Moody's Assesses

Life reinsurers have a higher risk profile than direct writers, but despite some negative trends the life reinsurance industry’s ratings are not currently under pressure, according to a new report issued by Moody’s Investors Service, New York.

While the rating agency notes the potential impact of an avian flu pandemic on life reinsurers’ ratings, it says overall ratings would not be impacted because it is largely a business conducted by “large, highly-rated global multi-line reinsurers”

However, the commentary continues, stand-alone mono-line reinsurers and offshore start-ups do present greater risk.

The rating agency cites the life reinsurance industry’s higher risk profile as being the result of a number of factors including: industry concentration, limited capital, collateral requirements, a reliance on bank letters of credit and vanishing retrocession capacity. Retrocession is reinsurance for reinsurers.

In fact, the report cites a Society of Actuaries study, which noted that market capacity, once as high as $250 billion to $300 billion several years ago, has diminished to $100 billion today. The reason, according to Moody’s, is that “new, inexperienced retrocessionaires, which provided ‘na?ve’ capital in the beginning of the 1990s, left in the wake of the London reinsurance ‘spirals’ at the end of the decade, never to return.”

The report cites a Munich American Reassurance Corp./Society of Actuaries study released in May 2006 which indicated that approximately 72% of the U.S. industry’s recurring individual life reinsurance premiums and almost 80% of its business in-force were accounted for by the top five global reinsurers as of year-end 2005.

Moody’s, citing the MARC/SOA report, states that “the much smaller U.S. group life reinsurance market was even more concentrated as of year-end 2005, with the top 5 players totaling in the 90% range, in terms of both premium assumed and business in-force.”

And, while consolidation can leverage a small workforce and expense base and quickly grow business, it can “significantly” influence profitability and volatility, according to the report, prepared by Moody’s analysts Laura Bazer, Joel Levine and Robert Riegel.

Consequently, the report says, “this high degree of concentration has become a growing concern for ceding companies, which have begun to reach or actually exceed internal reinsurer credit exposure limits.” For this reason as well as for the increase in the cost of reinsurance, retention rates will increase, the report notes.

All signs, Bazer says, point to a reinsurance downturn, with the contraction of annual premiums assumed from traditional reinsurers and the emergence of new entrants continuing throughout 2006.

This may be something of a blessing in disguise, however.

“Despite the drop in top-line growth we believe that the downturn should prove to be a pause that will allow reinsurers to correct past underpricing on certain lines of business and to eventually improve profitability,” Bazer says.

But she also notes that on balance, the life reinsurance market is healthy.

While issues such as concentration of business among fewer participants create a greater risk profile for reinsurers than for direct writers, most are highly rated or are diversified companies that are well capitalized.

Bazer says Moody’s does look more closely at stand-alone reinsurers when it assesses ratings. The reason, she continues, is that the life reinsurance business is capital intensive, something that can be a strain on stand-alone and start-up companies.

Securitizations can be a good way for reinsurers to address the issue of capital, Bazer notes.

On a positive note, the report cites life reinsurers’ increasing use of capital markets to manage risk exposures and their balance sheets, particularly with regard to Triple-X reserving requirements.

Additionally, the market is witnessing the growth of a new reinsurance niche for blocks of business assumed.

Moody’s also addresses the issue of creating standards and processes for industry treaty and data standards in the life reinsurance industry.

“It is important that there be a process by which data can be transferred to reinsurers in a manner that is consistent from one company to another,” Bazer says. Both direct writers and reinsurers have their own systems for transmitting data, she continues.

Reinsurers have a greater need for standards because they have riskier profiles than direct writers, according to Moody’s. That reason is amplified by the “current volume of reinsurance business, combined with a highly concentrated reinsurance industry.”