The already substantial obstacles to entry into the financial guaranty industry have become even more formidable in the reinsurance sector, according to a new report from Fitch Investors Service.

"Reinsurers' Shrinking Pie." released yesterday, details primary insurers' declining use of monoline reinsurance and their increasing reliance on other forms of reinsurance.

Despite a $288 million, or 38%, increase in premiums written last year by the primary monoline bond insurers, premiums ceded to the monoline reinsurers declined, Fitch reports. Premiums ceded to Capital Re Insurance Co. dropped $5.1 million, or 8.5%, from 1991. And premiums ceded to Enhance Financial Services Group were off $140,000, or 0.3%.

At the same time, premiums ceded to the four most active international multiline companies increased 29 million, or 87%, the report says.

Monoline companies like Capital Re and Enhance focus exclusively on municipal bond reinsurance. Multiline companies are active in several insurance sectors, such as property/casualty and life and health. Fitch does not rate either Capital Re or Enhance.

"While the primaries clearly are interested in further diversifying their reinsurance business, the shrinking pie of reinsurance cessions poses a barrier to a new monoline successfully entering the industry," the report says.

Municipal Insurers Reserve Corp., or MuniRe, is the only known entity currently planning to enter the municipal market as a monoline reinsurer.

Richard P. Smith, a managing director at Standard & Poor's Corp., said MuniRe "will have a much harder time than Capital Re and Enhance. It has never been easy, but Enhance and Cap Re came into the business with blocks of business they had taken over. That's a tremendous advantage over starting day one with nothing. "

MuniRe officials declined to comment.

MuniRe issued a private placement memorandum in an effort to raise the capital necessary for a triple-A rating, according to industry analysts. A total of $100 million is considered the industry standard for start-up monolines.

"A new reinsurer could jump start its business by acquiring a portfolio for outstanding capacity-constrained issues," Fitch's report says, "but it may be challenged to find sufficient recurring business to maintain adequate long-term returns, particularly in light of initial capital requirements."

Some monoline industry officials say such an argument is contradictory.

The officials say that Fitch and other rating agencies have criticized the primaries for a lack of diversification among their reinsurance providers, but at the same time the agencies say there is no room for more players because cessions are failing.

Three weeks after it began operations in 1986, Enhance had $47 million of premiums from business ceded to it by multiline companies and some business from the primary monolines, according to Daniel J. Gross, the company's executive vice president and chief executive officer.

Capital Re started in 1988 with a book of business that came mainly from USF&G Corp.

The environment now is more hazardous than the one faced earlier by Capital Re and Enhance, Smith of Standard & Poor's said. "Premiums are thin right now," he said. "It's tough to make wonderful returns."

Smith also noted that unlike in past years, investors now have the choice of buying into established, prospering financial guaranty firms.

Officials of both Capital Re and Enhance privately doubt whether a new monoline would be able to enter the reinsurance market successfully. And even if one did, any business it secures "wouldn't come out of our hide," one reinsurance official said. The addition of a new company would ease capacity constraints and allow the primary companies to cede more business overall, he said.

In response to declining business from the primary insurance companies, the monoline reinsurers have stepped up their diversification efforts.

In 1992, $39.2 million, or 28%, of the combined gross premiums written by Capital Re and Enhance came from sources other than the primary bond insurers, the Fitch report says, up from $16.2 million, or 12%, in 1991; $2.7 million, or 3%, in 1990; and $1.4 million, or 2%, in 1989.

"The monoline reinsurers are compensating for the decrease in business from the primaries by pursuing other lines of business," said David T. Litvack, vice president at Fitch and one of the authors of the report, in a recent interview. "In effect, the reinsurers have been put on a nouvelle culsine: less meat and potatoes and more exotic vegetables."

Capital Re for example, recently filed a "notice of intention" with the New York State Insurance Commission to create Capital Mortgage Reinsurance Co.

Alan S. Roseman, senior vice president and general counsel for Capital Re, said that the firm has been active in reinsuring private mortgage deals in the past, and that the notice was done for strategic reasons.

"We are always looking to maximize regulatory flexibility in light of our operating and business plan," Roseman said. "In the context of our reinsurance operations we are considering. among other things, setting up a separate legal vehicle."

Enhance initiated the industry's diversification phase when it created Asset Guaranty in 1988. The specialty product subsidiary insures small, low investment-grade business in the primary market. Asset Guaranty makes up for the higher credit risk and increased underwriting effort by charging Premiums two to three times higher than the primaries, Fitch says. The firm only insures issues that are deemed too small or uncreditworthy by the primary monolines.

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