A rocky time for Bermuda

It has been a difficult 12 months for the Bermudian (re)insurance industry. There have been the worr...

It has been a difficult 12 months for the Bermudian (re)insurance industry. There have been the worries at XL, a string of investment losses - mixed with losses from Hurricanes Ike and Gustav - that took most companies' full-year results into negative territory, as well as worrying noises from US (re)insurers about limiting the tax advantages of the island. With much more happening besides, Alexander Ferguson talks to some of the island's biggest players about the past, present and future of the Bermudian industry.

Re-visit spoke to:

Mitch Blaser, CEO, Ironshore Bermuda

David Brown, CEO, Flagstone Re

Don Kramer, chairman and CEO, Ariel Re

Greg Richardson, CEO, Harbor Point

How have the last 12 months been for the Bermudian (re)insurance industry?

Greg Richardson: On balance, the BDA reinsurance has performed well over the last year. Ike was a big event but most companies took it in their strides and still made underwriting profits. Except for XL, most Bermuda reinsurers haven't had significant balance sheet or asset issues. Furthermore, rates have generally firmed.

Don Kramer: Over the last year, the Bermudian insurance industry, with one high-profile exception, experienced significant underwriting losses from catastrophic events but generally performed better than most US financial institutions with regard to capital losses.

Mitch Blaser: The industry has responded well to the challenges of the economic crisis, diminished capital, portfolio deterioration and political uncertainty. The notable exception has been XL because the additional risk exposure taken on the asset side of the balance sheet was disproportionate to the rest of the Bermuda-based industry players. This further emphasises the need to focus on core competencies and that risks taken on both sides of the balance sheet must be carefully managed in the context of solid enterprise risk management policies and procedures.

David Brown: The first six months of that period was chaotic, with a financial market meltdown of a magnitude not seen for generations; this was coupled with one of the most active natural catastrophe years on record. The bad news was that the industry suffered poor or negative book-value growth during the last half of the year. This overshadowed some good news: despite such an active catastrophe year, the Bermudian reinsurance industry absorbed significant losses from Ike and other events without any serious loss of capital from those events. This compares well to the mess that followed in the wake of Katrina and indicates that, as an industry, we have a better handle and control on our exposures. Furthermore, the most recent six months have seen the impact of the capital losses from 2008 create an imbalance between the demand for reinsurance and the industry's ability to supply it. This has been particularly acute in the capital-intensive property catastrophe lines. As a result, we have seen an increasingly attractive rate environment for these lines starting from 1 January and continuing through the current June and July renewals.

What were the biggest highlights of the year for you?

Richardson: I expected June and July's renewals to be a train wreck but instead it appears to be going pretty smoothly; healthy but reasonable increases on peak cat. Programmes appear to be being done.

Kramer: The biggest highlight of the year was that the Bermuda insurance industry accredited itself quite well with regard to claims payments, solvency measures and financial security, despite the global financial crisis.

Blaser: The addition of Kevin Kelley has brought industry leaders to Ironshore from Shaun Kelly, to Joe Boren in the environmental business, John Murphy and Tony Mamolite in the property arena, Tim McAuliffe in excess casualty, Geoff Smith in excess cat casualty and Steve England to lead our wholesale business and US field distribution. We have also been fortunate to avoid many of the exposures to the current climate on the financial institution business and related legacy concerns that many in the industry will have to face.

Brown: We expanded our platform significantly with the acquisition of Marlborough - a Lloyd's underwriting agency - and syndicate 1831, which it manages. Also, Flagstone produced positive underwriting results for 2008 despite being one of the most active catastrophe years in memory. We are very pleased that our investments in infrastructure and technology have paid off with our underwriting performance.

What were the lowest points?

Richardson: It doesn't appear that the asset hits on major players - especially AIG, Swiss Re, XL, Hartford and others - have translated into primary-rate improvement. In some cases, it may have intensified competition.

Kramer: The biggest disappointment of the year was the magnitude of the underwriting losses from hurricanes Gustav and Ike, particularly with regard to the marine and energy sector. The second was clearly the global financial meltdown: only four of the largest Bermuda companies were able to post a gain in book value per share for 2008, while 14 posted declines of 1% to 18% and one outlier declined by 32% in book value per share.

Blaser: The losses associated with last year's hurricane season were as unfortunate for us as they were for everyone else in the industry but we don't believe in 'spending relative performance'.

