A.M. Best today posted a stable outlook for the reinsurance sector in 2009 following very extreme events in 2008.  I found several aspects of today’s press release interesting because it indicates a relatively benign environment when it comes to insurance pricing in 2009.

The reinsurance industry is marked by periods when significant capital flows into the industry and places pressure on pricing.  In an effort to maintain premium volume, some insurers end up under pricing risks in order to maintain market share.  Since many reinsurance policies result in losses only years after the policy is written, the temptation can often be high to write business that will ultimately prove to be unprofitable.

A.M. Best cites the following factors to support the stable outlook:

Factors that support this view are sound underlying operating earnings generated over the most recent timeframe, assessment that management teams have demonstrated underwriting discipline and our view that the risk-adjusted capital adequacy of the segment is currently adequate relative to existing ratings with sufficient cushion to absorb a normal level of catastrophic activity. On a total return basis, 2008 margins were compressed largely as the result of drastically rising credit spreads and severely depressed asset valuations. From an underwriting perspective, despite one of the worst catastrophe years on record, the majority of reinsurers generated combined ratios below 100%, demonstrating strong underwriting discipline.

The report also noted that while there were many catastrophes in 2008, other than Hurricanes Ike and Gustav, most events were relatively small in magnitude and therefore losses from the smaller events were contained at the primary insurer level which spared the re-insurers from significant impact.  Additionally, the report forecasts that capital is not likely to flow into the industry this year even in the event of a major catastrophe.  This would support relatively firm pricing this year:

The over-arching issue facing reinsurers is that the wells are dryer going into 2009, as capital is not expected to flow into the industry in a meaningful way, even if a considerable industry-wide catastrophe where to occur. This represents a different position compared with other cycle inflection points, for example, following the World Trade Center tragedy and Hurricane Katrina when new capital poured into the segment.

While the report notes that there has been resistance to price increases so far in 2009, it is likely for the general trend in pricing to be firm for the duration of the year given the absence of capital flowing into the industry.  The report notes that strong carriers have opportunities in 2009 based on the overall industry climate:

While there are expected to be underwriting opportunities in 2009, reinsurers must be careful when deploying capital due to constrained financial flexibility given the present hurdles for carriers wishing to access capital markets at a reasonable price. However, for carriers that have successfully managed capital and have strong ERM practices, operating results for 2009 are expected to be favorable, providing opportunities to replenish capital that was lost in 2008.

Overall, this seems like an environment well suited to strongly capitalized entities that can take advantage of the pricing power that exists to write profitable business and generate new float at low cost.  Clearly Berkshire Hathaway’s position of strength is one that most reinsurers would envy in this market environment.  It looks like Berkshire can expect another year of solid underwriting profits barring a mega-catastrophe in 2009.