European reinsurers outlook still negative


Chennai: When the outlook is negative for primary insurers, the prospects for reinsurers, too, may not be different. In its report on the European reinsurance market, the global credit rating agency Standard and Poors (S&P) has said that due to an uncertainty over the long-term sustainability of rate increases, it is giving a negative outlook grading for the industry.

The interesting aspect is that S&P is giving this grading for the fifth year in succession. Recently, S&P had revised its outlook to negative from stable for the European general insurance industry.

"The negative outlook indicates that market trends will continue to exert downward pressure on the credit ratings on many reinsurers in the market, with rating downgrades more prevalent than affirmations or upgrades," says S&Ps credit analyst Christian Dinesen.

After the 9/11 incidents in the US, major reinsurers have increased their rates significantly across a variety of business lines and also tightened the terms and conditions of reinsurance contracts. This had its impact even on Indian general insurers. For instance, all the general insurance underwriters are covering terrorism risks as an additional cover under their policies. Earlier, the risk cover was an in-built one.

According to S&P, the new developments have sharply enforced a market hardening that follows the very low rating levels reached in 1998, which were subsequently compounded by nine $1-billion catastrophe losses in 1999. Nevertheless, the developments are not yet sufficient to support a change in the outlook for the market, S&P feels.

"Rates on some lines of business have not yet reached a level where reinsurers will break even in terms of technical underwriting," says S&Ps credit analyst Stephen Searby. "To reach breakeven, rates need to increase by about another 10-15 per cent." The main reason S&P is maintaining its negative outlook for the reinsurance industry is uncertainty over the sustainability of the rate increases.

"Although S&P is fairly confident that most reinsurers will reach a technical profit in the next 12 months, there are very real risks that competition will re-emerge before reinsurers have rebuilt their financial strength and are ready to face additional large claims," says Searby.

Furthermore, reinsurers have made net pretax provisions for losses arising from 9/11 of at least $15 billion in addition to provisions made to accommodate the losses from 1999, and they need several years of real profits to recuperate.

"Although the reinsurance market is making firm statements against the return to cyclicality, competition for market share and more competitive, less profitable rates, it has to prove that the old habits are dead and gone," adds Rob Jones, another credit analyst.

With significant industrial loss activity from the last quarter of 2001 compounding the losses of 9/11, the market suffered one of its least profitable years ever in terms of pure underwriting. At the same time, although reinsurers invest the majority of their assets in fixed-income bonds, the downturn in global equity markets has exacerbated the markets difficulties by putting yet more pressure on capital.

Nevertheless, the poor investment returns will contribute to enforcing market underwriting discipline among reinsurers and their clients the insurance companies who have greater exposure to equities.

Searby warns that if the investments market resurges the rate increases by reinsurers would be undermined, given the current reinsurance market environment.

Continued depressed capital markets remain a key factor in the longevity of the hard market. Although European reinsurers are expected to remain consistent in their underwriting approach well into 2003, history has shown that falling costs of capital resulting from strong equity markets and low interest rates are important factors in establishing a softer premium rating environment.

"It is too early to say whether the high cyclicality that has dogged the industry in the past few decades has been removed. And there is no hard evidence to suggest that in a profitable investment environment the market will not return to cash flow underwriting or offering multiyear deals," says Searby.

The importance of maintaining underwriting discipline is highlighted by the recent loss activity. S&P now estimates that about 35 per cent of net losses arising from the terrorist actions of 9/11 have settled in the European reinsurance market, with the total European loss rising to nearer 50 per cent when primary insurers retentions are included.

With the absence of any unusual loss activity for the rest of 2002, meanwhile, the benign claims environment allied to the recent rate increases should see a relatively high level of profitability on large property accounts. Nevertheless, concerns remain in the market over asbestosis, toxic mould, and directors and officers (D&O) liabilities. Although the majority of claims activity arising from related loss activity has settled in the US to date, there is potential for it to spread to Europe.

"France and the UK have already experienced asbestosis-related court cases, while US claims from both toxic mould and D&O policies are growing large enough to potentially trigger some reinsurance policies, some of which will most likely reach the European market," says Dinesen.