Q3 2008 was a challenging quarter for reinsurers, writes Mark Rouck.

Reinsurers’ results are reflecting tough conditions. We expect that the sector experienced a material decline in shareholders’ equity in the third quarter. While catastrophe losses from events such as Hurricanes Ike and Gustav and cyclical pricing

pressures are not unusual, realised and unrealised losses on reinsurers’ investment portfolios related to the capital market crisis are materially larger than those incorporated into “base case” expectations.

The reinsurance sector’s third quarter bond portfolio losses on investments in securities issued by high profile troubled companies look modest as the sector does not appear to have had concentrated exposure to them. In contrast, unrealised losses from widening credit spreads across virtually all classes of corporate bonds have been much more significant than realised losses, and has had a material effect on reinsurers’ capital bases.

Major equity market indexes in the US and Europe declined by between 8% and 11% in this year’s third quarter. This led to further erosion in shareholders’ equity and appears more pronounced among European than North American reinsurers due to the Europeans’ larger allocations to equity investments.

Fitch believes that credit market contractions are likely to make it more difficult for reinsurers to obtain bank-issued letters of credit. This potential difficulty in arranging suitable collateral, along with Bermuda-based reinsurers’ comparatively large portfolios of non-agency residential mortgage-backed securities, the value of which held up reasonably well through the first half of 2008, are areas that Fitch is monitoring closely as reinsurers report results.

Mark Rouck is senior director at Fitch Ratings.