Standard & Poor’s Ratings Services said today it is maintaining its stable outlook on the global reinsurance industry. However, the ratings agency warns that the regulatory fallout of recent investigations will be a key issue in the coming year.

S&P says that there remains a possibility that some downgrades may occur during the remainder of 2005, but upgrades will be few and far between. Nevertheless, for the majority of the industry’s constituents, the ratings will not change.

S&P notes that the 2004 reporting season shows a respectable performance despite the U.S. and Japanese storm activity of the third quarter, with an improvement in risk-based capitalization and more gentle declines in pricing than had been expected. However, these positive factors are offset by further adverse reserve development in 2004, the question of whether underwriting discipline can be maintained, and the impact of New York Attorney General Eliot Spitzer’s ongoing investigation into insurance industry practices.

“With prospective quantity and quality of earnings being crucial arbiters of reinsurers’ financial strength, the indication that wholesale softening has not taken place is key to the outlook for the sector,” it says. “The accounts affected by the storms inevitably have not been able to press through significant price increases, although the renewal of the Florida accounts on July 1 will be important for a more accurate picture. For property lines where general price declines have been recorded, rates still appear to be at economic levels and other terms and conditions have remained intact.”

“Adverse reserve development is an enduring issue, with well-publicized reserve additions having been made by Converium, GE Insurance Solutions, and Swiss Reinsurance America Corp. in the 2004 financial year,” it adds. While most of the issues relate to accident years prior to 2002, Standard & Poor’s also notes that many U.S.-based reinsurers reported adverse development for the 2002 accident year, and while that remains a profitable year, the initial overestimation of profits by some reinsurers is “concerning”.

S&P also cautions that support from parent companies is susceptible to change, and shareholders may withdraw support if they consider that the investment is not paying adequately for the degree of volatility. “Given the turn of the premium rating cycle, investors generally may be wondering whether now is the time to reduce their exposure to the reinsurance sector,” it says. “In this context, the investigations of Mr. Spitzer into the broking community and finite reinsurance put the industry in an unwelcome spotlight, highlighting a lack of transparency in some of its practices and disclosures.” It predicts that the short-term financial fallout is likely to be limited, but also warns that “the falling demand for finite reinsurance could hurt revenue lines for some key reinsurance providers. In addition, insurance regulators, particularly in Europe, are working to bring reinsurance into the regulatory framework, and although this is welcome, Standard & Poor’s does see the economic impact of requiring greater levels of local regulatory capital as an area of potential concern.”

“The drama of the storms and the Spitzer enquiry made 2004 memorable, and while the reinsurance industry has held steady so far, the next 12 months will prove critical,” it says. It warns that the most significant question for the next 12 months focuses on discipline. “The crucial issue is whether the discipline shown in the January 2005 renewals is built on sand or on the solid foundations of a more sophisticated approach to analyzing the risk-return relationship,” said Standard & Poor’s credit analyst Stephen Searby. “Financial strength remains dependent on whether further declines in premium prices can be halted by the beginning of 2006 when prices, based on current trends, look set to begin testing economic levels.”