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Moody's Assesses

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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.”

The report goes on to say that progress is being made. “The introduction of Sarbanes-Oxley requirements has contributed to the recent tightening of treaty language, particularly in the area of treaty ‘terms and conditions,’ ‘errors and omissions,’ and reporting lags.”

That tighter treaty language, among other things, “has translated into more frequent and tougher cedent reporting audits; less tolerance of long cedent reporting delays; less willingness on the part of reinsurers and retrocessionaires to accept all cedent underwriting ‘exceptions;’ and the disavowal of reinsurance coverage if the policyholder ‘listings’ are not transmitted by a certain date.”

The need for more facile transmission of detailed data is underscored by the advent of risks including terrorism and pandemic risks, according to Bazer.

For instance, she says that a better understanding of concentration risk by both ZIP code as well as where employees actually work, is necessary for reinsurers.

That level of detail is developed over time, she says, explaining it is a slow process that takes investment in systems to help develop.

Over the last couple of years, there has been a reinsurance boom because of pricing, but now that pricing has increased and cedents are retaining more business, that boom is over, she explains. This could be a good time to evaluate system processes, although companies will have to be “financially motivated” to make the change, Bazer adds.

The need for life insurers and reinsurers to create systems and processes that better assess their risk was captured in a recent Moody’s report dated February 2006.

Among other points, the report detailed results of a Moody’s survey of 34 companies that found that:

o Approximately 60% of all respondents indicated that their business procedures have changed in the wake of 9/11. Those changes, according to the report, “have ranged from the lowering of limits on group policies and the greater use of mortality reinsurance, to the mapping and modeling of terrorism risk exposures for one or more lines of business.”

o “Almost 70% of respondents map their larger risk exposures to determine geographic concentrations. However, the quality of these ‘mappings’ appears to vary significantly by company in terms of data quality, sophistication, and therefore, accuracy and usefulness in terms of exposure management. The remaining 30% that do not map their business cited either inadequate address data or businesses with wide geographic dispersion.”

o Roughly a third of respondents “use specialized third-party and/or internal terrorism risk models to calculate probable maximum losses to help manage their exposures for new business.”

o In general, group insurance providers have the most advanced mapping and modeling capabilities, while reinsurers and individual life insurers have the weakest capabilities.

The survey, according to the Moody’s terrorism report, found that although 9/11 losses were manageable, approximately 60% of survey respondents indicated that 9/11 changed the way they conduct business.

The remaining 40%, according to the survey, did not change their practices for reasons that varied from confidence their existing practices addressed terrorism risk to a belief that their business would not be impacted by terrorism risk.

In its commentary, Moody’s said that mapping their businesses to determine policyholder concentration is “essential” whether it be for terrorism or for mortality and morbidity management. But, in order to do that, according to the report, companies need to start with good data.

Kicker: Taking Count

o Market capacity, once as high as $250 billion to $300 billion several years ago, has diminished to $100 billion today.

o Approximately 72% of the U.S. industry’s recurring individual life reinsurance premiums and almost 80% of its business in-force are accounted for by the top five global reinsurers at year-end 2005.

o The much smaller U.S. group life reinsurance market was more concentrated as of year-end 2005, with the top 5 players having about 90% of the business.

Source: Moody’s Investors Service Reports. Some of the information is derived from data culled by the Society of Actuaries and Munich American Reassurance Corp.