Shake Up Continues In U.S. Reinsurance Market:S&P

Following an array of large underwriting losses in recent yearsand yet another disappointing year in 2002, the industry hascontinued to see a number of reinsurance players exit or reducetheir participation in the U.S. market.

In just the last 18 months, Gerling Global, AXA Solutions andSCOR-subsidiary Commercial Risk (all on Standard & Poors top 35list in 2002) were placed into run-off.

This is in addition to the spin-off of Platinum Underwritersfrom its previous parent, The St. Paul Companies; the recent saleof Hartford Reinsurances renewal rights by its parent, TheHartford, to Bermuda-based Endurance Specialty; and the demise ofTrenwicks operations.

These actions have come even as premium rates continue to hardenand terms and conditions are the best in more than a decade,underscoring the heavy toll taken by the last soft cycle on marketparticipants.

Unlike their European counterparts, which have been recently hitwith significant investment losses from the crumbling values oftheir large equity portfolios, the major culprit behind U.S.reinsurers significant losses continues to be the need to shore upreserves for the 1997-2000 underwriting years and for asbestosliabilities.

Even after significant reserve strengthening in the fourthquarter of 2001which became known as the kitchen sinkquarterreserving actions by U.S. reinsurers in 2002 significantlyexceeded the expectations of most industry observers and easilyoffset the benefits of better premium rates and conditions. Thishas led the industry to report an unfavorable 122 combined ratioand a dismal 0 percent return on revenue for the year.

Given the magnitude of recent losses, the issue of parentalcommitment has become crucial in light of the markets structure, inwhich most U.S. reinsurers are not independently owned, but ratherare subsidiaries of larger, often non-U.S.-based reinsurance groupsor other conglomerates.

Having entered the U.S. reinsurance market as a means of riskand earnings diversification, many of these parent companies haveexperienced losses from their U.S. subsidiaries that are muchlarger than ever contemplated, forcing many to reconsider theircommitment to this market.

Although this has resulted in several players exiting themarket, such as in the instances mentioned above, a number ofparent companies reaffirmed their commitment to their U.S.operations in 2002. Among these are companies such as MunichReinsurance, which contributed $1.4 billion in capital andstrengthened quota share and other reinsurance support arrangementswith its U.S. subsidiary, American Re, following a $2 billionreserve strengthening in the second quarter of 2002.

This renewed commitment, however, has often been accompanied bysignificant changes in management, substantial restructuring andmuch tightened parental oversight. New management teams put inplace in the United States are also under significant pressure totruly turn these units operating performance around, if they are toremain strategically important or core to the parent over themedium and long terms.

Flight-to-quality trends have also continued in the market, asdemonstrated by cedents increased concerns about their reinsurancerecoverables. The weakened financial position of severalreinsurersreflected in the decision by S&P to downgrade severalreinsurers significantly in the last two yearshas amplified theseconcerns.

At one extreme of this spectrum is American International Group,which has recently announced its intention to request its U.S.reinsurers to post collateral for the reinsurance they providearequirement until now reserved for non-U.S.-based reinsurers.Although it is unlikely that this practice will become prevalent inthe market, it does illustrate the level of increased concern aboutthe ability of reinsurers to pay their future claims.

U.S. reinsurers are also not yet fully out of the woods withregard to reserving. Given the large numbers of primary insurersposting huge reserve strengthening in the fourth quarter of 2002and the first quarter of 2003particularly for asbestosliabilitythere is a question as to whether reinsurers fullyaccounted for these recent losses in their previous reservingactions.

The market also remains exposed to the highly litigiousenvironment in the United States, which continues to produce everlarger and more frequent claims awards. On the asbestos side,although a potential global settlement bill has been introduced inWashington this year, most industry players give it less than a50/50 chance to pass.

Unless an agreement is reached, insurers and reinsurers willremain exposed to significant uncertainty in this line of business.Given these challenges, it is likely that there will be somefurther reserve activity by U.S. reinsurers, though not to the samemagnitude as what these companies posted over the last twoyears.

It is worth noting, however, that a closer look at individualperformance by market participants suggests that the significantlosses incurred by U.S. reinsurers in recent years have not beenshared equally among the companies.

The big four direct writers in the marketAmerican Re, GeneralRe, Employers Re and Swiss Rehave recognized a disproportionateamount of the market losses compared with the broker marketparticipants.

There is uncertainty about whether the direct reinsurers wroteless appropriately priced business in the 1997-2001 timeframe or ifthey have more promptly acknowledged the required need foradditional loss reserving. Some believe that the business strategyadopted by the broker reinsurance market allowed reinsurers toavoid the financial distress encountered by their directbrethrens.

Companies that have chosen to take more opportunisticstrategies, such as Transatlantic and Everest Re, seem to havemanaged to avoid the magnitude of losses incurred by others becausethey chose to cut back premiums and write in less-competitive linesof business during the soft market.

Smaller and more nimble Bermuda writers following similaropportunistic strategies also seem to have been able to performbetter. This raises the question of whether more opportunisticplayers have a better chance to achieve more favorable operatingperformance over the long term, given their ability to exit ordiminish their participation in unfavorable lines of business,while large, market-share-driven companies lack this type offlexibility.

Although operating performance by U.S. reinsurers is expected toimprove significantly in 2003 and to remain strong at least through2005 (barring extraordinary levels of catastrophe losses), thevolatility and cyclicality of the U.S. reinsurance business willcontinue to challenge reinsurers to maintain profitability over thelong run.

Looking into 2003 and beyond, it is likely that the face of U.S.reinsurers will continue to change, as global groups continue toreevaluate their strategies and weaker players continue to beweeded out.

Laline Carvalho is a director for Standard & Poors in NewYork City.

Reproduced from National Underwriter Edition, July 7, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.