A study conducted by A.M. Best Co. has concluded that Europe’s reinsurers have seen their financial strength stabilize after a two-year period of downward pressure.
“Strong accident year results were maintained through the 1st quarter of 2004 and are expected to persist through the year,” said Best. “Combined with a partial restoration of capital levels, this has helped support the current ratings.”
The bulletin notes that “accident year results reflect the ongoing hard market (albeit with property now softening somewhat, along with aviation). The lag in this being recognised in earnings will support the underwriting result through the rest of 2004, subject to not very severe catastrophe losses. Capital has partially recovered due to both equity raising and some recovery in the capital markets.”
Best observed, however, that, “while the absolute levels of European reinsurer financial strength ratings remain healthy, an overall return to the higher ratings of recent years seems unlikely.”
It highlighted the following factors affecting the European reinsurance market as follows:
— Capital is now being more actively managed to balance financial strength with return on capital employed. The extremely higher levels of capital adequacy seen in some cases historically are unlikely to be a management goal going forward.
— For those with historical exposure to U.S. casualty business, the risk of further adverse development on U.S. exposures remains, which could lead again to a strong 2004 accident year result being significantly pulled back by these prior year losses. Adverse development is most commonly recognised in the 3rd or 4th quarters.
— Some non-U.S. liability markets have also shown substantial adverse development in recent years (e.g., Employers Liability & Professional Indemnity in the UK, Medical Malpractice in France). While the scale of this is not yet close to that seen in the U.S., the potential for a more litigious environment in Europe, driving greater liability losses in future cannot be ignored. For example, asbestos related disease development in Europe is probably some 20 years behind the U.S., with mesothelioma deaths slowly increasing but not expected to peak until around 2020. More positively, there are signs that reinsurers are taking steps to anticipate problems in Continental European liability lines before they reach truly serious proportions
— While reinsurance recoverables are generally being managed down (although they remain an important issue), debt leverage continues to grow. For some reinsurers, an increased presence in the life markets has also increased the amount of recognition of expected future profits from their life business in their current balance sheets. Accordingly, the overall quality of capital in the industry remains lower than the historical levels. That is, capital reflects greater amounts of debt and non-liquid investments than previously.
Even with the good results experienced so far, Best cautioned that “the absolute levels of underwriting profitability are not as strong as might be hoped for at this stage in the cycle. Thus, unless the downside of the cycle proves much shallower than in recent times, or volumes are greatly reduced, a meaningful level of aggregate ‘through the cycle’ underwriting profitability may well prove unachievable.”
The rating agency also noted that “reduced volume (i.e., reduced risk, not just the inevitable drop in premium income) in a softer market is the publicly stated intention of most market participants. But the pressure to make profitable use of equity capital will pressure reinsurers to return capital to shareholders in line with reduced expected profitability. For those carrying any material degree of casualty/liability reserves into the soft market, this would put pressure on risk-adjusted capital adequacy as both reserve risk and asset risk will always fall more slowly than premium risk.”
The bulletin concluded that the current results should be seen “in the appropriate context,” and added that the “overall healthy levels of ratings of Europe’s reinsurers reflect A.M. Best’s view that capital adequacy is generally sufficiently robust to manage these challenges. But, they also set the context for why strong current underwriting results and some restoration of capital do not inherently mean a return to higher ratings.”
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