S&P Report Says Despite 2003 Profitability Global Reinsurance Market’s Poor Outlook Remains Unchanged

April 15, 2004

The ratings outlook for the global reinsurance market remains negative, despite an expectation that the market’s 2003 reported financial year-end results will return it to overall underwriting profitability for the first time in eight years, according to a new report released by Standard & Poor’s Ratings Services.

“The reinsurance industry is expected to report an overall technical
profit for year-end 2003, even after the impact of prior-year losses.
Meanwhile, continued rate increases at the 2004 January renewal augurs well for an improving accident year for the market in 2004-2005,” said Standard & Poor’s credit analyst Stephen Searby. “Nevertheless, negative pressures remain on some ratings in the sector. The market outlook–negative now for the seventh consecutive year–therefore reflects an expectation that more ratings will be lowered than raised over the next six months, albeit at a much slower rate than experienced during 2002-2003,” he added.

Key among the negative influences in the market are: diverging fortunes between the companies; the impact of the flight to quality and the associated problem of rating-related triggers for weaker reinsurers; continued prior-year reserve developments in the U.S.; the likely need for the industry to make further provisions for asbestos in 2004; and diminishing parental support.

“The performance of market participants continues to diverge as the
catastrophe writers benefit from a benign year, while prior-year legacies and operational difficulties continue to drag down the larger players,” added Searby. Although the 2003 year-end results are expected to see the market’s average combined ratio–a key indicator of operating profitability–fall to below the 100% break-even mark for underwriting, the results for individual companies can be expected to be as much as 70 percentage points apart.

Intensifying the growing divergence among participants is the continued flight to quality. Many of the less well-positioned players are seeing their share of the better quality business diminish. “It is not just the small players that are suffering. Some of the larger groups are losing business as cedents are also increasingly concerned about concentration risk in their ceded portfolio,” said Searby.

Associated with the flight to quality is the increased attention being
paid to the use of rating triggers. Triggers can create a false sense of
security, as they may not work for the cedent when needed most; for
example, after a large industry loss. Furthermore, the growing demand for triggers could also backfire on cedents. Reinsurers will have to hold more capital in order to raise enough cash to service the requirement for separate pools of collateral, ultimately leading to higher reinsurance premiums across the market.

Standard & Poor’s does not expect further announcements of billion dollar reserve developments in the U.S.; the problem, however, remains. Further adverse development on U.S. liability lines stemming from the 1997-2001 underwriting years is expected to continue throughout 2004, although this will be hidden to an extent by releases on short-tail business and masked by strong accident year profitability. In addition, given the current levels of profitability, some reinsurers will take the opportunity to top up their asbestos-related provisions. Although asbestos-related loss reserves among the major reinsurers have stayed fairly stable in recent years, there has been an acceleration in asbestos-related reserving in the U.S. primary market and this is expected to influence the reinsurance market over the coming years.

Diminished parental support also looks set to become an increasingly
prevalent ratings issue in 2004, particularly for subsidiaries that
continue to underperform. “Increased sophistication in the measurement of return over risk-based capital, and its application as a tool for measuring the relative performance of lines of business and/or subsidiaries, gives management less of an excuse to persevere with underperforming units than in the past,” said Searby.

The report, “Global Reinsurance Outlook 2004: Pockets of Weakness
Remain,” was published on April 15, 2004, and is available to subscribers of RatingsDirect, Standard & Poor’s Web-based credit analysis system, at www.ratingsdirect.com.

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