News Analysis - Life on the A- precipice.

(From Reinsurance)

If you dig deep into PXRE's 2004 annual report (on page 40, to be precise), among the long list of disclaimers nestles a very revealing paragraph on the potential threat of downgrade clauses to the company's business: "Certain of our ceded excess-of-loss reinsurance contracts require us to transfer premiums currently retained by us on a funds-withheld basis into a trust for the benefit of the reinsurers if AM Best were to downgrade us below 'A-'.

"In addition, certain of our other ceded excess-of-loss reinsurance contracts contain provisions that give the reinsurer the right to cancel the contract and require us to pay a termination fee. The amount of the termination fee would be dependent upon various factors, including the level of loss activity."

Not so great for cash flow, one would assume, but the now-beleaguered firm continues: "It is increasingly common for our assumed reinsurance contracts to contain terms that would allow our clients to cancel the contract if we are downgraded below various rating levels by one or more rating agencies, and a majority of our contracts now contain such clauses."

Teetering on the brink

PXRE then spells out exactly how exposed it is: "...for example, 47% (by premium volume) of our reinsurance contracts that incepted at 1 January 2005 contained provisions allowing clients additional rights upon a decline in PXRE's ratings."

Well, that was when they had a clean AM Best rating of 'A' - two notches above the drop zone. Now, fast-forward to February of this year - by this time, PXRE was teetering on the brink with an A- rating, and the volume of business vulnerable to cancellation had shot up to 75%.