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Portfolio > ETFs > Broad Market

S&P: Reinsurance May Be An Increasingly Rotten Crutch

By Allison Bell

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NU Online News Service, Aug. 13, 2003, 6:14 p.m. EDT – U.S. insurers “could be leaning ever more heavily on an increasingly rotten reinsurance crutch,” according to Steven Dreyer and Ian Reed, analysts at Standard & Poor’s, New York.

The analysts point out in an S&P commentary on reinsurance collateral that the top 10 U.S. users of reinsurance are counting on reinsurers to make $28 billion in reinsurance payments.

The reinsurance recoverables for those 10 companies amount to 56% of their surplus, the analysts write.

Meanwhile, the analysts warn, many reinsurers are suffering from a combination of high claims rates and poor investment results.

“The fortunes of reinsurance companies are highly correlated with those of their customers,” the S&P analysts write. “In other words, reinsurers are likely to encounter difficulties just when primary companies need them most.”

American International Group Inc., New York, made headlines earlier this year by announcing that it wants all of its reinsurers, not just foreign reinsurers, to back all of their AIG reinsurance arrangements with collateral.

Other U.S. insurers and U.S. insurance regulators demand that foreign reinsurers have enough collateral to back 100% of their exposures to U.S. insurers, the S&P analysts write.

In the short run, requirements that reinsurers supply extra collateral may distort the market by helping weak reinsurers, because collateral makes the reinsurance supplied by weak companies look as secure as reinsurance supplied by strong companies, the analysts observe.

In the long run, although the probability of a reinsurer and a bank failing simultaneously is low, “the wisdom of relying on banks to provide collateral remains subject to question,” the analysts write. A letter of credit “is only as good as the bank behind it, and many of the institutions providing them are rated lower than the reinsurers they are backing.”

Moreover, a bank may include provisions in a letter of credit that give it the right to back out when a reinsurer is suffering from serious financial problems, the analysts write.

The analysts also argue that U.S. reinsurers would have a hard time coming up with enough collateral to back 100% of their exposures if regulators required them to do so.

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