers have been clear and forthright in incorporating communicable disease exclusions.
On the other hand, a shortage of capacity in casualty retrocession markets had been forecast, based on the expectation that locked-in capital would affect ILS markets, but in reality, this has not happened to the extent expected with some funds even managing to increase their assets under management.
With the improvement in the terms and conditions of reinsurance written, some reinsurers adjusted their retrocession strategies and sought less coverage by increasing their retention. Rates increased and capacity was generally constrained, but buyers were able to obtain capacity through increased catastrophe bond issuance and the growth of legacy reinsurance capacity, which was poised to allocate more capital in light of improved pricing and structures.
An efficient market always finds an appropriate balance between supply and demand, as well as the requirements of different parties, and the renewal season of late 2020 and early 2021 has proven that the global reinsurance market continues to operate efficiently.
Reinsurers have voiced some disappointment that they have not achieved all the improvements they sought across their portfolios but are pleased that the persistent downward trend that has market past years has been halted and reversed. For cedents, terms and conditions have generally been reasonable, with the greatest distress points centered on renovations that were clearly in need of improvement.
Conditions appear poised to extend through 2021, taking into account the following key factors over the next 12 months:
Adverse Factors:
- Legacy soft market in some regions and business lines
- COVID-19 pandemic loss growth
- Increased losses from natural catastrophes and climate change concerns
- Technical reserve criteria to be updated
- Global recession leading to lower premium estimates
- Financial market volatility
- Technical risk premiums vs. market premiums, due to entry of new players to reinsurance panels where they did not previously participate
- Higher retrocession costs
Supporting Factors:
- Strong capitalization
- Proven resilience
- Segments benefiting from low claims due to the pandemic, such as automobiles and medical expenses for non-COVID related diseases
- Increased demand for reinsurance coverage
- New opportunities and solutions: Cyber, social unrest, online sales distribution channels, space overhaul, parametric coverages, among others
As with the direct insurance sector, the reality is that the way we work will evolve more rapidly than it would have before COVID-19, and already the entire market is updating operating models for the future.
It is no doubt 2020 brought great economic and social upheaval to most of society, but it must be noted that the future for our industry globally is perhaps more optimistic than the challenges faced by so many other industries, and even, as has been mentioned, with new growth opportunities.
Strategic and Corporate Aspects
The Board has assisted in the formulation, approval, and oversight of the execution of the Organization's strategic guidelines and takes part in the review and adoption of the policies required for the business’ development, while being informed of the different actions implemented by the Organization.
For this purpose, it was supported by several committees, such as the Audit, Risk, Retrocession, Underwriting, Communication and Control, Investment, and the Committee for the Protection of Personal Data.
Regarding the corporate governance system, during 2020 we pushed forward the restructuring of the Boards to make them entirely composed of independent directors with extensive experience and reputation, visionary, efficient, strategic, results-oriented, who not only adapt to change, but also promote it by ensuring that the decision-making process is inclusive and representative, fostering transparency and accountability.
The members of the Board were appointed following the Group's guidelines and the review of suitability criteria. The Board stands out for its work, experience, and independence, since it is the body responsible for overseeing the management, operation, and execution of the Company's business with the support of the corresponding Committees.
In this way, we ensure an efficient and transparent operation within the framework of ethics, integrity, investor confidence, and sustainable performance.
With the purpose of further strengthening corporate governance, we developed a training program for board members in economic and governance issues related to the insurance and reinsurance industry, as well as onboarding.
In line with the above, a proposal was drafted for the organization of boards and committees, a structure that will allow the decisions made to be effectively implemented, bringing direct benefits to our clients.
Corporate governance and internal control are one of the cornerstones contributing to the achievement of Grupo Peña Verde’s 2020-2025 Business Plan: Sustainable Profitability.
Acknowledgement
I would like to thank our officers and employees for their valuable cooperation and dedication and express our gratitude to you, dear shareholders, for the trust you have always placed in our Organization.
Juan Manuel Gironella García
Reaseguradora Patria’s Chairman