Downgrade Risk Worth Taking For Some

"There is a large amount of exposure increase in the growth that we're seeing," he said. "Many of the downgradesthis year weren't necessarily because of poor results or unanticipated reserve issues." Instead, the downgraded companies have just "outrun their capital," he continued.

Nevertheless, he said, there are some companies that view the current business environment to be very favorable and "have determined it's in their best interest to write at higher leverage measures at this point in time, despite what the impact might be on their ratings," Mr. Mosher affirmed. He said this has been the case for a lot of medical malpractice companies, which have "pushed the leverage higher," and consequently have experienced ratings downgrades.

He said he has heard the comment that the risk of a downgrade in this business is worth taking, given the business opportunities currently available.

Nevertheless, Mr. Mosher said, when looking at the overall capital for the industry, it is still adequate to support business that's on the books. "But, certainly, there are large pockets where there isn't the capacity, the ability or willingness to write business," given some of the loss trends, he said.

Mr. Mosher commented he didn't want to go as far as to say that Best has a negative market outlook, because such judgment varies from company to company. Still, as a result of the industry's capital constraints, negative outlooks for individual insurers outnumber both stable and positive outlooks.

Stephen Searby, director of Standard & Poor's in London, said his firms outlook on U.S. personal lines insurance is stable and appears to be relatively well capitalized, as does most of the U.S. commercial lines industry.

"The reinsurance industry globally is probably more problematic than [personal and commercial lines] because of the historic volatility of earnings and the capital depletion that's taken place over the last couple of years," Mr. Searby said.

In line with this observation, he pointed to another issue that may affect the quality of capital: reinsurance recoverables. He noted that U.S.-domiciled reinsurers owed the U.S.-domiciled insurance industry approximately $170 billion at year-end 2002, which is a historic high. "Growth in that number has outstripped premium growth," he said.

He attributed this trend to the fact that severity of claims is increasing–highlighted by the World Trade Center disaster and the growth of long-tail liabilities. As a result, S&P is worried about the consequent systemic risk of reinsurance recoverables for such long-tail exposures, he said.

As the number of reinsurers getting into financial troubles grows, it has a domino effect on the primary industry, said Brian Brown, consulting actuary for Milliman USA in Milwaukee, Wis.

In addition, some primary companies need to take asbestos reserve increases and reserve increases for business written in the late 1990s, he said. "The combined effect of this, plus the reinsurance recoverable issue, is likely to affect the surpluses of many primary carriers," he added.

Mr. Mosher noted that, compared to two or three years ago, there is less willingness on the part of European parent companies to support subsidiary companies with pure capital if there are reserve issues. More recently, he explained, instead of providing support in the form of pure equity capital, "it came in the form of affiliated investments, very often guarantees, net-worth maintenance agreements and things of that nature."

These investments are not nearly as liquid "as we would like it to be in terms of the support," he said, noting that much of this trend is likely explained by "the troubles the European parents are having in their domestic markets."

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, September 1, 2003. Copyright 2003 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.