Best: Katrina Temporarily Halts Softening Reinsurance Markets

February 21, 2006

A.M. Best Co. has taken note of the apparent strengthening of the U.S. reinsurance market following the January renewal period.

In a recent comment, the rating agency noted that the “renewals experienced by a number of European-based global insurers confirms A.M. Best Co.’s expectation that significant price increases are by and large limited to business lines affected by the U.S. hurricanes.

Best indicated that “European treaties (which account for approximately two thirds of the renewable portfolio) saw relatively stable premium rates. This stability was also partially a result of a higher net retention by primary insurers, which to some extent eased the pressure to accept higher reinsurance costs.”

Best said it “believes that the significant losses from Katrina, Wilma and Rita incurred by reinsurers have only helped to halt temporarily the downward trend in the underwriting cycle prior to these events.” However, Best expects a return of price competition, “if underwriting results in 2006 turn out to be favorable, as capacity for most lines of business remains readily available.”

The premium rate rises affected mainly business lines comprised of offshore marine and property catastrophe, which are, in Best’s opinion, “insufficient to compensate for the losses incurred by reinsurers in 2005.” Best also indicated that not only as a “result of the severity of Hurricane Katrina, but also from the acceptance that such events are likely to occur more frequently, reinsurers are reassessing their internal models and their aggregate exposure. In some instances, this has already led to a reduction in limits by reinsurers.”

Best commented: “The hurricane seasons of 2004 and 2005 have highlighted the unpredictability and volatility of natural catastrophe reinsurance, which in turn raises questions about reinsurers’ ability to achieve sustainable earnings–an indicator as to whether a reinsurer’s balance sheet is likely to improve.” As a consequence, Best said it “is placing a much stronger emphasis on how reinsurers evaluate and control their exposure to world-wide natural catastrophe risks, although the credibility of a reinsurer’s risk management practice can only be fully tested when such an event occurs.” Best also said it has “revised its capital requirements for underwriting such risks and expects rated companies to maintain certain capital levels even if a second probable maximum loss occurs.”

Best expressed its belief that “the maintenance of the current financial strength of the European reinsurers will, to a large extent, depend on their ability to generate earnings supportive of their risk-adjusted capitalization through a period of more frequent and more severe natural catastrophe claims. Reinsurers need to adapt both their underwriting strategies and their risk controls to this changing landscape. Also, if underwriting results continue to be extremely volatile, investors may be reluctant to provide additional capital, hence also negatively impacting the financial flexibility of the reinsurance sector.”

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