NU Online News Service, Sept. 6, 3:13 p.m. EDT

Recent catastrophe losses have provided momentum for reinsurance rates to harden, and demand for reinsurance is expected to pick up, leading Moody's Investors Service to revise the sector's outlook to “stable” from “negative.”

“Following the worst quarter for natural catastrophes since [the 2005 third quarter]…not only have significant price increases been reported for some loss-affected regions/lines, but short-tail, non-loss-affected areas have seen pricing stability,” Moody's says, adding that general consensus after June and July renewals points to U.S.-catastrophe price firming of 5 percent to 10 percent.

Moody's states, “Although future pricing will key off the Atlantic hurricane season, we envisage broadly stable to strengthening prices at the forthcoming Jan. 1 renewals.”

The cat losses this year have also led to a halt in reinsurers' capital growth that occurred in 2009 and 2010. “To date, 2011 has witnessed a small reduction in the industry's capital cushion, driven by heavy cat losses.” Moody's says this capital development has “at least moderated somewhat the supply/demand imbalance” for reinsurance.

Capacity appears ample for now, Moody's says, but the rating agency notes capital positions may not be as strong as they appear, and while reinsurance demand is restrained for now, further reduction in capacity could change that. “One large hurricane could tip the balance in favor of demand over supply, as it would almost certainly lead to reduced equity at year-end 2011, for some companies significantly so,” Moody's says.

Aside from reductions in capital driving up demand, Moody's says it recently surveyed primary insurers in the U.S. and Europe, and more are now saying they are uncertain as to whether they plan to buy more reinsurance protection, as opposed to stating a clear “no” last year. While primary insurers' balance sheets strengthened in 2010, allowing them to retain more risk, Moody's says it believes the primaries have “little flexibility left in further reducing reinsurance usage.”

Furthermore, Moody's says the increased assessment of U.S. wind exposures according to the new Risk Management Solutions (RMS) model, as well as increased capital demands under Europe's Solvency II regulatory regime, could increase demand for reinsurance in the future.

In general, with respect to demand, Moody's says, “Our most likely global macro-economic scenario for 2011-2012 of a sluggish recovery in the world economy…would at least lead to a moderate uptick in insurance demand.”

Reinsurers will have to contend with pressure to short-term profitability. Pricing has been competitive in the recent past, Investment returns remain suppressed because of low yields, and reinsurers have already exceeded their cat budgets for 2011, Moody's says.

But the rating agency adds that, depending on cat activity for the rest of the year, it expects reinsurers' underlying loss ratios to at least stabilize during 2010 as pricing hardens.

Reinsurers also have to deal with depleting reserve cushions. Moody's says overall redundancies for standard commercial lines stand at around $2.5 billion, with those redundancies concentrated in the 2004 to 2008 accident years. Moody's expects that 2009 and 2010 were moderately deficient, and says despite small pricing increases, 2011 will end up deficient as well.

“While these potential deficiencies could ultimately drag on the sector's profitability, not all reinsurers are equally exposed,” Moody's says. “In particular, we believe that firms with sizable casualty businesses will be the most challenged, as these companies are vulnerable to unexpected shifts in loss-cost trends.”

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