Standard & Poor’s Rating Services has issued a series of reports on the global reinsurance industry, timed to appear as the annual Reinsurance Rendezvous opens its doors in Monte Carlo. The meeting, which features three days of talking, networking, deal making and partying by the movers and shakers of the global reinsurance industry, kicks off the first round of the January renewal season. More serious discussions come later – and a good deal more privately – in Baden Baden in November.
S&P’s seies of reports includes “Global Reinsurance: A New Dawn Or Another False Dawn For The Sector?” which addresses the age-old problem posed by the cycle. “With market conditions set to become ever more challenging, the behavior of reinsurers will be critical for their prospects of long-term success, and only a more disciplined approach can ensure a stable, financially strong future,” stated S&P credit analyst Peter Grant.
S&P sees 2008 as potentially being a “watershed for the reinsurance industry.” On the positive side “enhanced levels of underwriting discipline, underpinned by robust enterprise risk management and reinforced by proactive capital management, could welcome in for the sector a new dawn of earnings adequacy across the cycle.”
On the other hand “a period of poor discipline and a continuation of the extreme pricing cycles that have characterized the sector in the past, which would be harmful to the sector’s reputation,” pose threats to reinsurers’ “financial flexibility, and ratings.”
Grant observed that S&P remains “cautiously optimistic that the industry has armed itself with the tools necessary to, at the very least, avoid repeating the most harmful errors of the past.”
As a result the rating agency’s general outlook on the industry is stable. Whether it remains that way, depends on “the industry’s willingness and ability to deploy these tools effectively,” Grant continued. The outcome will determine “whether this will be a new dawn for the reinsurance sector, or another false one.”
In a separate report, “Global Reinsurers’ Complex Risk Profiles Demand Sophisticated Enterprise Risk Management, [ERM]” S&P discussed ERM’s increasing importance in determining ratings. The report compiles opinions gathered from those companies that have actively instituted ERM programs, and “for the first time explains our aggregate findings,” said S&P.
Credit analyst Christopher Myers noted: “ERM evaluation continues to play an increasing role in Standard & Poor’s analyses of the capabilities of reinsurers to manage the various risks to their balance sheets efficiently.” ERM enhancement, modeling improvement, economic capital, and cycle management are themes that underlie our global perspective of reinsurers’ ERM, and are covered in the report.
That perspective is discussed in a separate report – “(Re)Insurer Capital Analysis: What Does The Future Hold?”). S&P notes that it has “made significant changes to its risk-based capital adequacy model in 2007, incorporating diversification benefits for the first time.”
The next stage, expected in 2008, is S&P’s detailed analysis of economic capital models (ECMs) used by (re)insurers within their enterprise risk management (ERM) processes. The report also highlights the (re)insurers’ management of capital and comments on the growing expectation of a large-scale return of capital to shareholders.
“In global terms, the new capital model is not expected to have a significant impact,” indicated S&P credit analyst Rob Jones. “However, the incorporation of ECM analysis could have a more significant impact when it is rolled out over the next year.”
S&P said it would only undertake ECM analysis for (re)insurers whose ERM programs it has assessed as “strong or excellent.” One significant impact of the ECM analysis may be a finding that some “insurance groups are shown to be overcapitalized,” as currently suggested by their ECMs. “We are still open-minded about what impact this will have, given that ERM and ECMs are still in their infancy and untested by events,” Jones continued. “It seems likely that capital over and above modeled outcomes will be maintained for some time to come as comfort with ECMs grows over time.”
Legislative actions and regulatory procedures also closely concern the global reinsurance industry. Concerning the first, S&P has published an article, as part of the series, entitled “Private Reinsurers Find Business Opportunities Amid The Legislative Changes In Florida” (See separate article in “National” section). Among other conclusions S&P notes that “some private reinsurers are not only adjusting but are benefiting, finding new profit opportunities in the altered marketplace.”
The article on regulation, aptly titled “Insurance Regulation In The Midst Of A Global Revolution” examines the changes in how reinsurers are governed. The historical role the U.S. has played as a leader in global insurance regulation and accounting “is now being contested as other parts of the world set new standards,” said S&P.
“In the 21st century, the pace has been set by Canada, Australia, the U.K., and Switzerland, and the EU will raise the bar still higher with the introduction of Solvency II, which should come into force by 2012 for Europe’s 27 member states,” S&P explained. “As a result, the (re)insurance sector is facing the challenge to meet the requirements of an increasingly converging regulatory system.”
Jones noted that “U.S. insurers are becoming concerned that they may be placed at a competitive disadvantage as regulatory change sweeps across the rest of the globe. At the same time, there is also evidence of convergence in accounting regulation with the IFRS standards established in Europe and much of Asia. Again, the U.S., with its use of U.S. GAAP, is an exception at this stage.”
S&P said the changes are “leading to a move away from rules-based, legalistic regulation, and are instead providing a system where forward-thinking takes priority and where substance is considered more important than form.” Solvency II is the prime example of the change, as it emphasizes the calculation of risk levels, rather than capital requirements.
“In this day and age, where new products, new risks, and new risk mitigants are appearing on a daily basis, a rules-based approach, which demands frequent and substantial revisions, does not respond well,” Jones continued. “It is therefore not surprising that principles-based approaches, which provide a framework for dealing with new developments, are now being favored in most insurance markets worldwide.”
In addition S&P analyzed the role “diversification” plays in the reinsurance industry, as well as several other markets. These reports are analyzed separately.
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