Moody’s sees negative outlook for global reinsurance

In a new report on the global reinsurance sector, Moody's Investors Service concludes that restrained demand, overcapacity and fragile market confidence point to a higher chance that credit support will weaken rather than improve over the next 12 to 18 months. As a result, Moody's has changed the industry outlook to ‘negative’ from ‘stable’.
By most standards the sector has weathered the crisis better than most financial institutions, which makes it all the more surprising that the sector on average is still trading below book value. For an industry that is renowned for raising capital after major catastrophes or downturns, uncertain reception from the capital markets is a credit negative, particularly when signs point to greater price competition in 2010.
"We think the reinsurance sector is operating with too much capacity but not enough certainty of capital," noted Kevin Lee, Vice President and author of the report.
He explained that the economy has pushed down demand for insurance coverage, suppressed insurers' profits and restrained their reinsurance budgets. Easing of credit in recent months has also encouraged protection buyers to rely on other sources of capital besides (additional) reinsurance.
To assess this, Moody's conducted a survey of insurance companies — both life and non-life, in U.S. and Europe — to gauge their sentiment about reinsurance purchases in 2010. Of the insurers that Moody's surveyed, the vast majority do not plan to buy more reinsurance next year and a fraction expect to buy less.
At the same time, Lee explained, reinsurance capacity is moving back into the sector in at least two ways. First, as asset values have partly rebounded, reinsurers' solvency positions have rebounded. The top 40 reinsurers saw shareholder funds fall by $50 bln between 2008 and 2007, but that deficit has been cut by nearly half in the first six months of 2009.
Secondly, alternative money such as hedge funds and cat bond investors has stepped off the sidelines. Although these alternative sources of capital may seem small, they play an important role in supporting retrocession, the transfer of reinsurance risks to other reinsurers.
Moody's notes that having too much capacity is not the same as saying the sector has too much capital. Fragile market confidence means that capital preservation will remain a priority for individual reinsurers, rather than return of capital. One hurdle to restoring confidence is that casualty reserves/rates may have some ways to go before they can be considered comfortably adequate. To solve overcapacity in this environment, capital may have to leave the sector in discrete increments — through consolidation for example.