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Capital adequacy vital in the risk business


INSURERS AND REINSURERS are greeting rating agencies' launch of revised capital adequacy models cautiously, out of fear that companies will have to put more capital onto their balance sheets.

As we report on page 3 of this issue and in prior stories during 2006, the major rating agencies are looking more critically at insurers' capital management. For property/casualty companies, this is largely a chain reaction from the record catastrophe losses last year.

Hurricane Katrina was a spectacular example of actual insured loss exceeding the modeled loss. But this happened with other storms, too, which led the catastrophe modeling companies to make their predictive models more conservative. If the expected exposure is greater, it follows that the capital supporting that exposure must increase.

Insurers are required to structure their capital according to the risks they assume, and rating agencies such as Fitch Ratings and Standard & Poor's Corp. view their revised models as tools to gain a clearer picture of how risk capital is performing. It's simply too early to say what effect, if any, the new capital models will have on company ratings.

We think the new models are both reasonable and beneficial, as long as they help increase insurers' financial security. Secure capital is important to investors, but it's critical to policyholders. Insurers and reinsurers must manage their capital to the benefit of both constituencies, and the volatility of underwriting risk makes that no easy feat. Companies often walk a tightrope between the demands of value for investors and long-term security for policyholders.

S&P indicates that its new model may increase capital requirements for some property/casualty companies and reduce them for some life/health companies. Whatever the case may be, insurers and reinsurers should focus on underwriting consistently to a profit and banking those profits in good years. After all, the next big test of insurers' balance sheets may be just around the corner.