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Risk management, modeling helped reinsurance industry in 2011

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Increasingly sophisticated risk management and modeling techniques helped the reinsurance sector weather near-record catastrophe losses in 2011, according to a report released Monday by Oldwick, N.J.-based A.M. Best Co.

The “Global Reinsurance Financial Review” notes that while the numerous loss events of 2011 cost the insurance industry approximately $110 billion in losses, the reinsurance market has seen only a minimal squeeze on capacity.

“It is reasonable to ask why the market did not turn more broadly, considering all that 2011 offered: significant catastrophe losses, record low investment yields, uncertain financial markets and the downgrade of U.S. sovereign debt,” the report states. “The simple answer is that reinsurance capacity remained ample despite the magnitude of losses and unrelenting headwinds.”

The report credits several factors to this resilience. One factor is a continuing evolution in enterprise risk management. The industry invested heavily in ERM initiatives in the wake of Hurricanes Katrina, Rita and Wilma in 2005, the report states.

Another factor helping the industry has been advances in catastrophe and economic capital models. A.M. Best said. “These tools significantly helped a reinsurer's ability to better allocate capital within complex risk portfolios,” the report states. “The models, while not perfect, helped keep both individual and cumulative losses in 2011 within stated risk tolerances for most of the global reinsurers.”

Additionally, reinsurers have adopted conservative capital management strategies in response to new pressures coming from regulators and rating agencies.

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“Reinsurers have tended to maintain a capital cushion in excess of the capital stress hurdle to ease rating agencies' post-event concerns and maintain financial flexibility,” the report states. “This cushion enabled reinsurers to withstand the 2008 financial crisis, when asset values eroded, capital markets became constrained, and reinsurers were concerned about their ability to access capital markets.”

Given the sector's strong, risk-adjusted capitalization and prudent ERM practices, A.M. Best said its ratings outlook on the segment remains stable, but said concerns about the pricing environment remain.

“History has shown that the market has a short memory, and if the sting of recent loss events quickly fades, the soft market may continue,” the report concludes. “In that scenario, the segment's capital strength would slowly erode, and A.M. Best would consider revising the ratings outlook to negative, as pressure on ratings would be expected to mount.”