Capital Stretched But Still Adequate In Commercial, Reinsurance Lines

The industrys capital position is becoming stretched as a result of the estimated $30 billion hit from the World Trade Center losses, natural catastrophe claims during 2001 of $10 billion, declining investment income, and the need by many companies to boost reserves, several industry analysts affirmed.

Although another $30 billion has come back into the reinsurance and insurance industry since Sept. 11, capital has still declined by about $10 billion, said Donald Watson, managing director of Standard & Poors in New York.

He emphasized, however, that at this point, capital adequacy is not an issue for the reinsurance industry in general, but is a problem for a number of individual reinsurers.

There are a lot more reinsurance companies that are under-capitalized for their risks today than there were a year ago, Mr. Watson added.

“With the improving rate environment, some companies are accepting, not only a lot more premium, but even more exposure and aggregate,” he said.

As a result, further capital strain on companies can be expected by the end of the year, he said, noting that this is why S&P continues to have a negative outlook for the industry.

“There are a group of companies that could lose their existing ratings because of capital adequacy concerns,” he said. “Its a much tougher environment and there isnt the cushion of reserve redundancy that their used to be.”

Nevertheless, he said, this is not going to pose a problem for the industry unless there is another significant catastrophe loss this year.

Mr. Watson said the industry is probably capitalized this year at the “single-A” level, excluding Berkshire Hathaway and Munich Re (which are so well capitalized they skew the numbers).

With those two companies included in the consideration, Mr. Watson said the industry is now at a “double-A” level.

(Mr. Watson was interviewed before Munich Res announcement that it boosted the reserves of its subsidiary, American Re-Insurance Company, by $2 billion as a result of adverse claims developments in liability and workers compensation in the United States. The action prompted S&P to put Munich Res “triple-A” rating on CreditWatch and to announce that American Res rating could be lowered if the company is not adequately re-capitalized.)

Matt Mosher, group vice president, property-casualty for A.M. Best in Oldwick, N.J., said that capacity problems in the global reinsurance industry appear to be connected with the unwillingness of reinsurers to expose that capital to certain risks, rather than issues of capital adequacy.

Reinsurers are unwilling to expose large lines to any one reinsured or one particular property, he said. “The overall capital appears to be adequate.”

Regarding commercial lines, Mr. Mosher said the primary market is becoming “somewhat stretched,” given the growing level of risk in the directors and officers liability market, the growing exposure to asbestos claims, and “the need for further rate increases to get to a truly adequate level of profitability in some lines.”

Some commercial lines carriers are facing a capital crunch in that they are unable to grow in areas that they view as profitable because they do not have the capital to support that growth, he said.

He cited the example of workers compensation for both commercial lines carriers and reinsurers. Although rates are increasing, some companies now dont have the capital necessary to support that type of growth in terms of premium, he said.

“There are various alternatives that theyre pursuing. Some stronger companies have been able to go to the markets and raise capital,” Mr. Mosher said.

“But there are many companies that dont have that flexibility and need to assess the overall exposure that they have on their books,” he said.

While certain companies may be having problems with capital adequacy, certainly, capital is adequate on an industry-wide basis, Mr. Mosher said.

Mr. Watson said that S&P holds a negative outlook for commercial insurers. “This reflects exposures that are not fully reflected on their balance sheets from D&O, casualty lines of business, problems in the workers comp, problems in professional liability, and problems with asbestos,” he said. “All of these things are negative concerns that will put pressure on those ratings and capital adequacy over the next couple of years.”

The offset to all of this, he said, is that rates are improving and will continue to improve through 2003. “The pricing power remains strong for the reinsurance industry to raise rates, so we can expect to see the ongoing rate strengthening at least through 2003,” Mr. Watson affirmed.

However, he was less certain about what will happen to rates at the end of 2003. “Im not sure whether the new capital will start breaking ranks and cutting prices to get premium or whether they continue to hold the line.”

Brian Brown, consulting actuary for Milliman USA in Milwaukee, Wis., said the industry needs a sustained hard market of three to four years to rebuild capital levels.

He thought that this was a possibility because there are so many problems facing the industry, such as the drop in investment income and asbestos liabilities, as well as D&O and accountants liability claims associated with Enron, World Com, Xerox and Qwest. “There are a lot of restatements, so Ive got to believe that those will eventually lead to claims.”

Mr. Brown does not believe that there is a shortage of capital in the industry. “But I think people are trying to use their capital a lot more wisely,” he said. “I think theyre trying to earn what they believe is a reasonable return.”

Mr. Brown said capital is adequate, based on what is known today, but if two or three reinsurers become insolvent and the asbestos trends continue or get worse, then “theres probably not enough capital.”

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 22, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Capital Stretched But Still Adequate In Commercial, Reinsurance Lines

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