Rating Agencies Revise Outlook for Global Reinsurance Industry

Posted on Sep 08, 2011 by Sergio Ulloa (G+)

The global reinsurance industry could be set to rebound, with rates finally rising to offset the record catastrophe losses incurred this year by an unprecedented series of natural disasters in both the Asia Pacific region and United States. New analysis released this week by worldwide credit and insurer rating agencies looks to assure clients that over the coming 12-18 months, positive market trends should be able to offset the significant challenges currently facing the industry. On Tuesday, Moody's Investors Service issued a report, indicating they had revised their outlook on the international reinsurance sector up to "stable" from "negative." The New York-based agency based their ratings decision on a combination of factors. Moody's believes that the good risk management and underwriting discipline displayed by the industry in the past year, combined with a hardening market and increased demand, would enable reinsurance companies to raise rates and respond to recent catastrophe losses. Moody's previous negative rating had been in place since 2009. Moody's reported that reinsurance prices had already risen considerably in recent months, and not only in the regions and lines of business most affected by natural disasters. Recent renewal data has indicated that the price for catastrophe reinsurance cover in the United States was firming from between a 5 percent to 10 percent increase. Moody's predicts further price increases at 1 January 2012 renewals as well. The lead author of the report, Moody's VP and senior credit officer, Dominic Simpson explained that the aftermath of the worst quarter for natural catastrophes since Hurricane Katrina could become an earnings event for the industry. "Recent catastrophe losses loom large in our decision to revise the outlook to stable, as they have provided momentum for reinsurance rates to harden. However, over the longer term, it remains uncertain whether this expected plateau is a temporary halt to further pricing weakness or whether it will be followed by sustained market improvements," Simpson wrote. Moody's indicated that the imbalance between supply and demand for reinsurance cover, in which overtly intense competition had kept pricing soft over the past few years, could be moderated by the current market environment. High catastrophe losses have already cut some of the excess capacity in the sector, and future supply could be further constrained by more expensive cover and consolidation within the industry, in which Moody's anticipate market conditions to remain favorable. In terms of demand, Moody's is confident that insurers will continue to take out reinsurance policies, despite tighter budgets. Natural disasters are one of the best reminders to have adequate protection against catastrophic loss. Moody's noted that while the balance sheets for insurers were strong in 2010, allowing them to retain more risk on their own, now many companies would have "little flexibility left in further reducing reinsurance usage." Insurers seeking further protection due to the updated Risk Management Solutions (RMS) hurricane model, as well as increased capital demands through Europe's Solvency II regulatory regime, could also increase demand for reinsurance in the future. Even though possible gains are on the horizon, Moody's notes that short-term profitability for reinsurance companies remains "under meaningful pressure." Reinsurers had already exhausted their 2011 catastrophe budgets before the Atlantic Hurricane and investment returns have been muted during the period as well due to low yields. Despite catastrophe budgets being stretched and a downward pressure on profits, Moody's believes reinsurer loss ratios will stabilize during 2012 as prices harden and companies adapt to the new market. Reserve levels for most major reinsurers have remained adequate. The ratings agency remains concerned, however, about reduced investor activity and confidence in the sector. In the long-term, Reinsurance companies with low equity valuations may struggle to replenish their equity capital after another major catastrophe. Security would be weakened for policyholders and bondholders of these insurance companies who cannot recapitalize to meet their obligations. "Against this background, and notwithstanding the existence of a number of credit challenges, including the low investment yield environment and constrained financial flexibility, we have revised our outlook on the sector to stable from negative," Moody's concluded The other major worldwide credit ratings agencies, including Standard & Poor's and Fitch, have confirmed Moody's outlook, each with their own stable rating for the global reinsurance sector. This week AM Best was the latest to offer its analysis in its Special Report, 'Reinsurers are Ready to Move as the Market Begins to Stir.' The Oldwick, New Jersey-based agency indicated that the reinsurance market may finally be able to tackle years of soft pricing and high catastrophe losses. AM Best, like the others, believes that recent events have triggered an increased focus on the value of reinsurance and this could be just the lift the industry needs. "The recent spike in global catastrophe activity, combined with changes in catastrophe models, is expected to bring about some change in the perception of risk on the part of the primary companies," the report said, adding that a severe hurricane on the US mainland could further push the market. "This, together with increased regulatory pressures on solvency margins, may turn the tide on reinsurance demand, which should help to bolster current pricing for property-related business," Best added. Ratings agencies have long recognized catastrophic loss as the primary threat to the solvency of both reinsurers and property and casualty insurers due to the severe, rapid and unexpected impact that can occur. Global demographic and economic trends have been pushing property values and concentration risk in catastrophe-prone areas upwards and insured exposure has in turn escalated rapidly in the past decade. As more and more people (and clients) inhabit these areas, insurers must take on more responsibility to provide coverage against a wide array of new concerns, including terrorism. As a result, the worldwide insurance industry's exposure to catastrophe losses continues to rise and solutions need to be found. Companies Mentioned A.M Best A.M Best Company was founded in 1899 and is a full-service credit rating organization dedicated to servicing the financial services industries, including the banking and insurance sectors. Moody's Moody's Investor Services provides credit ratings, research, credit risk management, and other services for more than a hundred thousand commercial and government entities around the world.