While reinsurer financial results reveal the negative effects ofthe same forces that battered insurers in 2008, executives believea higher level of discipline by reinsurance underwriters gives thegroup a more favorable outlook than would be the case for primarycarriers in 2009.

Speaking at theStandard & Poor's 2009 Insurance Conference in New York earlierthis month, executives whose organizations participate heavily inthe U.S. reinsurance market also said reinsurers are in bettershape than they were a decade ago, although some suggested thesegment remains vulnerable to the impact of severe losses.

Rolf Tolle, franchise performance director for Lloyd's, gave thefirst positive assessment during a session on reinsurancestrategies, later voicing a minority opinion about the reinsurancesegment's exposure to systemic risk.

“I think people have learned their lessons,” Mr. Tolle said,pointing out that market participants take a more conservativeapproach to underwriting than they did at the turn of the century.“In general, they are looking forward [and] taking a long-termview. That's what we have to put our attention on,” he said.

Mr. Tolle was responding to a question put forth by Rob Jones,an S&P managing director and moderator of a panel ofreinsurance executives. Following several panelists' remarks aboutthe relative conservatism that property and casualty insurers andreinsurers demonstrated in 2008 in managing the asset sides oftheir balance sheets compared to other financial services firms,Mr. Jones asked about worries they might have regarding theliability side.

“Am I concerned about it? No,” Mr. Tolle responded. “You have tounderstand that our book today is a shell of what it was in thelate '90s and early 2000s.”

Speaking about the p&c industry more generally, Mr. Tolleobserved that over the last few years, “the reinsurancemarket–particularly on the casualty side–has been more disciplinedthan the insurance market.”

John Charman, president and chief executive officer ofBermuda-based AXIS Capital, said the market has been “prettycompetitive in some primary casualty [areas], and that competitionhas not been fueled by the reinsurance market giving margins away,”echoing a view expressed at an earlier session by another Bermudaexecutive–Constantine (Dinos) Iordanou, president and CEO of ArchCapital.

“In many prior cycles, reinsurers had a big impact by providinginexpensive capacity,” Mr. Iordanou remarked. “Believe me, when yousend somebody to bet with somebody else's money, they'll takeunreasonable bets.”

Both Bermuda companies–AXIS and Arch–participate in both thereinsurance and primary insurance markets. “I have a good view ofthe reinsurance world from where I sit, and we've seen morediscipline by the reinsurance community in how they price theirproducts,” Mr. Iordanou said.

Asked specifically about the role of reinsurers in sustaining asoft p&c market overall, Mr. Charman said “the problem is notthe reinsurance market. The problem is the primary market. I thinkthe reinsurance market has done as much as it probably can withoutsacrificing its total revenue, because it's there to underwritebusiness.”

“For the last three years, I've found the reinsurance market tobe pretty stable [and] focused,” he added, noting that hiscompany's portfolio is currently more weighted toward thereinsurance side.

Overall, the reinsurance market “has a balanced portfolio bothby product and geography–and it's a much smaller marketplace interms of the number of players,” he said, citing the presence oftoo many players as “a destructive issue on the primary side,because not only is there an oversupply of capacity, but there's anoversupply of people.”

“That's where you get the excessive competition,” according toMr. Charman.

Noting that he is comfortable with current reinsurance marketunderwriting conditions, he said, “I'm much more concerned aboutthe failure of the primary market to properly understand andrecognize the weakness of the underlying pricing.”

While neither Mr. Charman nor Mr. Tolle could be coaxed by Mr.Jones to go so far as to say that reinsurance prices don't need togo up, Mr. Charman did confirm Mr. Jones' summary of theexecutives' remarks as meaning that the cycle trough forreinsurance “wasn't particularly deep” compared to previouscycles.

“I think the reinsurance market has learned a great deal sincethe turn of the century,” Mr. Charman concluded.

“They are prepared to say no,” Mr. Tolle added, referring toreinsurers.

W. Marston Becker, chair and CEO of Bermuda-based Max Capital,agreed. In the marketplace today, he reported many instances where“if the primary company is too aggressive, it just can't get [areinsurance placement] filled, [but] once they come for marketterms, they're likely oversubscribed in that placement.”

“I think that behavior pattern speaks well for the reinsuranceside of the industry in trying to exercise some discipline,” hesaid.

Looking back to the cycle of the late '90s, Mr. Becker agreedreinsurers drove soft pricing by rewarding primary carriers “forgiving their products away” by making cheap reinsurance abundantlyavailable.

“That's not been true in this cycle. You're seeing primarycompanies leading the way in pricing competitiveness and retainingmore of their own business, which will ultimately be reflected intheir loss ratios,” he said.

“I think the reinsurance sector is probably in a healthier placethan it typically has been at this stage of the cycle, and for goodreason. Our sector wrote off billions of dollars in 2000, 2001,2002. Hopefully, we learned something from that,” he said.

Although the nearly breakeven combined ratio for the U.S.reinsurance industry was neither dismal nor stellar in 2008,S&P assesses the ratings outlook as stable for the reinsuranceindustry globally.

