A.M. Best Sees Stable Ratings for Reinsurers

According to a report by A.M. Best Company, improved reported results for 2003 and the first quarter of 2004, stable equity markets, marginal increases in bond yields and raising of some fresh capital after two years of strong rate increases have led to relative stability in reinsurers’ financial strength ratings.

Best believes the global reinsurance sector remains broadly disciplined and firmly focused on underwriting profitability, although the observed softening in some lines may challenge players pursuing growth. The unequal distribution of capacity has become more accentuated, with clear signs of excess capacity in property but limited capacity in casualty.

Notwithstanding many reinsurers’ stated commitment to price discipline, a softer market appears likely to develop through the remainder of 2004 and 2005, led by property, according to the rating organization.

Managing capital through the cycle will involve balancing shareholders’ returns and the maintenance of risk-based capital adequacy. The report said that this will be more challenging than in previous cycles, as reinsurers will enter the downside of the cycle with less redundant capital while facing more pressure from investors for risk-adjusted returns on the capital they do hold.

The logical economic reaction to the softening market is reducing premium volume. However, this action alone in a softer market will not necessarily free sufficient capital to return some to shareholders without increasing pressure on the ultimate risk-adjusted capital adequacy, according to Best.

Best believes that headline rates remain attractive by historical standards, but some softening has begun, highlighting the start of the much-debated turn of the cycle.

U.S. property/casualty reinsurers’ earnings seem to be stabilizing after a reported 22.5 percentage point improvement in their combined ratio to 100.4 for 2003.

However, property premium rates have passed their peaks and began to fall during 2003. Most casualty classes continued to show positive pricing trends at the 2004 renewal.

Bermuda-based reinsurers reported a second year of strong earnings and significant growth. The average combined ratio for the top 15 reinsurers was 89.3. Best believes the increasing participation of some of these players in casualty lines could cloud future earnings, given the inherent volatility of this business.

Europe-based reinsurers also improved their earnings in 2003 and in the first quarter of 2004, reflecting relatively benign weather, continued rate increases, tighter terms and conditions, and investment gains. Cost cutting is likely to improve 2004 expense ratios, but whether the underwriting discipline will be maintained remains uncertain.

The reinsurance sector’s risk-adjusted capital base has been partially restored after stabilization in the capital markets and raising of some new capital. Best sees a rapid change in the sector’s capital structure, with increasing reliance on “soft” capital lowering the overall quality.