Mr. Tolle was responding to a question put forth by Rob Jones, an S&P managing director and moderator of a panel of reinsurance executives. Following several panelists' remarks about the relative conservatism that property and casualty insurers and reinsurers demonstrated in 2008 in managing the asset sides of their balance sheets compared to other financial services firms, Mr. Jones asked about worries they might have regarding the liability side.

“Am I concerned about it? No,” Mr. Tolle responded. “You have to understand that our book today is a shell of what it was in the late '90s and early 2000s.”

Speaking about the p&c industry more generally, Mr. Tolle observed that over the last few years, “the reinsurance market–particularly on the casualty side–has been more disciplined than the insurance market.”

John Charman, president and chief executive officer of Bermuda-based AXIS Capital, said the market has been “pretty competitive in some primary casualty [areas], and that competition has not been fueled by the reinsurance market giving margins away,” echoing a view expressed at an earlier session by another Bermuda executive–Constantine (Dinos) Iordanou, president and CEO of Arch Capital.

“In many prior cycles, reinsurers had a big impact by providing inexpensive capacity,” Mr. Iordanou remarked. “Believe me, when you send somebody to bet with somebody else's money, they'll take unreasonable bets.”

Both Bermuda companies–AXIS and Arch–participate in both the reinsurance and primary insurance markets. “I have a good view of the reinsurance world from where I sit, and we've seen more discipline by the reinsurance community in how they price their products,” Mr. Iordanou said.

Asked specifically about the role of reinsurers in sustaining a soft p&c market overall, Mr. Charman said “the problem is not the reinsurance market. The problem is the primary market. I think the reinsurance market has done as much as it probably can without sacrificing its total revenue, because it's there to underwrite business.”

“For the last three years, I've found the reinsurance market to be pretty stable [and] focused,” he added, noting that his company's portfolio is currently more weighted toward the reinsurance side.

Overall, the reinsurance market “has a balanced portfolio both by product and geography–and it's a much smaller marketplace in terms of the number of players,” he said, citing the presence of too many players as “a destructive issue on the primary side, because not only is there an oversupply of capacity, but there's an oversupply of people.”

“That's where you get the excessive competition,” according to Mr. Charman.

Noting that he is comfortable with current reinsurance market underwriting conditions, he said, “I'm much more concerned about the failure of the primary market to properly understand and recognize the weakness of the underlying pricing.”

While neither Mr. Charman nor Mr. Tolle could be coaxed by Mr. Jones to go so far as to say that reinsurance prices don't need to go up, Mr. Charman did confirm Mr. Jones' summary of the executives' remarks as meaning that the cycle trough for reinsurance “wasn't particularly deep” compared to previous cycles.

“I think the reinsurance market has learned a great deal since the turn of the century,” Mr. Charman concluded.

“They are prepared to say no,” Mr. Tolle added, referring to reinsurers.

W. Marston Becker, chair and CEO of Bermuda-based Max Capital, agreed. In the marketplace today, he reported many instances where “if the primary company is too aggressive, it just can't get [a reinsurance placement] filled, [but] once they come for market terms, they're likely oversubscribed in that placement.”

“I think that behavior pattern speaks well for the reinsurance side of the industry in trying to exercise some discipline,” he said.

Looking back to the cycle of the late '90s, Mr. Becker agreed reinsurers drove soft pricing by rewarding primary carriers “for giving their products away” by making cheap reinsurance abundantly available.

“That's not been true in this cycle. You're seeing primary companies leading the way in pricing competitiveness and retaining more of their own business, which will ultimately be reflected in their loss ratios,” he said.

“I think the reinsurance sector is probably in a healthier place than it typically has been at this stage of the cycle, and for good reason. Our sector wrote off billions of dollars in 2000, 2001, 2002. Hopefully, we learned something from that,” he said.

Although the nearly breakeven combined ratio for the U.S. reinsurance industry was neither dismal nor stellar in 2008, S&P assesses the ratings outlook as stable for the reinsurance industry globally.

During the conference, S&P Director Laline Carvalho highlighted several differentiation points between the reinsurance and primary sectors, noting that the commercial and personal primary lines segments have negative outlooks from S&P.

Agreeing with the executives that reinsurance prices have not fallen as far as primary prices during the soft market, she also noted that property reinsurance prices rose for Jan. 1 renewals and casualty reinsurance prices are flattening.

