Reinsurers Resilient Despite Catastrophes, Economic Uncertainty, Says A.M. Best

April 24, 2012

In a special report A.M. Best summed up the financial position of the global reinsurance industry as “resilient” in light of “the volatile economic conditions and the frequent and severe loss events of 2011.”

Best pointed out that the only year that produced larger cumulative insured catastrophe losses than 2011 was 2005, when hurricanes Katrina, Rita and Wilma (KRW), in combination with other, smaller events, produced about $125 billion in industry losses.

“The numerous loss events of 2011 came very close to that tally with approximately $110 billion of losses. This time, however, the market responded without any significant dislocation or squeeze on capacity. The January and April 2012 renewals for the most part were orderly and timely. While pricing, terms and conditions improved for property catastrophe covers, the broader market benefited from a stable supply of reinsurance capacity, and pricing generally remained flat,” Best wrote in its report.

At the end of 2010, market observers questioned what it would take to turn the market. Best said it had posed the same question in April 2011. “The typical answer then was a significant loss of between $50 billion and $100 billion. Little did anyone know that 2011 would produce cumulative losses exceeding $100 billion,” the rating firm said.

Best then examined the often-asked question as to why the market did not turn more broadly, considering all that 2011 offered: significant catastrophe losses, record low investment yields, uncertain financial markets and the downgrade of U.S. sovereign debt.

According to Best, the simple answer is that reinsurance capacity remained ample despite the magnitude of losses and unrelenting headwinds. Reinsurers absorbed their share of losses and ended the year at approximately the same level of capital as they started.

“In fact, few reinsurers experienced cumulative loss impacts beyond their stated loss tolerances. For the majority of global reinsurers, the losses in 2011 amounted to nothing more than a negative earnings event,” Best said.

Best’s report cites several reasons that contributed to this resilience including lessons learned from previous large catastrophic events such as enterprise risk management and more prudent capital management strategies.

Also, Best credits advances in catastrophe and economic capital models. “These tools significantly helped a reinsurer’s ability to better allocate capital within complex risk portfolios. The models, while not perfect, helped keep both individual and cumulative losses in 2011 within stated risk tolerances for most of the global reinsurers,” Best said.

Best said that global reinsurers historically have taken a proactive approach to modeling, avoiding reliance on any one model and in many cases developing their own proprietary cat models. “This has tended to result in a more conservative view of risk,” Best said.

It also appears likely that the reinsurance industry will continue along this path, as ERM practices evolve. Best cited the fact that, historically, reinsurers have considered places such as Australia, New Zealand, and Thailand to be “diversifying, nonpeak zones” in relation to their peak zones. These zones, or “cold spots,” were not expected to produce significant losses, and as a result often were written at lower margins. “That notion now has been challenged, and reinsurance companies have already responded by reallocating capacity and demanding higher rates,” Best said.

Best also cited the “conservative capital management strategies” and the requirements that the industry “maintain rigorous capital stress tests to simulate the impact of catastrophic losses on a company’s capitalization” as additional factors contributing to the reinsurers’ resilience.

Best said reinsurers have tended to maintain a capital cushion in excess of the capital stress hurdle to ease rating agencies’ post-event concerns and maintain financial flexibility. “This cushion enabled reinsurers to withstand the 2008 financial crisis, when asset values eroded, capital markets became constrained, and reinsurers were concerned about their ability to access capital markets. It also played a role in the curtailment of share repurchases despite continued low stock valuations,” Best said in its report.

Source: A.M. Best

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