Moody's highlights increased vulnerability to catastrophe losses

Three major reinsurance brokerage firms reported last week that reinsurance pricing for the important 1 January, 2010 renewal period was soft across most lines of business in major markets around the globe.

Year over year, prices appear to be flat to down 10% nearly across the board for most coverage subclasses. While not unexpected, Moody’s says the continued soft market will place additional pressure on reinsurers’ underwriting margins and profitability during 2010. The soft market could also mean that the credit profile of the reinsurance industry may not be as healthy as current capital levels indicate. Additionally, in the absence of attractive opportunities on the underwriting side, reinsurers may step up share repurchase activity, which could increase their vulnerability to catastrophe losses.

“We view these developments as having negative implications for policyholders and other creditors of reinsurers,” says the Moody’s credit outlook report.

In the US, the largest reinsurance market in the world, property catastrophe reinsurance rates are reported to have declined by 5% -15%, with pricing for hurricane risks holding up better than for earthquake risks. US casualty rates were generally flat to down 10%, continuing a downward trend over the past few years. Certain segments, however, such as professional liability for financial institutions, had slight price increases. In Europe, rates were generally flat to down 5% for most business lines, with some firmness for property coverages in regions that had catastrophe losses during 2009.

The soft reinsurance pricing results from both increased capacity and reduced demand. On the supply side, the sharp rebound in credit and equity markets during the second half of 2009 boosted reinsurers’ capital positions. In addition, 2009 earnings were robust for the industry, reflecting light catastrophe losses and reserve releases on business written between 2002 and 2006. Consequently, the equity capital position of the reinsurance industry begins 2010 at near peak historical levels. On the demand side, reduced economic activity and the strained reinsurance budgets of primary carriers have had an adverse impact on reinsurance purchases.

In September 2009, Moody’s changed its outlook on the reinsurance industry to negative from stable1, highlighting several key concerns; namely, excess capacity and slack demand leading to price competition; the fragility of the capital markets, which could preclude weaker firms from recapitalizing after a catastrophic event; and inadequate casualty rates potentially leading to future reserve deficiencies. With early confirmation that rates are continuing their downward trend, we believe the credit profile of the industry may not be as healthy as current capitalisation levels suggest.

Absent a transformational catastrophic event, Moody’s expects reinsurer profit margins to come under increasing pressure as rate decreases affect the top line, investment income drops owing to low investment yields, and the impact of reserve releases, which have bolstered underwriting results in recent years, diminishes.

A Moody’s spokesman said: “Given these headwinds, we believe that many firms may decide to repurchase shares to boost returns on equity. However, this course of action could result in increased vulnerability to shock losses from catastrophes, with negative implications for ratings.”