Another issue cited by reinsurance executives is that even though primary companies are enjoying a better rate adequacy, that doesnt always make it to the reinsurance sector since many primary insurers are choosing to keep the business net and buy less reinsurance.

“I believe the biggest challenge is the rapidly changing environment, said William Jewett, chief operating officer at the White Plains, N.Y.-based Endurance Reinsurance Corp. of America, part of Endurance Specialty Holdings in Bermuda. “The landscape will be continuously changing,” he warned.

“The challenge for all reinsurers is to be able to read the market quickly, be decisive, and react and move quickly, since the pace of change is accelerating.”

Specifically, reinsurers have to be perceptive to the marketplace and be able to identify opportunities, whether on the individual-transaction basis or the business-segment, marketplace-opportunity basis, Mr. Jewett advised. “In this marketplace, as we all know, some segments are more profitable than others, but the pattern could change over the course of a year. So you have to know when to participate, when to target and focus, and when to sit back.”

There is a sense among reinsurers that there will be a continued dislocation in the marketplace over the next 12 months, and that within that shifting landscape, reinsurers will see challenges as well as opportunities, depending on how well-prepared they are.

In 2003, a number of institutions exited the reinsurance business, among them established players like Chicago-based CNA and PMA Capital in Philadelphia. And with some other large U.S. players also withdrawing from unprofitable lines in this sector, businesses have been shifting among U.S. reinsurers as well as to offshore companies.

“There continue to be companies that withdraw from the reinsurance marketplace, either voluntarily or involuntarily, as a result of ratings actions that basically made them uncompetitive,” observed Jack Snyder, chief marketing officer at American Re Corp. in Princeton, N.J. “And based on how ratings agencies are posturing themselves, it appears that there will be more downgrades, and, yes, there will be more consolidations in 2004.”

One example of shifting business in the marketplace can be seen at Endurance Reinsurance, which bought most of Hartford Financial Services Groups reinsurance unit last May. This unit, which was called HartRe, wrote more than $700 million in treaty and facultative reinsurance in 2002.

Mr. Jewett said that in the past 12 months, some shifting businesses in the reinsurance sector have been picked up by U.S. onshore companies that are subsidiaries of offshore companies. “There will be more changes and shuffling within the industry this year,” he predicted.

Some reinsurance experts are also worried that despite significant reserve additions made by reinsurers in recent years there may still be a potential for further reserve deficiencies in the industry, and even the possibility of a lagging effect at work on reserves.

Last year, some of the reinsurers that announced reserve additions included SCOR U.S. Group/SCOR Reinsurance Company, part of Paris-based SCOR and XL Reinsurance, part of Bermuda-based XL Capital.

Rick Smith, president and chief executive officer at the global property and casualty unit for Employers Reinsurance Corp. in Overland Park, Kan., told National Underwriter that his company has faced some adverse developments in the past few years and has strengthened its balance sheet.

“Across ERC, we have strengthened reserves in the past few years by over $6 billion across all major lines,” Mr. Smith said. “ERC has scoured every reserve segment that it has, including asbestos and environmental, and strengthened its reserves. We feel that we have done what is right, and we are in a great position now to capitalize on the market going forward.”

“Most ratings agencies have negative outlooks on the reinsurance sector, due in part to the potential future emergence of reserve inadequacies,” Mr. Snyder observed. In theory, he acknowledged, there really may be a lagging effect at work here.

“The further you get away from the original pricing and underwriting of the business, the more you introduce delays in the availability of information. You also get information that is not only delayed, but its quality may not be as good as you want,” he added.

Due to this business model and how the information is gathered and transferred from primary companies to reinsurers, “the reinsurance sector does tend to lag in reserving actions taken by primary companies,” Mr. Snyder said.

There is also a growing difference of opinions among reinsurers on how conservative they should be with respect to loss-reserve adequacy. “There are emerging differences on how companies reserve on average and what they are carrying in terms of loss ratios for certain accident years of business, mainly in the problematic accident years of the 1997-to-2001 period,” Mr. Snyder noted.

This is partly the reason why, he said, there is a heightened scrutiny by Wall Street and ratings agencies, trying to forecast where the next big reserve charges might take place in the reinsurance sector.

Furthermore, these various challenges are compounded by the fact that the reinsurance sectors underlying client–the primary insurance sector–is continuing to keep more business net.

Mr. Snyder observed that even though the primary industry is enjoying better rate adequacy in most lines, “that doesnt always translate into business flowing into the reinsurance sector.” Many primary insurers, especially the ones that have the financial wherewithal to do so, are electing to keep the business net, he said.

“Its not that they dont buy reinsurance anymore, but they tend to buy less, and they buy more excess, higher layers of limits to protect themselves. But at the same time, these are also the most volatile layers of business–they typically dont have a lot of ceded premiums associated with them.”

This represents a significant trend in the marketplace–the primary marketplace appears to be growing faster than the reinsurance sector, he said.

“Thats because less businesses are being ceded to the reinsurance marketplace. Some businesses are being converted from a proportional or quota-share type of reinsurance to an excess-of-loss [basis], which involves less ceded premiums,” Mr. Snyder said.

“So we have all these challenges to deal with in the reinsurance sector, and buyers are tending to buy less,” he observed. On top of that, “we also have to be much more disciplined with maintaining an underwriting profit,” Mr. Snyder noted, explaining that the ongoing low-interest-rate environment doesnt allow reinsurers to make their margin from the management of investment assets at the end of the day.

“The business is more capital intensive; its becoming more volatile and there is a greater correlation of risks across classes of business. And there are the historically low interest rates,” Mr. Snyder said as he went down the list of challenges. “So there is an urgent need to generate an underwriting profit to be economically healthy and viable in this marketplace.”

Thankfully, reinsurers staying in the business are starting to realize the need for more disciplined underwriting. “It wasnt too long ago that reinsurers would throw around combined-ratio targets of something like 105s, 103s, 107s,” Mr. Snyder recalled. But beginning in 2002, reinsurers started to understand that their combined-ratio targets needed to be below 100.

“I think the reinsurance industrys combined ratio, despite more reserve strengthening that remains to be seen, should further improve in 2004,” said Mr. Snyder, whose company, American Re, has a general portfolio target of a mid-90s combined ratio.

Another forthcoming issue in the reinsurance sector is the terrorism reinsurance and the federal Terrorism Risk Insurance Act, noted Guy Carpenter & Company Inc., a reinsurance brokerage unit of New York-based Marsh & McLennan Companies. “We have been seeing more activities here. As TRIA retention increases, and as TRIA expires on 2005, insurers are looking for ways to manage that through reinsurance,” said Peter Zaffino, managing director at Guy Carpenter. “So we are exploring a lot of opportunities with reinsurers in that segment.”

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 2, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.