Reinsurers have managed to avoid ratings downgrades despite the unprecedented market challenges this year only due to excess capital the industry had accumulated in recent years, according to a report issued by ratings agency Standard & Poors yesterday.

But the report warned that excess capital has been severely depleted and the industry now has little margin for error in its operational decision making. Barring "significant" rate increases at the January renewal period, ratings will be negatively affected, S&P said, particularly on the most exposed reinurers.

According to the report, at the beginning of this year, the top nine global reinsurers has more than $25 billion in excess capital but 85 percent of that has now been eroded and more write-downs are expected along with results from the final quarter of the year.

"The sector has been subjected to, and successfully withstood, a 'AAA' stress during 2008," the report said, but that capital must be rebuilt.

Rate increases of between five and ten percent on average are needed, the ratings agency said, in order "to enable reinsurers to rebuild excess capital to the extent we consider necessary to compensate for their loss of financial flexibility".

The report — entitled "Global Reinsurance: Excess Capital Absorbs The Shock To Date; But There Is Limited Further Margin For Error" — said S&P has "revised some of its medium-term expectations for the sector in light of recent events".

"We now expect the combination of the substantial capital depletion seen to date, lower prospective investment yields, a spike in the cost of capital, and constrained financial flexibility to translate into substantial (risk-adjusted) price increases at the forthcoming January renewal."

Credit analyst Peter Grant added: "Lesser price increases could cause us to change our outlook on the sector to negative, and to revise the outlook or ratings on those reinsurers that we believe to be most exposed, namely those that are either thinly capitalised relative to their current rating level or that are, in our view, excessively exposed to further declines in investment markets or concentrations of insurance risk."