Bermuda-based ACE Limited yesterday experienced the knock-on effects of the financial deterioration of other reinsurers in the industry.

Fitch Ratings has downgraded the rating of ACE Limited's debt and the financial strength rating of one of its subsidiaries, ACE INA Holdings, Inc by one notch. They also downgraded the rating on existing preferred securities to BBB+ and downgraded the insurer financial strength ratings of certain subsidiaries associated with the company's asbestos exposure.

Fitch is one of the four ratings agencies who assess financial strength of companies and their securities and the action follows a similar downgrade by Standard & Poors in March. In the insurance industry, Fitch are widely regarded as an alternative rating agency choice after AM Best, Standard & Poors.

Although the rating agency was generally upbeat about ACE, describing strong underwriting earnings and adequate overall reserve levels, they are concerned about what they call ACE's high exposure to reinsurance recoverables.

It's a view which Fitch insurance analyst, Keith Buckley touched on during a presentation at the Risk and Insurance Management Association (RIMS) conference 2003. He said that during the previous soft market some companies took reserves and underwriting so far out of kilter with investment results that there has been permanent damage to the reinsurance industry.

This weakening of the reinsurance industry is bad news even for healthy insurers like ACE because if more reinsurers go out of business, it will mean that companies like ACE will not be able to collect reimbursement from their reinsurers.

This could be a problem for ACE because they inherited certain potential asbestos and environmental claims from its 1999 acquisition of Cigna's domestic property casualty/insurance operations and a January assessment of those liabilities led to them taking a gross charge of $2.2 billion.

After reinsurance, that charge falls significantly to $354 million, but if reinsurance contracts prove difficult to collect the reserves would presumably have to increase and would further cut into ACE's earnings.

On the positive side, Fitch predicted that ACE will continue to benefit from the hard market conditions through 2003. They also mapped out potential for future ratings upgrades if ACE successfully completes a planned preferred securities issue and contributes $250 million of capital to certain ACE USA subsidiaries.