Best Holds Stable Reinsurance Outlook

A.M. Best Co. has issued an analysis of the global reinsurance sector, indicating that it will maintain an overall “stable outlook” for 2008 for the second consecutive year.

“The affirmation of the sector’s outlook reflects generally strong balance sheets, continued improvements in enterprise risk management (ERM) and general earnings momentum through 2007,” said Best. “This current outlook implies that the majority of 2008 reinsurer rating actions are likely to be affirmations with stable outlooks and only a modest amount of anticipated rating or outlook changes. However, as assessed at the January 1, 2008 renewal, price deterioration, competition and increased cedant retentions are drivers of concern relating to the sustainability of the sector’s long-term operating performance.”

Essentially the reinsurance market has stabilized since the catastrophes of 2005. It has certainly “benefited from two years of moderate catastrophe losses and solid operating earnings,” as Best notes. Additional capital has also contributed to healthy balance sheets. Best did point out that capitalization problems are “still nagging a handful of companies,” but overall legacy issues from the soft market years continue to diminish.

“Nonetheless,” said Best, “with rate declines in both property and casualty business lines, it is unlikely that current reserving levels can be maintained or be relied upon to boost earnings in outward years.

Much depends on “catastrophe activity” in 2008. Best said it expects that “the sector is poised for a profitable 2008 given that technical rates of most major lines of business are still profitable to this point. Investment income fueled by strong cash flow should also support earnings.”

Best also indicated it “believes that 2008 results will reflect more accurately current market trends as margins are expected to moderate.” Barring a mega-catastrophe that removes enormous amounts of industry surplus from the market, Best doesn’t foresee any “improvement in pricing levels for some time. The success factors for navigating these rough waters are for reinsurers to maintain underwriting controls and standards to determine pricing adequacy and maintain discipline in a challenging environment. History indicates these are not easy tasks to accomplish.”

As usual the ever-present industry cycle, and how the reinsurers manage it, will remain a “critical factor.” Following dividend increases and share repurchases, “there is considerable pressure on reinsurers to achieve targeted return on equity,” said Best. “Many carriers have established diversified operating platforms, while newer formations have looked to build underlying capabilities to manage the cycle and deploy capital.”

Best also indicated that it expects to see “merger and acquisition buzz through 2008 with the possibility of more deals.

“Despite the improved position of the reinsurance sector, challenges remain in light of the increased capacity of industry participants, new entrants and forms of capital. It is no longer easy to ignore the reality of the capital markets as an alternative solution for primary markets. After paying high reinsurance costs over many years, financially improved cedants are more sophisticated and are assessing how much reinsurance coverage to buy in more economic terms.

“Although the reinsurance sector’s capital position is strong, recent history indicates the pain that soft casualty markets can inflict on required capital year after year, and how large-scale catastrophes can remove massive amounts of capital from the market in the blink of an eye.”

All in all Best concludes “2008 will be an important year for the global reinsurance industry, as it can influence the direction of the market for years to come.” The rating agency acknowledges that the reinsurance sector has embraced “ERM practices and the subsequent improvement of data capture risk modeling and correlation analysis.” However, Best points out that “ERM enhancements have not been tested by a mega-catastrophic event as two category five hurricanes did strike landfall in 2007, but the dynamics of these storms—to a great extent—limited insured losses.

“The true success of reinsurers achieving value through ERM is the ability to adhere to its role through all phases of the pricing cycle. If this can be achieved, perhaps this soft market will not be as painful as the previous one.”

Source: A.M. Best – www.ambest.com.