She cited additional positive factors for reinsurers:

o The current environment in the financial markets, which strengthens the position of reinsurers since they may be viewed as a cheaper source of capital than the capital markets.

“We're not seeing many primary companies trying to…keep more and more of their business” as in recent past years, Ms. Carvalho said. “If nothing else, I think primary insurers are looking to get at least as much reinsurance as they had before, and in some cases they're trying to get more as a means of capital relief.”

o Strong first-quarter operating results, with several top reinsurer combined ratios in the 80-to-90 range. (See chart accompanying story on page 18 for first-quarter results of the top-25 reinsurers.)

o Capital positions that remain in line with current ratings, in spite of the erosion that occurred last year.

Later, pointing to the substantial erosion of excess capital as a negative factor that S&P can't ignore, Ms. Carvalho said that on average, capital adequacy has fallen by a category for major players.

In other words, reinsurers with “AAA” levels of capital adequacy going into 2008 (as measured by the S&P capital model) likely dropped down to “AA” by year-end, while “AAs” fell to “A” capital adequacy.

o Reinsurers have the largest proportion of strong and excellent enterprise risk management scores based on S&P's evaluation of ERM processes for rated companies.

VULNERABILITIES EXIST

Still, Ms. Carvalho–noting the material impact of catastrophe losses and capital market volatility on 2008 reinsurer operating performance–warned that “the jury is still out, in our opinion, as to whether, long term, reinsurers will be able to maintain adequate profitability.”

She went on to discuss the possibility of a massive catastrophe loss occurring this year while reinsurance companies are still trying to rebuild capital. “We believe a catastrophe loss in the $40 billion range or higher could present issues for some players,” she said.

“Some reinsurers would probably need to access the capital markets at that point,” she added–warning that if they can't, they might need to sell some fixed-income securities, turning unrealized capital losses into realized losses.

In summary, noting that reinsurance is a “volatile, risky business,” she said that “if you look at earnings performance over a long period of time, the reinsurance industry has tended to disappoint.”

Ms. Carvalho used exactly the same words during a 2002 S&P conference when she explained S&P's negative outlook for the reinsurance sector back then.

Reinsurance executives speaking at the same 2002 conference described reinsurance as a “fundamentally flawed business model,” suggesting the segment could never recover from disastrous losses.

At this year's conference, a different set of reinsurance executives–responding to the question of whether standalone reinsurance companies are an endangered species–continued to express negative views.

Mr. Charman said that's the reason AXIS was deliberately set up with primary insurance and reinsurance “operating side-by-side” in similar product lines and geographies. That structure, he said, allowed the company “to properly utilize capital to try to maximize the earnings potential.”

Mr. Becker agreed that a mixed insurance-reinsurance business model is better than monoline reinsurance. “The rationale…is that our markets don't move in lockstep,” he said, adding that the ability to write insurance or reinsurance “can be a competitive advantage if you truly have the discipline to move capital” when opportunities present themselves.

“Where you so often get trapped is in your own internal bureaucracy, [when] you don't make the conscious decision to shift capital to where…the optimum returns are.”

Mr. Tolle said that “you have to really have the controls to do the analysis and prepare early enough” if you want to shift the mix of business between insurance and reinsurance, explaining that in some regions, regulatory constraints limit the flexibility to move in and out of markets quickly.

Mr. Tolle also has concerns about consolidation in the reinsurance industry. He said panels of reinsurers that he reviews for Lloyd's syndicates are much shorter now than 20 years ago.

“It creates, in my opinion, systemic risk, which is quite dramatic,” he noted. “If we really get the truly 1-in-200 [year] hurricane, a $180 billion [loss] roaring through Miami, and one of the 10 large reinsurers should not make it, what is the domino effect on the other nine?”

Mr. Charman responded that he “would prefer to have a limited number of much more competent, stronger balance-sheeted businesses.” While that cuts down competition and choices for buyers, he said they benefit from the greater levels of competence and resources larger reinsurers can bring to bear for global businesses.

“I'm not too worried about systemic risk” because of the analytical discipline that reinsurers apply to potential catastrophe loss aggregations, he said. “I'd hate see the $180 billion Miami wind event, but while there will be a loss of capital,” he added, based on the stress-testing he's seen, “the reinsurance industry would stand up pretty well.

Related Charts:

Underwriting Results For Top Reinsurers

Year-End Policyholders Surplus For Top Reinsurers