S&P Comments on the Reinsurance Business

Standard & Poor’s recently announced that reinsurers are reducing their emphasis on long-standing client relationships and adopting a more clinical approach to underwriting, as both the insurance and reinsurance markets scrutinize their profitability in the wake of the World Trade Center terrorist attacks.

Meanwhile, it is likely that insurers’ risk retention will rise, as their loyalty to the reinsurance relationship also wanes and they become even more opportunistic in their reinsurance buying.

Commenting on the changing relationship between reinsurers and their clients, Christian Dinesen, a director of S&P’s Financial Services Ratings in London, said, “The impact of the terrorist attacks in the U.S. will change the way insurers and reinsurers look at their relationships. With underwriting profitability increasingly important, the process is becoming more intensely managed.”

Reinsurers will apply even greater financial analysis to the underwriting process, taking a further step back from more traditional, “client-focused” underwriting. There is likely to be an increased emphasis on their combined ratios and the link to return on capital allocated to any given line of business or sector. Also, falling investment income will result in technical underwriting results having greater importance in the future.

“Reinsurers seem determined to turn their backs on some long-standing relationships if they cannot make a profit from the business on offer. Previously, an existing relationship might have led them to be more inclined to write unprofitable risks, but as a result of the very significant costs related to the WTC tragedy, this style of business is hardly viable any longer,” Dinesen commented.

The reinsurance market is not the only driver in the shift away from the “relationship,” however. Buyers are also taking a more opportunistic stand. “During the soft market, insurers often bought protection on the basis that it was cheap, rather then because they needed it. As the price of reinsurance rises, however, they are likely to become more discerning and retain a higher proportion of risk,” Dinesen said.

Although the changing environment aims to create a more efficient industry, there remain unresolved issues. “It is not clear to what extent the improvement in rates and conditions, and a very high focus on results, will be sustainable for the reinsurance market going forward. Also, the market’s obsession with the size of rate increases being implemented neglects the fact that the amount of cover bought by insurers threatens to become an even more significant issue,” Dinesen noted.

The end of the reinsurance relationship has been predicted in the past, following such disasters as Hurricane Alicia in 1983, Piper Alpha in 1988, and Hurricane Andrew in 1992. The sheer magnitude of the terrorist attacks, however, means that this time reinsurers are much more likely to need to focus on selective, and therefore opportunistic, profitability.

“Closer scrutiny by reinsurers of the profitability of underwriting in the short and medium term had already begun following the high frequency of nine $1 billion insured catastrophes in 1999, and this development is likely to be strongly enforced by the events of September 11,” Dinesen concluded.