Nigel Allen describes the efforts by Bermuda's plethora of reinsurers to get their finances back on track after suffering a battering during last year's hurricane season, and asks whether they are ready for a possible round two?

Bermuda has long proved a sturdy platform in the sea of volatility that is the reinsurance industry. Withstanding the financial lashing of numerous catastrophic hurricanes, both on its own shores and across the portfolios of its reinsurers, the island has stood firm, its moorings holding fast. But the storms of 2005 inflicted severe damage on Bermuda's reinsurance infrastructure. With the last 12 months seeing a number of reinsurers sucked down into the "B" ratings whirlpool, while others struggle hard to resist its pull, just how stable are the financial moorings of the island's longer-term residents as we approach another active hurricane season?

Back on course

There is no doubting the effort being exerted by XL Capital to bounce back from what was a truly horrendous year that saw the industry stalwart take a catastrophe battering of over $2bn, further compounded by the $834m Winterthur hit, resulting in a downgrade and a shareholder net loss of $1.3bn. In fact, rumblings about Brian O'Hara's ability to retain his position as president and CEO resulted in XL issuing a statement of support for the under-fire head. Core to this drive has been a successful $3.2bn capital raising exercise; coupled with a three-pronged risk management assault to cap portfolio volatility, the central prong of which is Cyrus Re, the $500m funded quota share entity; and a senior management reshuffle which has seen James Veghte take the helm of XL's reinsurance general operations.

XL kicked off 2006 with a strong Q1 result, however, it should be noted that despite record income for the quarter of $406m, both reinsurance and insurance underwriting profits were down on the first quarter of 2005, with written premiums hit by selective treaty cancellations and falling European property rates respectively, leaving the record performance heavily reliant on impressive investment returns.

Endurance saw its net income plummet from $355.6m in 2004 to a net loss of $220.5m in 2005, with the storms resulting in an underwriting loss of some $830m. But a two-week capital raising surge saw the company re-float its balance sheet by some $600m, with a favourable reserve release adding a further $65m to the company's financial hold. Q1 saw Endurance record an 11% rise in net income to $107m, while gross written premiums fell off by 18% to $571m to $702m. The GWP decline stemmed primarily from the non-renewal of certain contracts in the group's property per risk treaty reinsurance and casualty treaty reinsurance segments which "did not meet our return criteria or our underwriting and claims review recommendations." Commenting on the results, Kenneth LeStrange, chairman and CEO, said, "We are confident that the catastrophe modelling and risk management enhancements that we implemented following the hurricanes of 2005 position us very well to achieve strong returns for our shareholders."

The side-car flotilla

XL's Cyrus Re is not the only side-car to have been rolled out onto Bermuda's reinsurance forecourt. Arch Re Bermuda announced at the end of last year that it had entered into a quota share reinsurance treaty with Flatiron Re, under which Flatiron assumes a 45% quota share of certain lines of property and marine business underwritten by Arch Re Bermuda for 2006 and 2007. The move forms part of what is clearly an extremely comprehensive risk management strategy, which enabled Arch to record a combined ratio for 2005 of 95.8%, despite catastrophe losses totalling some $330m, with net income of $256m. The impact of the side-car was immediately apparent in the Q1 results, which saw ceded reinsurance premiums hit 15.6%, up from 2.3%.

Heading the pack in the recent side-car rally however is Montpelier Re, which now participates in two such vehicles, Cayman-based Rockridge, set up pre-Katrina to focus on "attractive" high layer, short-tail risks, and Blue Ocean Re, set up recently to offer property catastrophe retrocession cover.

Despite responding quickly to the storm losses, with a successful rapid reaction capital raising of $600m, followed by other capital generating exercises, resulting in the company now underwriting based on some $1.7bn in capital (including Rockridge and Blue Ocean), overall storm losses topping $1bn meant it could not stave off a downgrade. Montpelier Re currently sits with an "A-" AM Best rating on negative outlook, while Fitch took the decision in November to drop the reinsurer's rating to "BBB", citing the fact that the storm hit equated to some 70% of the company's equity (as of 30 June 2005), indicating a much higher risk concentration than Fitch expected.

Montpelier's Q1 results, however, reveal a clear push to reduce volatility, with the company recording a fall in gross written premiums attributable to a reduction in peak zone exposures, the non-renewal of certain contracts and the ending of a three-year contract with Aspen. Furthermore, the quarter saw a marked change in ceded earned premiums in the quarter as a result of additional reinsurance purchasing at the end of 2005.

Forging ahead

Some of Bermuda's reinsurers have resisted Mother Nature's best efforts to destroy 2005 profits, and have either eked out a small return or reported limited losses. Arch has already been mentioned, but it was not alone in reporting a 2005 profit, with ACE achieving a net income of $1,028m with a combined ratio of 99.6%, while AXIS carved out net income of $90m, although saw its combined ratio creep just across the 100% mark, even though both saw storm losses top $1bn. Tokio Millennium Re also managed to limit its losses to $50m for the worst year on record, a fact due mainly to its decision, following intensive research into hurricane activity in the Atlantic basin, to adjust the exceedance probability curves by an average of 50% resulting in a massive reduction in business written for US hurricane exposed contracts during the July 2005 renewal season.

