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Moody's: Reinsurers Vulnerable Due to Soft Pricing

Source: National Underwriter

Posted on 17 Jan 2011

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Reinsurance firms' credit profile may be weak and their potential share repurchase activity could mean problems with catastrophe losses, said Moody's Investors Service.

These factors create negative implications for the companies' policyholders and creditors, the rating firm warned today in a Credit Outlook report appraisal written by James Eck, Moody's vice president and senior analyst.

Mr. Eck wrote that the credit profile of the reinsurance industry "may not be as healthy as current capital levels indicate," and a lack of attractive opportunities on the underwriting side may lead to increased repurchase activity, increasing "their vulnerability to catastrophe losses."

Mr. Eck's analysis followed the report last week by three major reinsurance brokerages that Jan. 1, 2010 renewal prices were soft for most business lines in major markets around the globe.

Reports that prices range from flat to down 10 percent for most coverage subclasses compared with last year, while not unexpected, "will place additional pressure on reinsurers' underwriting margins and profitability," according to the report.

Moody's noted that in the United States, the world's largest reinsurance market, property catastrophe reinsurance rates are reported to have declined by 5-to-15 percent, with pricing for hurricane risks holding up better than for earthquake risks.

U.S. casualty rates were generally flat to down 10 percent, continuing a downward trend over the past few years. Certain segments, however, such as professional liability for financial institutions, had slight price increases In Europe, rates were generally flat to down 5 percent for most business lines, with some firmness for property coverages in regions that had catastrophe losses during 2009, Moody's found.

The drop in rates stems from increased capacity and reduced demand, the report said.

On the supply side, the sharp rebound in credit and equity markets during the second half of 2009 boosted reinsurers' capital positions. In addition, 2009 earnings were robust for the industry, reflecting light catastrophe losses and reserve releases on business written between 2002 and 2006, Moody's advised.

As a result, reinsurance industry equity capital position begins 2010 at near peak historical levels, the firm said. On the demand side, reduced economic activity and the strained reinsurance budgets of primary carriers have had an adverse impact on reinsurance purchases, Mr. Eck noted.

Moody's recalled that in September 2009, the firm had changed its outlook on the reinsurance industry to negative from stable, "highlighting several key concerns: namely, excess capacity and slack demand leading to price competition; the fragility of the capital markets, which could preclude weaker firms from recapitalizing after a catastrophic event; and inadequate casualty rates potentially leading to future reserve deficiencies," wrote Mr. Eck.

With rates continuing their downward trend, Moody's report said it believes the industry credit profile "may not be as healthy as current capitalization levels suggest."

"Absent a transformational catastrophic event, we expect reinsurer profit margins to come under increasing pressure as rate decreases affect the top line, investment income drops owing to low investment yields, and the impact of reserve releases, which have bolstered underwriting results in recent years, diminishes," Mr. Eck wrote.

"Given these headwinds," he said, Moody's believes "many firms may decide to repurchase shares to boost returns on equity. However, this course of action could result in increased vulnerability to shock losses from catastrophes, with negative implications for ratings."