S&P: Reinsurance Backing Increasingly Flimsy, Conference Panelists Say

June 21, 2004

Insurance companies are going to find reinsurers less and less reliable as pricing weakens in the U.S. property/casualty market, panelists at Standard & Poor’s Ratings Services Insurance Conference warned last week.

“Everyone pays claims today, but when you get to the bottom of the cycle, they don’t pay,” said Stephen L. Way, CEO of HCC Insurance Holdings Inc. Among the tactics used by reinsurers to delay payment, he said, are “more questions, more excuses. You see it all.” Way advises primary companies to “budget for slow-paying claims, because they will happen” and argues “solvent reinsurers that don’t want to pay are 100 times as big a problem as insolvent reinsurers.”

The problem is magnified on lines of business where claims are paid out over a long time, he said. “The issue becomes how much money will the reinsurer owe you 10, 15, 20 years from now, and will the reinsurer outlast the claim? If it doesn’t, you never had reinsurance. Worse, you paid premiums, and you’re not getting them back.”

Smaller insurers are particularly vulnerable to this type of treatment
and “get squeezed regularly,” Way added. “A primary company still has to pay claims whether the reinsurer pays or not. Reinsurers apply pressure by paying less to companies that can’t afford the cash flow.”

Nevertheless, primary companies are proving increasingly adept at
protecting themselves. “There’s much more scrutiny being brought to bear on reinsurers by the ceding clients,” said Roderick P. Thaler, Executive Vice President of brokerage company Willis Re. “They’re demanding much more intimate knowledge about how the reinsurers are managing their exposures, what issues they’ve had with their loss reserving, and what modeling they’re using. They want to know about their business plan, diversification, growth, and where the growth is coming from.”

These factors underlie a reinsurer’s ability to pay claims, but Thaler
reports Willis Re is also very focused on a reinsurer’s willingness to pay and is “doing much more in the way of tracking payments and sharing the information with our clients. We see the smokescreens and stalling tactics, we know who they are, we know where they live.”

Thaler warns insurers against being seduced by bargain prices. “It’s a
pyrrhic victory to get cheap reinsurance, because you’re buying problems for the future,” he said. “If the reinsurer is offering you low rates, then you know they’re doing it for others. It’s just a matter of time before they don’t have enough to pay claims.” In time, he expects to see “reinsurers with better security getting a higher price.”

Stephen Searby, a credit analyst in Standard & Poor’s London office and moderator of the New York panel, cited a recent job advertisement in the Financial Times as a signal the “reinsurance recoverables” asset may not be so recoverable after all. The advertisement describes a new position for “proactive management of reinsurance credit assets” at an insurance company and stresses the importance of reducing the insurer’s exposure to the reinsurance industry.

Reinsurance recoverables now stand at about 49% of surplus for the U.S. primary industry as a whole, Searby noted, “so it’s a significant issue, both in relative and absolute terms.”

On the whole, panelists saw little mileage in the idea of capital-market investors taking on insurance risk instead of reinsurers. “It’s worthwhile to explore if it’s a feasible alternative,” said Dr. Elke K├Ânig, CFO of Hannover Re, “but so far, capital markets are not a cheap alternative and not really an efficient alternative to traditional techniques.”

“The inability of capital markets to understand the underlying risks makes it very difficult to use them,” Thaler added. “It doesn’t make sense financially, and there’s no counterparty stepping up to do this.”

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