Brown: As everyone now knows, 2008 was a lousy time to be the owner of almost any financial asset. Our asset portfolio was allocated in a diversified manner and thus we had exposure to equities, commodities and real estate in addition to our core fixed-income holdings. Historically, such a portfolio performs well in most market scenarios; unfortunately, 2008 was a unique year in that diversification did not pay for anyone because all asset classes seemed correlated and so we suffered some losses on our investments. This somewhat overshadowed our excellent underwriting performance for the year.

Have regulatory worries shaken Bermuda's standing as a capital centre?

Richardson: Regulatory worries have caused people to seriously consider alternatives and that in itself is a threat; ideas have a way of turning into reality. That said, the effectiveness of Bermuda as a market remains strong and switching costs are high enough to deter rapid change.

Kramer: Bermuda has undertaken meaningful steps to increase the international recognition of its regulatory competency. It has demonstrated that it is a vigilant and responsible regulator; there are no challenging regulatory issues threatening Bermuda's international business sector. In addition, it has signed numerous tax treaties with more than 12 jurisdictions, assuring transparency and co-operation.

Blaser: I don't think that regulatory concerns are the issue for capital in Bermuda - the issue is that capital has not been available in any geography over the last two years regardless of regulatory or tax related issues. Bermuda is the third-largest insurance market and the ability for trading partners to meet and conduct business in an open market that is friendly to the encouragement of international business is the key to both the continuance and potential flourishing of this market.

Brown: I don't think so. Bermuda is extremely well-regulated by the BMA and is proactive in making sure it's reputation and standing are respected internationally. The BMA is at the forefront of development in modern regulatory standards and I believe its regulatory regime could serve as a model for other jurisdictions. In fact, Bermuda was independently assessed by the IMF and found to be highly observant of international best standards set by the IAIS. The BMA has set out its roadmap to mutual recognition and is on course to meet future regulatory challenges.

What do you think of HR6969, or the 'Neal Bill', as it is known? What will happen to Bermudian (re)insurers if it is passed?

Richardson: I haven't studied the Neal Bill. From what I have heard, it doesn't appear that Bermuda is a specific target. There seems to be an awareness of Bermuda's importance to the problem of managing the US's - especially Florida's - cat risk; Bermuda-domiciled companies have paid billions in US cat losses. In the discussion of tax issues, people tend to think only about taxes on profits and forget the opposite tax impact on losses.

Brown: The Bill seems to me more of a protectionist measure for a few US- based reinsurers than anything else. In a world where global free trade is considered vital to the wellbeing of the global economy - especially in a recession - this seems to be ill-timed. In terms of the impact on the Bermuda reinsurers, it impacts only those that have a US insurance or reinsurance subsidiary: many do not. The Bill, as introduced last year, renders the utilisation of any affiliated reinsurance non-economic. It would force some companies to change their flagship business models and will have an impact on some large companies if enacted as introduced. The Bill affects all international insurers with US subsidiaries: Bermuda is not singled out.

Kramer: The Neal Bill is flawed in many ways and it is infuriating to hear the coalition seeking protectionist tax legislation say repeatedly that all they want to do is level the playing field when, in fact, the cession of inter-company reinsurance to Bermuda involves the assumption of significant risk. When catastrophic claims payments were made last year without tax offset, no one spoke about a level playing field. Costs to US consumers would rise and besides, those actively promoting the legislation don't write the high- volatility catastrophy business.

Blaser: Any bill that encourages protectionism will ultimately have the biggest negative impact on the consumer: costs would increase as the sources of capital become more expensive. Furthermore, the belief that Bermuda-based companies do not pay taxes is another misconception. FET at 4% of gross translates into taxes of 20-40% of net income assuming a 10-20% profit and there wasn't as much profit in the business over the last two years. However, these taxes are still paid. The issue that the US has to deal with is to be careful not to tar abusers of tax advantages with the same brush. If wealthy individuals, hedge funds or pharmaceutical companies are taking unfair advantage, the focus should be on those issues and not ones that US citizens take advantages from. By the way, my guess is that for every job created for Bermudans in the industry, there are five to 10 jobs created in the US or other tax paying jurisdictions.

How much pressure is being felt by companies to diversify?

Brown: I'm not sure because we certainly don't feel any. Diversifying into poorly performing lines of business does not make economic sense and moving into lines where you have no expertise doesn't make any sense either. Flagstone is in an excellent position because we are extremely diversified within our property and catastrophe book on a geographic basis and our non-cat lines now account for 45% of our book of business. Our focus is on diversified short-tail lines, where the current market opportunity resides.

