Insurers continue to emerge from the credit crisis with strength and are among the least impacted of all financial institutions, according to a senior ratings agency official speaking at the Casualty Actuarial Society’s annual Seminar on Reinsurance.
Jeffrey Berg, senior vice president and group credit officer with Moody’s Investors Service, described the credit crisis by saying, “The housing bubble burst with interest rate resets, tighter credit, and falling home prices, making some mortgage borrowers unable to afford their existing mortgages, unable to refinance, and unable to sell their homes.”
The contagion risk of the crisis — the spreading to other assets — was demonstrated by prime residential mortgages showing increasing losses, pressure in commercial real estate markets, the economic impact on credit cards, car loans and student loans, and elevated corporate defaults in a recessionary environment that will raise investment losses further.
Regarding the ratings impact on primary carriers and reinsurers, Berg said, “Very strong current financial profiles will enable most insurers to handle these investment losses, and few rating downgrades driven solely by credit market concerns are expected.” But he cautioned that insurers with outsized investment losses, combined with industry pressures, could prompt downgrades for weakly positioned firms.
The Moody’s official told the actuaries that rated property/casualty insurers’ exposure to non-agency structured mortgage investments are moderate, with a median of 12 percent of invested assets and 47 percent of equity. And he said the exposure to structured mortgage investments from riskier borrowers is modest, with a median of 4 percent of assets and 17 percent of equity.
Berg pointed out some other impacts on the insurance business, among them a negative impact on professional lines such as directors and officers liability and errors and omissions losses from litigation related to mortgage lenders. Additional effects include a negative impact on sales of discretionary insurance products, rising claim costs for business lines like workers compensation, and a weaker U.S. dollar.
“The market’s view of insurers has deteriorated, somewhat constricting their financial flexibility, but much less than with other financial institutions,” Berg said. He said stock prices have dropped about 10 percent to 20 percent in the past six months, but with a more dramatic decline for P/C insurers that diminish their intentions to issue shares.
The Moody’s senior vice president concluded that although insurers are facing higher investment loses from a position of current strength, incremental pressure on the industry is increasing due to the economic recessionary conditions, higher anticipated corporate default rates, and the softening P/C pricing environment.
“Where was the risk management in this crisis?” questioned Donald F. Mango, managing director of Guy Carpenter, the leading global risk and reinsurance specialist. He said risk management in financial services faces three central problems: fear, greed, and stupidity.
Mango said, “Insurers and reinsurers are lenders with the signs reversed.” This means they are exposed to similar kinds of risks, including the failure to assess correlation, contagion risks, an over-reliance on leverage and hedging, a softening of underwriting standards, an expansion of exposure as well as terms and conditions, and undesirable market herding effects.
Regarding the subprime crisis, Mango asked, “Was there was a failure to recognize the problems or a failure to act to correct them?”
Drawing parallels to reinsurance, Mango highlighted how fear, greed and stupidity all play parts in the reinsurance cycle. Greed and stupidity show up in flawed incentive plans that provide benefits to a limited number of senior employees at the expense of other stakeholders. Fear for one’s job produces internal impetus for the firm to “make the plan” regardless of its realism or achievability (for example, profitable growth in a declining pricing environment).
Giuseppe Russo, senior vice president and chief risk officer with ACE Tempest Re, moderated the panel session.
Source: The Casualty Actuarial Society
Topics Carriers Reinsurance Property Casualty
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