Hurricanes Hit Reinsurers Hard, But Don't Deliver Knockout Blow, Rating Firms Say

Mr. Waterman said that despite "the worst catastrophe year on record for insured losses last year," Fitch did not change its rating outlook from stable to negative, but "retained the stable outlook." He said a "very small" number of downgrades were experienced as a result of the hurricanes, "but the majority remained unchanged."

For the first half of 2006, he said, the insurance sector reported "very strong" operating performance, achieving a combined ratio of 89.9. This is compared with 95.9–"six percentage points worse"–in the same period of 2005.

Mr. Waterman cited several reasons why 2005 was a worse year than 2006 thus far. One is that the premium rate environment in 2006 is better, with low rate increases. The main driver, however, is the relative lack of catastrophe activity so far this year.

He said it's difficult to take a half-year result and "extrapolate that for the full year," adding that most reinsurers see strong results in the first half, but that most damage typically occurs during the second half.

Lines of business impacted by hurricanes have seen significant rate increases, while those not affected have been relatively stable or have even seen premiums fall–particularly with some U.S. casualty lines such as directors and officers liability, he said. Overall, however, "combining cat-impacted with non-cat-impacted lines, we're seeing…single-digit increases of premium rates reported in 2006," he noted.

Mr. Waterman said Fitch expects to see further divergence between lines of business going forward, with the expectation that "rates will begin to decline modestly in 2007 with a continued downtrend into 2008."

He also noted a trend in capital-raising–$30 billion by the insurance sector, much of it within the Bermuda market. The $30 billion in new capital, however, "more or less offset the $35 billion that we're estimating the reinsurance sector took off for total catastrophe losses last year," he said.

The biggest challenge facing reinsurers in the next couple of years is cycle management, he emphasized. "Reinsurers need to maintain underwriting discipline to reserve their capital and to maintain their financial strength," he said. "The decision of when to exit or come back from lines of business is not an easy one."

Standard and Poor's is also "reaffirming the stable outlook of the reinsurance industry," said Laline Carvalho, primary credit analyst in New York. She explained that in the fall of 2005, the industry's outlook was changed to negative, anticipating strains from Hurricane Katrina, Rita and Wilma losses.

She noted that S&P believes conditions in the market have stabilized, and expects the number of downgrades and upgrades to balance going forward. "In fact, we don't expect a lot of rating changes overall in this industry," she said, adding that the last three years have been stable.

"It's also interesting to note that 2005 was the highest catastrophe loss year ever experienced by both insurers and reinsurers, with over $80 billion in estimated [hurricane] losses," she said. "Despite that, we really didn't see many ratings changes for reinsurers."

Reinsurers, she said, are "enjoying a position of much better financial strength," while premium rates overall are stronger relative to 2001. "So while the magnitude of losses incurred by global insurers last year was much higher than what the industry incurred in 2001 relative to the Sept. 11 event, the operating performance of the industry was not so bad."

She said the combined ratio for the global reinsurance industry was estimated at 114 at year-end 2005, compared with 128 in 2001, "so the impact was not as large."

Nevertheless, she noted, there still are plenty of challenges for the reinsurance sector–among them the fact that the industry is "still haunted by over a decade of poor operating results." Ms. Carvalho said reinsurers continue to face significant earnings volatility, "given the unpredictable nature of the business they're in."

She cited a very real concern that a period of increased catastrophe losses could bring "even higher volatility in [reinsurer] earnings and their balance sheets."

A stable outlook for the reinsurance industry, according to Moody's, is "more newsworthy than it seems on the surface, because the industry went through a most tumultuous period over the last 12 months," according to analyst Bruce Ballentine.

He said the industry is stable because it "passed a fairly severe test of capital strength and capital raising capability."

He explained that reinsurance company ratings haven't changed dramatically during the past year, with only two companies downgraded by Moody's. Those downgrades were primarily a result of catastrophe losses and concerns over risk management. Otherwise, he said, the majority of companies were able to "hold their credit positions and are in pretty good shape this year relative to last year."

Previously, reinsurers have absorbed about one-third of catastrophe losses, but the percentage jumped to one-half–or $40 billion–with the hurricanes of 2005, according to Mr. Ballentine, due to the severity of Hurricane Katrina coupled with heavy commercial losses.

"That's the tough news," he said. "The good news is that capital poured back into the sector–about $27 billion."