Global reinsurance outlook remains stable, says Moody’s

The outlook for the global reinsurance sector remains stable, says Moody's Investors Service in a new Industry Outlook. Following two years of strong profitability and enhanced risk management processes, the industry's robust capital position places it on solid footing to confront both softening underwriting conditions, the challenges posed by continuing capital market turbulence and the threat of global economic instability, Moody's said.
"Pricing continues to decline steadily in both property and casualty lines of business, but generally remains near or above technical levels as rates have not cheapened enough to reduce underlying retentions, though we expect that primary carriers have begun to actively evaluate the lower alternative layers for casualty business," said Pano Karambelas, Moody's senior analyst and author of the report.
Moody's continues to view the reinsurance underwriting cycle as the primary determinant of the fundamental credit conditions of the industry.
However, the sector is subject to economic conditions of multiple geographic zones and faces the prospect of incremental volatility arising from a number of broad economic perils, including ongoing credit market turbulence, and, notably, the impact of inflation on underwriting margins over the medium term.
"Given the leveraging effects of their excess of loss positions, reinsurers will be especially challenged in projecting the impact of inflation on long-tail business. Firms with significant property portfolios are exposed to recent price spikes in basic inputs to building materials, a phenomenon not captured in catastrophe models," said Karambelas.
Moody's said continuing turbulence in the capital markets has placed incremental pressure on sector balance sheets as a number of reinsurers (particularly those with financial product and/or life operations) have reported meaningful losses to their structured fixed income investments and/or equity portfolios over the last several quarters. Overall, sector holdings of these securities are fairly modest, however.
Although the sector does not face widespread capital raising needs, a large catastrophe event in the midst of turbulent financial markets may stress the financial flexibility of some carriers, particularly smaller startups or firms with outsized losses.
In general, Moody's expects the sector is well-positioned to weather the effects of the current capital market turbulence.
Karambelas noted that two years after the 2005 US hurricane season, catastrophe linked securities now feature more prominently in the mainstream reinsurance landscape, simultaneously competing with and complementing the traditional market.
That said, plentiful and increasingly inexpensive reinsurance capacity has led to a sharp decline in issuance of reinsurance sidecars and has precipitated the windup of many existing deals. Meanwhile, notwithstanding wider credit spreads, cat bond issuance has not slowed as sharply and appears to be buoyed by a significant number of indemnity transactions (approximately one third of 2008 cat bonds issued to date).
Barring significant industry catastrophe losses, Moody's expects that issuance activity will remain substantially below the peak issuance activity of the last two years.
Hurricane Gustav is viewed as a "near miss" for the sector and will likely not meaningfully influence ongoing price softening trends. However, Gustav (as well as the storms brewing behind it) should serve as a tangible reminder of the significant level of catastrophe exposure facing the industry and the need to maintain adherence to adequate risk adjusted pricing.
As important, Moody's warned that companies must be vigilant in managing weakening terms and conditions given the potential for hidden correlations in underwriting portfolios, further heightened in some cases by recent business expansion efforts into harder-to-model specialty reinsurance lines.