S&P Mid-Year 2005 Report on Outlook for U.S. Reinsurers – Sector Stable, “But Only Because Of Parental Support”

June 8, 2005

Standard & Poor’s Ratings Services has issued its assessment on the U.S. reinsurance sector, which concludes that it remains stable, even though there have been declines in pricing.

S&P notes: “The market has witnessed some softening in terms and conditions, the evidence is that the majority of reinsurance contracts are still being priced at economical terms. In addition, the very strong support shown by parent companies despite poor results in 2004 means a level of ongoing stability in U.S. reinsurer ratings is expected over the medium term despite Standard & Poor’s expectation that reserve additions are likely to continue into 2005 and, to a lesser degree, 2006. However, underlying this stability, there is still a question about when the market will achieve underwriting profitability and whether this profitability is going to be sustainable.”

In a companion announcement S&P stressed that the U.S. reinsurance industry is largely dependent on parental capital, much of it from outside the U.S., to maintain ratings stability (See related article in “International”). “In fact,” said S&P, “without the support of their stronger parents, a much larger number of U.S. reinsurers would have gone into run-off or insolvency over the last four years. Parental support has continued despite disappointing results reported by the U.S. reinsurance market in 2004, with reserve strengthening for prior years and moderate third-quarter 2004 catastrophe losses contributing to the industry reporting another year of underwriting losses.”

Of the “Top 10” largest reinsurers operating in the U.S. the first three have parents offshore – Swiss Re America, XL Re and American Re (a subsidiary of Munich Re). The remaining top 7 are: GE Insurance Solutions (a part of GE), Transatlantic/Putnam (controlled by AIG), Everest Re (controlled from Bermuda), National Indemnity and the Gen Re Group (Berkshire Hathaway), Odyssey Re (controlled by Canada’s Fairfax) and Berkely Ins. Co.

S&P noted: “In 2004, U.S. reinsurers had a combined ratio of 111 percent and an ROR of 2 percent (excluding the results of National Indemnity Co., which substantially distort industry figures). However the price increases over the past four years should have meant that results for 2004 would be very good. Instead, results have been dragged down by continued reserve strengthening of slightly more than $4 billion reported, which contributed to an estimated 16 percentage points to the 2004 combined ratio. These results come at the heels of equally unimpressive operating performance in 2002 and 2003, with the U.S. reinsurance industry reporting a combined ratio of 127 percent and an ROR of negative 7 percent in 2002 and a combined ratio of 106 percent and an ROR of positive 6 percent in 2003. “

Commenting on the ongoing reserving demands, S&P indicated that it “should be coming to a point where it is less of a drag on the balance sheet. There is an expectation that reserve deficiencies should be of lesser magnitude over the next two years, as the peak of reserve strengthening actions for the 1997-2001 years is reached.”

However the rating agency also noted: “There continues to be a gap between the timing of the reporting of primary companies’ reserve deficiencies and when these deficiencies are recognized by reinsurers. Although the magnitude of reserve additions reported by reinsurers over the last three years leads Standard & Poor’s to believe that they are addressing this gap, in reality, both sides probably have to acknowledge a higher degree of loss. The primary companies need to recognize that they are not going to recover everything they say they will, and reinsurers will have to take some higher losses than the ones they have on their balance sheet.”

The study notes that several players have exited the North American market, and also points out: “There is a need to keep an eye on the continuing investigations generated by the office of the Attorney General of New York.” S&P said the “questions about finite reinsurance are the most pertinent, but it is too early to tell what the consequences of the investigations will be, though it appears that the main focus of investigation is on the purchasers of finite reinsurance products rather than the sellers. As such, the reinsurance industry could be less affected than the primary market.” S& P also indicated that it believes “that even if finite reinsurance business ceases to be viable, there is likely to be minimal impact on reinsurers because the loss of this low-margin business could be picked up by other products.”

The report concluded: “U.S. reinsurers are enjoying substantial parental support, which ensures a stable outlook for the remainder of 2005.” S&P believes “premium rates and terms and conditions of business written over the past 12 months will enable most U.S. players to report 2005 accident-year combined ratios in the mid-90s. However, the challenges remain significant, with reinsurers expected to post further reserve additions into 2005 and 2006, although these additions will be smaller than those of prior years. Thus, it is unlikely that the market will achieve an underwriting profit in 2005. As of March 31, 2005, the market turned an unimpressive 99 percent combined ratio for the first quarter, and this did not include the substantial reserve additions that are typically seen in the third and fourth quarters of the year.

“Declining premium rates and pressure on terms and conditions in the U.S. reinsurance market will place further pressure on this market to post adequate rates of return over the medium term. The weak prospects of profitability in the U.S. market will continue to pose a challenge both for the U.S. companies and for the global groups and other parent companies that are supporting them.”

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