Fitch Ratings said that it maintained its stable rating outlook on the global reinsurance sector. However, it cautioned that over the next 12 to 24 months the sector faces a number of key challenges, the biggest of which will be cycle management.

In a special report published today, the rating agency said that over the next two years the underwriting, operating and capital trends will generally support reinsurers’ current ratings. Fitch’s stable rating outlook reflects the agency’s expectation that the number of upgrades and downgrades during the next 12-24 months is likely to closely correlate.

“Downgrades are likely for reinsurers that underperform relative to their current rating level, and whose business models and franchises suffer materially during a cyclical downturn, said Chris Waterman, senior director in Fitch’s Insurance Group in London. “Fitch typically views significant merger and acquisition activity and expansion beyond core competencies as an indication that reinsurers may be experiencing difficulty coping with cyclical underwriting conditions,”

A key challenge facing reinsurers in the short term will be cycle management, as they try to identify when lines of business are no longer technically profitable and therefore need to be exited or de-emphasized, Fitch noted. “Such a skill has proven to be elusive for many in the past,” it said.

Although 2005’s catastrophe losses resulted in positive premium rate development in 2006, Fitch says it continues to believe that reinsurance pricing is cyclical due to the ease with which capital can enter and leave the market. Subject to a return to historical catastrophe experience in 2006, Fitch expects that reinsurers will experience moderate premium rate reductions in 2007 but see their cycle management strategies truly tested in 2008.

Fitch notes that the reinsurance sector proved extremely resilient despite the largest insured catastrophe year on record in 2005. Insured losses from hurricanes Katrina, Rita and Wilma totaled approximately US$65 billion, yet the sector retained its financial strength with only a very limited number of downgrades. Fitch viewed last year’s hurricane season as an earnings event for the reinsurance market rather than a capital issue. Most reinsurers that suffered material capital declines were able to raise capital quickly, filling holes created by the hurricanes, and to position themselves to take advantage of the current hard market.

“Ironically, the reinsurance sector’s unprecedented 2005 losses have in many ways left it in a stronger position today than before Hurricanes Katrina, Rita and Wilma hit,” said Mark Rouck, senior director in Fitch’s Insurance Group in Chicago. “Reinsurers are modelling their exposures to more severe and frequent catastrophic events, and cedants are retaining more risk due to the price of reinsurance capacity. Additionally reinsurers have trended away from proportional reinsurance covers towards excess of loss protection where they have more control over pricing and coverage.”