During the conference, S&P Director Laline Carvalhohighlighted several differentiation points between the reinsuranceand primary sectors, noting that the commercial and personalprimary lines segments have negative outlooks from S&P.

Agreeing with the executives that reinsurance prices have notfallen as far as primary prices during the soft market, she alsonoted that property reinsurance prices rose for Jan. 1 renewals andcasualty reinsurance prices are flattening.

She cited additional positive factors for reinsurers:

o The current environment in the financialmarkets, which strengthens the position of reinsurerssince they may be viewed as a cheaper source of capital than thecapital markets.

“We're not seeing many primary companies trying to…keep more andmore of their business” as in recent past years, Ms. Carvalho said.“If nothing else, I think primary insurers are looking to get atleast as much reinsurance as they had before, and in some casesthey're trying to get more as a means of capital relief.”

o Strong first-quarter operating results, withseveral top reinsurer combined ratios in the 80-to-90 range. (Seechart accompanying story on page 18 for first-quarter results ofthe top-25 reinsurers.)

o Capital positions that remain in line with currentratings, in spite of the erosion that occurred lastyear.

Later, pointing to the substantial erosion of excess capital asa negative factor that S&P can't ignore, Ms. Carvalho said thaton average, capital adequacy has fallen by a category for majorplayers.

In other words, reinsurers with “AAA” levels of capital adequacygoing into 2008 (as measured by the S&P capital model) likelydropped down to “AA” by year-end, while “AAs” fell to “A” capitaladequacy.

o Reinsurers have the largest proportion ofstrong and excellent enterprise risk management scores based onS&P's evaluation of ERM processes for rated companies.

VULNERABILITIES EXIST

Still, Ms. Carvalho–noting the material impact of catastrophelosses and capital market volatility on 2008 reinsurer operatingperformance–warned that “the jury is still out, in our opinion, asto whether, long term, reinsurers will be able to maintain adequateprofitability.”

She went on to discuss the possibility of a massive catastropheloss occurring this year while reinsurance companies are stilltrying to rebuild capital. “We believe a catastrophe loss in the$40 billion range or higher could present issues for some players,”she said.

“Some reinsurers would probably need to access the capitalmarkets at that point,” she added–warning that if they can't, theymight need to sell some fixed-income securities, turning unrealizedcapital losses into realized losses.

In summary, noting that reinsurance is a “volatile, riskybusiness,” she said that “if you look at earnings performance overa long period of time, the reinsurance industry has tended todisappoint.”

Ms. Carvalho used exactly the same words during a 2002 S&Pconference when she explained S&P's negative outlook for thereinsurance sector back then.

Reinsurance executives speaking at the same 2002 conferencedescribed reinsurance as a “fundamentally flawed business model,”suggesting the segment could never recover from disastrouslosses.

At this year's conference, a different set of reinsuranceexecutives–responding to the question of whether standalonereinsurance companies are an endangered species–continued toexpress negative views.

Mr. Charman said that's the reason AXIS was deliberately set upwith primary insurance and reinsurance “operating side-by-side” insimilar product lines and geographies. That structure, he said,allowed the company “to properly utilize capital to try to maximizethe earnings potential.”

Mr. Becker agreed that a mixed insurance-reinsurance businessmodel is better than monoline reinsurance. “The rationale…is thatour markets don't move in lockstep,” he said, adding that theability to write insurance or reinsurance “can be a competitiveadvantage if you truly have the discipline to move capital” whenopportunities present themselves.

“Where you so often get trapped is in your own internalbureaucracy, [when] you don't make the conscious decision to shiftcapital to where…the optimum returns are.”

Mr. Tolle said that “you have to really have the controls to dothe analysis and prepare early enough” if you want to shift the mixof business between insurance and reinsurance, explaining that insome regions, regulatory constraints limit the flexibility to movein and out of markets quickly.

Mr. Tolle also has concerns about consolidation in thereinsurance industry. He said panels of reinsurers that he reviewsfor Lloyd's syndicates are much shorter now than 20 years ago.

“It creates, in my opinion, systemic risk, which is quitedramatic,” he noted. “If we really get the truly 1-in-200 [year]hurricane, a $180 billion [loss] roaring through Miami, and one ofthe 10 large reinsurers should not make it, what is the dominoeffect on the other nine?”

Mr. Charman responded that he “would prefer to have a limitednumber of much more competent, stronger balance-sheetedbusinesses.” While that cuts down competition and choices forbuyers, he said they benefit from the greater levels of competenceand resources larger reinsurers can bring to bear for globalbusinesses.

“I'm not too worried about systemic risk” because of theanalytical discipline that reinsurers apply to potentialcatastrophe loss aggregations, he said. “I'd hate see the $180billion Miami wind event, but while there will be a loss ofcapital,” he added, based on the stress-testing he's seen, “thereinsurance industry would stand up pretty well.

Related Charts:

Underwriting Results For Top Reinsurers

Year-EndPolicyholders Surplus For Top Reinsurers