Capital Stretched But Still Adequate In Commercial,Reinsurance Lines

The industrys capital position is becomingstretched as a result of the estimated $30 billion hit from theWorld Trade Center losses, natural catastrophe claims during 2001of $10 billion, declining investment income, and the need by manycompanies to boost reserves, several industry analystsaffirmed.

Although another $30 billion has come back into the reinsuranceand insurance industry since Sept. 11, capital has still declinedby about $10 billion, said Donald Watson, managing director ofStandard & Poors in New York.

He emphasized, however, that at this point, capital adequacy isnot an issue for the reinsurance industry in general, but is aproblem for a number of individual reinsurers.

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

“With the improving rate environment, some companies areaccepting, not only a lot more premium, but even more exposure andaggregate,” he said.

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

“There are a group of companies that could lose their existingratings because of capital adequacy concerns,” he said. “Its a muchtougher environment and there isnt the cushion of reserveredundancy that their used to be.”

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

Mr. Watson said the industry is probably capitalized this yearat 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 thatit boosted the reserves of its subsidiary, American Re-InsuranceCompany, by $2 billion as a result of adverse claims developmentsin liability and workers compensation in the United States. Theaction prompted S&P to put Munich Res “triple-A” rating onCreditWatch and to announce that American Res rating could belowered 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 globalreinsurance industry appear to be connected with the unwillingnessof reinsurers to expose that capital to certain risks, rather thanissues of capital adequacy.

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

Regarding commercial lines, Mr. Mosher said the primary marketis becoming “somewhat stretched,” given the growing level of riskin the directors and officers liability market, the growingexposure to asbestos claims, and “the need for further rateincreases to get to a truly adequate level of profitability in somelines.”

Some commercial lines carriers are facing a capital crunch inthat they are unable to grow in areas that they view as profitablebecause they do not have the capital to support that growth, hesaid.

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

“There are various alternatives that theyre pursuing. Somestronger companies have been able to go to the markets and raisecapital,” Mr. Mosher said.

“But there are many companies that dont have that flexibilityand need to assess the overall exposure that they have on theirbooks,” he said.

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

Mr. Watson said that S&P holds a negative outlook forcommercial insurers. “This reflects exposures that are not fullyreflected on their balance sheets from D&O, casualty lines ofbusiness, problems in the workers comp, problems in professionalliability, and problems with asbestos,” he said. “All of thesethings are negative concerns that will put pressure on thoseratings and capital adequacy over the next couple of years.”

The offset to all of this, he said, is that rates are improvingand will continue to improve through 2003. “The pricing powerremains strong for the reinsurance industry to raise rates, so wecan expect to see the ongoing rate strengthening at least through2003,” Mr. Watson affirmed.

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

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

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

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

Mr. Brown said capital is adequate, based on what is knowntoday, but if two or three reinsurers become insolvent and theasbestos trends continue or get worse, then “theres probably notenough capital.”

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