Stock Market Wrong On Re Outlook: Analysts

By Lisa S. Howard

NU Online News Service, Oct. 16, 12:02 p.m.EDT?Although the casualty reinsurance market was the lastto turn in the hard market, it is "poised to outperform the primarycasualty lines that feed it," according to Morgan Stanleyanalysts.

Looking at loss ratio data since 1988, the U.S. casualty excessof loss market showed "meaningful outperformance" after the lasthard market in the years 1988 to 1991, according to William Wilt, aMorgan Stanley research analyst, during a recent conference call todiscuss the reinsurance industry.

For the 1988 accident year, loss reserves showed a full 16points of favorable development from the initial report to itsultimate resting place of a loss ratio in the high 50s, heexplained.

And Mr. Wilt suggested that there are meaningful parallelsbetween 2003 and 2004 and 10 to 14 years ago.

Further, there are "a host of macro factors that we think aregoing to drive that loss ratio down and keep it down?at leastarguably, for a couple of years," Mr. Wilt added.

He said these macro factors include rating agency downgrades,increased focus on creditworthiness, new management in thereinsurance sector, and continual pressure from the rating agenciesto show capital increases and underwriting discipline.

As a result, Morgan Stanley thinks "the casualty excess of losscycle is going to last longer and prove more profitable," which isnot being reflected in stock prices, Mr. Wilt said.

Vinay Saqi, vice president, with Morgan Stanley, said casualtyplayers tend to benefit during the latter stages of the cycle.Reserve deficiencies within casualty reinsurance tend to work theirway though the system slowly due to time lags in reporting, hesaid.

As a result pricing for these products tends to pick up with alag as well, which means earnings growth from the sector will showup in later years, Mr. Saqi said.

During the last two years, a lot of the reserve deficiencieshave come through for the reinsurers and the primary companiesalike, Mr. Saqi said.

Looking forward to 2004 and 2005, some of the stronger companiesshould benefit from the rate increases that they've put forth inthe last two years, he said.

After the last hard market in the mid-1980s, casualty-orientedinsurers and reinsurers performed better "from 1986 though thebeginning of the 1990s," he said. These were companies like AIG,Chubb and General Re?all of them did better relative to otherinsurers and reinsurers, he added.

Despite the positive fundamentals for the strongest reinsurers,Espen Nordhus, executive director with Morgan Stanley, emphasizedthat stock prices have not responded accordingly.

"Clearly there are other issues around but it's safe to say themarket has not really gotten very excited about this upswing," hesaid.

"We dispute the apparent market conclusion that for want of abetter phrase, it's all over for reinsurance stocks in Europe,"said Rob Proctor, managing director, for Morgan Stanley in London."In fact, we believe pretty much the converse may be the case, inthat, for the first time in many years?, 2004 could be a strongyear for earnings, given [the convergence] of both goodunderwriting results and also a stabilization and arguably animprovement of investment results."

Reinsurers, at this point in the cycle, benefit from severalleverage effects, versus the exposure of the primary industry, hesaid.

He pointed to the aftermath of the hard market in 1988 to 1991,when reinsurers had loss ratios at around 10 points lower onaverage than the primary insurance industry, which could lead to atheoretical combined ratio of 80 percent for some Europeanreinsurers.

While he didn't expect European reinsurers to publish or printcombined ratios as low as 80 (due to inherent reporting lags), it"does demonstrate the potential scale of the positive surprisehere."

Mr. Proctor said Morgan Stanley is estimating an averagecombined ratio of around 97 for the European reinsurers next year,while it is expecting combined ratios in the area of 93 in theUnited States. "Roughly a 3-point surprise in combined ratios canequate to up to 30 percent in terms of earnings surprise."

The leverage effects on the reinsurance industry were discussedin a recent reinsurance report issued by Morgan Stanley on Oct.1.