Fitch: Reinsurance Sector Rating Outlook Revised from Negative to Stable

July 27, 2004

Fitch Ratings has revised its Rating Outlook for the global reinsurance sector to Stable from Negative. Prior to this change, Fitch had maintained a Negative Rating Outlook on the sector since 2001.

Fitch’s revised Outlook reflects the agency’s expectations for fewer rating changes in the near-term, and that the number of rating downgrades will more closely compare to the number of rating upgrades going forward.

A major contributing factor to Fitch’s revision in Rating Outlook is the sector’s improving reserve position along with the agency’s heightened comfort that company-specific projected reserve deficiencies have been incorporated into current ratings. Fitch believes that adverse reserve development over the next 18-24 months will be lower in magnitude than that experienced in 2003 and notes that 2003’s adverse development was significantly less than that experienced by the sector in 2002.

In addition, Fitch believes that such development will affect a more limited number of reinsurers, and given the sector’s recent strong capital formation, will be manageable from a capital perspective.

Fitch cites two primary reasons for the improvement in the reinsurance sector’s reserve profile.

First, is the improving, although still deficient, reserve position of the property/casualty sector in the U.S., which was a key factor behind Fitch’s recent decision to revise its rating outlook on the commercial lines sector to Stable from Negative. Historically, the U.S. has been a major source of much of the global reinsurance sector’s adverse development and Fitch’s projected industry-wide deficiency has declined moderately to a range of $44-62 billion, compared to a range of $46-77 billion a year ago.

Second, reinsurers and cedants re-underwrote large portions of their books of business in recent years, which when coupled with the significant rate increases implemented during the 2001-2003 hard market, results in comparatively little risk that reserves for the more recent accident years will develop adversely.

The revision in Fitch’s outlook also reflects its belief that market conditions will continue to support adequate profitability and returns on capital. Although premium rate increases in the sector have moderated from those prevalent in 2002 and 2003, Fitch believes that they are moderating from a technically adequate level that is able to produce an underwriting profit.

Market conditions have clearly evolved over the last 12 to 18 months. Starting in 2001 when the reinsurance sector emerged from the soft market, essentially all segments of the sector were able to implement rate increases and to tighten terms and conditions. Fitch views the current and near-term market as much more of a ‘risk selectors’ market, since the ability to maintain rate adequacy and hard fought terms and conditioning tightening, depends on the reinsurer’s specific characteristics and the class of business being written.

Fitch’s revised Outlook also reflects its expectation of a higher interest rate environment as global economic growth accelerates. Fitch believes that this environment will foster continued improvements in bond portfolio credit-quality and higher bond portfolio yields on new cash flows that from a rating perspective, will more than offset interest rate driven declines in bond values.

While Fitch believes that this return to a more ‘typical’ interest rate environment will ultimately pressure the sector’s premium rates and terms and conditions, it believes that this pressure is unlikely to materialize in the near-term.

Absent a large natural catastrophe, Fitch projects the sector’s 2004 combined ratio in a range of 95-98% as earnings will continue to benefit from strong premium rate increases implemented during the hard market of 2001-2003.

Fitch expects the sector’s combined ratio to bottom-out within the next 12 months as the earnings benefit from the hard market runs off and the impact of the more moderate rate environment takes effect.

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