Following its upbeat analysis of the personal lines market (See related article in National section), A.M. Best Co. has also given a thumbs up to the global reinsurance market.
Best revised its 2007 outlook for the sector to stable, which, it said “reflects a change from a negative outlook originally assigned nearly two years ago.” The revised outlook implies that “the majority of 2007 reinsurer rating actions are likely to be affirmations with stable outlooks and only a modest amount of anticipated rating or outlook changes.”
However, Best warned that “should price deterioration and competition persist at a faster pace than anticipated, the outlook could be revised back to negative by the end of the year.”
Most global reinsurers turned in very good 2006 full-year financial results (a 180 degree turnaround from 2005) with many carriers reporting record earnings. Best also noted that the “January 1 renewal set the tone for near-term optimism despite increased competition, primarily associated with non-catastrophe exposed business lines. In 2006, adverse development on older casualty years slowed considerably for the majority of carriers, and the only meaningful noise of the year was adverse development relating to the 2005 hurricanes.”
Best said that it appears “the sector is poised for a profitable 2007 given the potential for favorable underwriting margins in many lines of business and reinsurers reporting strong operating cash flow that will likely fuel investment income generation. Moreover, reinsurers are entering this softening phase of the market with replenished balance sheets due to earnings and improved loss reserving positions.”
Although the rating agency certainly expects that 2007 “should be another good year for the sector,” it wisely hedged its forecast with the admonition that “the eventual outcome as always will be based on how well reinsurers manage their catastrophic exposures relative to capital at risk, given that the benign catastrophe season is unlikely to be repeated in 2007.”
In addition Best signaled that the “optimism for longer-term robust performance from the reinsurance sector is somewhat dimmed due to the resounding sentiment that market conditions will continue to deteriorate, particularly for non-catastrophic exposed business lines. Additionally, many cedants enjoying the strongest industry results in decades continue to retain more risk, thereby reducing the overall demand for reinsurance. With only recent history to serve as a guide, it is critical for participants to remember how quickly the good times can turn sour should the next “unforeseen mega-event” unleash itself onto the industry.”
The future financial results, Best indicated, depend on how the sector maintains “underwriting margins in light of increased competition,” which in turn “will depend largely on how reinsurers monitor loss cost trends in key business segments and manage risk profiles. After the calm of 2006, the majority of reinsurers improved their respective risk profiles by managing aggregate exposures while beginning to fully embrace the concept of enterprise risk management. Nevertheless, it is A.M. Best’s expectation that reinsurers will have their capital management strategies tested on how to deploy capital while garnering adequate risk-adjusted return measures through this next market phase.”
Best also commented on the recent actions of the Florida Hurricane Catastrophe Fund. “The July 1, 2007 renewal was expected to be moderately calm for catastrophe risks with continued casualty price softening,” said the bulletin; however, “the recent legislation changes in the state of Florida that include the near doubling of capacity provided by the Florida Hurricane Catastrophe Fund,” may affect those renewals.” In effect Florida’s action has removed “a significant portion of catastrophe premiums” from the private reinsurance market.” Best said it “expects that reinsurers attempting to fill catastrophe limits will likely shift capacity to other markets and could impact pricing in non-coastal property and casualty markets.
“Another wild card going into 2007 and beyond is the potential magnitude that billions of dollars of additional and alternative forms of capital sourced from hedge funds and the capital markets will have on the competitive landscape. Since 2005, sidecar formations, catastrophe bonds and industry loss warrantees (ILWs) offered options other than traditional reinsurance capacity. How this capital is deployed in the future will clearly affect underwriting margins and emphasize the importance of reinsurers holding the line on pricing and policy terms.”
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