Richardson: There is a strong economic pressure to diversify risk - that is really the essence of insurance. The problem is that, in the quest for diversifying business, the market often competes away the margin. There is no value in a non-correlated risk that has no profit margin. Ratings agencies seem to push for diversification beyond what pure economics would justify.

Kramer: Most companies have sought to diversify, if for no other reason than to allow them to manage large, highly volatile risks.

Blaser: Diversification and de-risking portfolios is a critical initiative for all. Mono line is still a challenge, however being in too many businesses and not knowing enough about them or having the core expertise to manage them is equally challenging and can lead to bigger mistakes. An important part of good risk-management practices for clients of the insurance industry will be to further spread or syndicate their risk exposures over greater numbers of markets. The idea of 'parking' risk with one market as being in secure financial condition are over.

Last year in Re-visit, we talked about the saturation of the Bermudian (re)insurance market. Is the market seeing any signs of thinning out?

Richardson: Rents are down in Bermuda, which suggests it is less saturated. There is some downsizing and consolidation. Recent staff growth has tended to be in the US, UK or Europe rather than Bermuda.

Kramer: The global insurance and reinsurance industry has lost large amounts of capital but the current economic situation offers little prospect for raising additional capital on favourable terms. Accordingly, the formation of new companies is very limited. In addition, companies are trying to acquire capital by issuing stock to buy other, more highly capitalised companies. I don't see much activity in this area but I would keep an eye out for capital market solutions should opportunities arise in attractively priced sectors.

Brown: There has certainly not been a 'Class of 2009' and, due to the tough conditions of 2008, capacity is at a premium, so I would say there is not any saturation. I think each member of the Bermudian market has begun charting its own course and therefore you are seeing a significant amount of divergence and diversification in strategies. The market is certainly maturing.

If you had a magic wand, what would you do to improve the Bermuda market?

Richardson: The main challenge of Bermuda as a market is that we require very specialised skills and experience so, inevitably, much of the human resource is imported.

Kramer: I would love to see Bermuda continue to demonstrate its global credit worthiness. Possibly it could demonstrate its counter-party strength in a manner similar to Lloyd's.

Brown: I believe that the Bermuda market is now the pre-eminent reinsurance market in the world and it doesn't need any further help from me. I think that recent improvements in risk management and underwriting have improved standards and lessened some of the volatility that this market has experienced historically, so improving the future prospects for profitability on a risk-adjusted basis.

We've seen a lot of Bermudian companies flex their muscles at Lloyd's over the last 12 months. Do you think this will continue?

Richardson: Lloyd's and the London market have great attractions: sizeable market for risk other than peak cat; licensing advantages; capital leverage through the central fund; and a deep talent pool. I have long believed that the true economic benefits of the tax regime are generally overstated. So yes, I think interest in Lloyd's and London will continue.

Kramer: The combination of Bermuda companies and Lloyd's has been beneficial to both markets. Lloyd's is going through a flowering period as it emphasises its counter-party credit worthiness as a result of to the guaranty fund and the syndicated market.

Brown: Lloyd's offers an attractive diversifying platform for reinsurers and we recently entered this market with our purchase of Marlborough. I think that the Lloyd's market will continue to be attractive, however I am not sure about the ease of entry and it may indeed become more difficult as well as more expensive for new entrants to set up shop.

Where is the next place to be for Bermudian companies? Where do you think that the market will see the greatest expansion over the next year?

Richardson: The Bermuda story has focused heavily on the US, first due the casualty crisis in the 1980s and then in response to Andrew and the need to better manage US cat risk. As you pointed out, Bermuda seems to be looking a bit more toward London, which provides a more global view of the insurance maketplace. I suppose, at some point, Bermuda companies might look to Asia but as vast as those economies are, it seems as if the profit potential is still very small relative to the US.

Brown: Bermudian companies already have a global reach and are expanding their business lines. To a degree, brokers and clients are bringing new risks to Bermuda in the aviation, energy and marine (re)insurance markets. I see this continuing as the capital and expertise of the Bermuda market continues to grow.

Kramer: Bermuda will continue to lead the catastrophe insurance market and its largest expansion will come from reinsurance. Capital losses over the last year have forced affected companies to retain less risk. Reinsurance is the banking sector of the insurance industry and is its strongest sector currently.

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