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Investors warned on European (re)insurers’ reserves

The profitability of European (re)insurers will face headwinds from diminishing reserve releases in 2013 and beyond, according to Moody's.

The rating agency added to a growing chorus of commentators predicting a slowing of the releases that have helped support P&C underwriting margins in recent years.

"Allowing for differences in business mix and geography, our expectation is that the pace of reserve releases will continue to slow into 2013 and beyond as the effects of the general deterioration in insurance rates across Europe from 2005-2009 play out," Moody's predicted.

"In addition, the fact that 2012 is the seventh consecutive year that our cohort has reported reserve releases raises questions as to how much additional cushioning is left in the older, better-priced accident years," it added.

But despite the pressure on earnings, Moody's said it was not expecting "severe" reserve deterioration such as that seen in the early part of the 2000s, as long as the low inflation environment persisted.

The agency noted that prior-year reserve releases among the 11 European insurance groups in its study had grown from 2006 until peaking in 2008 as a percentage of opening reserves (see graph).

Since 2008 the rate of releases has declined, although both 2010 and 2011 saw a slight pick-up.

Moody's said this pattern of reserve releases "generally conforms with what we would expect in light of rate movements during the decade", with prices hardening between 2002 and 2004.

"By 2006, the need to strengthen reserves on pre-2002 business had largely receded and the benefits of rate increases were starting to work their way through the reserving system," Moody's explained.

However, as markets began to soften after 2006, (re)insurers were more incentivised to release reserves to maintain profitability as current accident year margins shrunk.

Moody's said that since 2006 prior-year reserve releases have contributed 26 percent of annual aggregate pre-tax operating profits for large European (re)insurers, based on a composite of 11 carriers.

This ranged from a high in 2008 of 51 percent to a low in 2006 of 10 percent, although this measure reflects the movement of total profit more than it does changes in reserve releases (see graph).

Moody's said that 10 of the 11 companies in its study had recorded overall prior-year reserve releases for the period. Such releases contributed between 15 percent and 52 percent of these firms' pre-tax profits on a company-by-company basis.

However, Moody's warned that reserve strengthening or releases did not necessarily indicate the strength of a reserve position. A company could add to its reserves to keep an industry-leading margin above its best estimate, or release too aggressively and undermine the strength of the reserve position.

Moody's warning on European insurance reserves follows several market watchers predicting a similar problem for US commercial insurers, including fellow rating agency Standard & Poor's and Barclays analyst Jay Gelb.

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