Reinsurers’ profitability is threatened by a continued soft market and low investment returns, S&P Global Ratings says.

In the first half of this year, the sector generated returns only 1.2% above its cost of capital.

“Excluding heavily catastrophe-exposed years, this is the lowest excess in more than a decade,” S&P said. “Reinsurers’ ability to earn returns above their cost of capital has declined significantly.”

The ratings agency says the tide of cheaper alternative capital continues to compete with, and crowd out, traditional players.

The sector’s return on capital was 8.6% last year, with S&P expecting it to drop to about 5-7% by the end of this year. Meanwhile, the sector’s cost of capital was 6.5% last year, and is expected to increase marginally throughout the rest of this year and next.

“These trends indicate that, even if prior-year reserve releases remain favourable for the next two years, reinsurers are likely to barely cover their cost of capital under a normalised level of natural catastrophe losses,” S&P said.

“We are also seeing signs that prior-year reserve releases could decline; some reinsurers have already demonstrated this during [last year] and after the lowering of the UK’s Ogden discount rate during the first quarter of [this year].

“Insured catastrophe losses have also been historically low – were they to return to historically average levels, the sector’s profitability could dip below its cost of capital.”

Despite these challenges, market valuations for listed reinsurers remain near to historical highs. But S&P says its stable outlook on the sector “would likely change to negative if the industry’s profitability sustainably falls below its cost of capital”.