Despite incurring a net loss of $178m, Aspen has also emerged relatively unscathed from 2005, managing to rebuff the many negative outlooks which were levelled at its ratings and beginning 2006 on a fairly stable footing. However, this has not prevented the company undergoing a major risk restructure, as explained recently by CEO Chris O'Kane, who said in April, "We were extremely active in refocusing our property catastrophe exposures, which resulted in a major reduction in critical zone exposures beyond what we had contemplated in our planning."

While for some of Bermuda's reinsurers, the storm losses have warranted a change in tack and a re-jig of their portfolio make-up, PartnerRe believes that despite incurring a 2005 net loss of $51m, its performance has served to strengthen its risk taking resolve. In his letter to shareholders, CEO Patrick Thiele stated that the loss was in line with long-term expectations for the magnitude and frequency of the catastrophic events, and as a result, "Our appetite for risk remains the same, as does our approach to pricing that risk. In fact, rather than create a need for change, the challenges of 2005 validated the effectiveness of our strategy, and we emerge stronger than we have been at any time in our history." However, in May while affirming PartnerRe's "AA-", Standard & Poor's revised its outlook to negative, citing concerns over operating capital adequacy.

Setting a new course

In March, AWAC took its plans to separate from parent company AIG one step further with the announcement that it had filed plans for an IPO with the SEC. Details of the amount of shares or potential price range were not revealed. The decision to severe ties with the US giant elicited a speedy response from AM Best, which downgraded the company to "A" from "A+", citing amongst its reasons concerns about the loss of "the strategic benefits" AIG offered, although the agency is confident the transition will be successful.

The separation process also included plans to terminate an underwriting contract between AWAC and IPCRe, another AIG affiliated Bermuda operation. IPC has experienced a difficult 12-month period, with losses for 2005 $613m, while IPCRe has been downgraded by AM Best and Standard & Poor's, both highlighting its difficult position as a monoline property catastrophe operator. AIG also recently announced the sale of 25% of its share holding in IPC Holdings, although it will not affect their ongoing relationship. The company has entered 2006 on a sturdy capital footing, however, due to strong investor backing during its capital raising exercises. Despite concerns about poor pricing in non-US lines, Q1 results remained strong, with Jim Bryce adding, "We remain watchfully optimistic about conditions in the property reinsurance industry for the remainder of 2006 and 2007".

Taking the helm

"This is certainly not the letter I envisioned as my first as White Mountains' new CEO" wrote Steven Fass in his inaugural message to shareholders. "As a result of the financial impact of hurricanes Katrina, Rita, and Wilma on our insurance operations, and the related decline in the value of our investment in Montpelier Re, our financial results for 2005 were very disappointing." However, despite these storm losses of $228m - primarily borne by White Mountains Re - combined with a $104m drop in the value of its Montpelier Re holdings, the company was still able to record a $68m net income, although sharply down on the $539m in 2004.

White Mountains Re, now headed up by Tom Hutton, has since renewed but revised its quota share reinsurance agreements with Olympus Re, which now sees Folksamerica ceding up to 35% of its short-tailed excess of loss business to Olympus and to Helicon Re, a class 3 Bermuda-based reinsurer set up in December, with the "up to" 35% being divided approximately 56% and 44%, respectively. Olympus Re found itself in the unenviable position of being one of the first reinsurers to be downgraded by AM Best in the aftermath of Katrina, the agency subsequently downgraded the company again in March citing the deterioration in its risk-adjusted capitalisation due to the storm losses. While Olympus recently raised $156m to continue writing business on a limited basis, management decided to request that there rating be removed.

White Mountains Re has also sought to reduce its exposure to catastrophe prone areas, which was reflected in the fact that the company reported only a marginal premium increase in Q1 2006. Hutton commented, "Although our premiums are only up slightly, we have taken significant price increases and reduced exposure in catastrophe-prone areas. As a result, we have a less risky book of business than we did at this time last year."

There are two camps developing in terms of the response to catastrophe reinsurance in 2006, with one steering clear of the inherent volatility in favour of more stable sources of business, while the second is upping its involvement to avail of the current and predicted rate hikes. RenaissanceRe is firmly in the latter camp, announcing in May that it had raised its managed catastrophe reinsurance premium by 23% in the first quarter, in response to improving pricing and conditions, with expectations - although with a recognition of the inherent uncertainty - of growth topping 15% for the year. The company's 2006 operating return on equity target of 25% is partly based on achieving this 15% growth level, which also takes into account a decline of some 35% in specialty reinsurance premiums, due to unfavourable market conditions. However, the first quarter saw specialty premium drop 43%, although CEO Neil Currie remains confident that over the 12 months, this decline will level out at the predicted 35%.

At the time of writing, RenaissanceRe was set to announce its participation in a new side-car called Starbound Re, to which the reinsurer will cede some 80% of premiums from a certain property catastrophe business.

RenaissanceRe perhaps to a greater degree than many of its Bermudian neighbours has been the subject of a turbulent 12 months. As well as recording the first loss in its 13 year history, with a net loss of $274m as a result of storm losses of over $900m, the company was also subjected to two Wells Notices (one issued to Jim Stanard, who subsequently resigned, and the second to the company itself) following its financial restatement at the beginning of the year.

At the time of writing, the market is still waiting to find out whether Max Re will have to restate its results. Max Re has yet to file its Q1 results, having missed the 10 May due date, as it seeks to complete a review of three finite risk retrocessional contracts written in 2001 and 2003. Should the reinsurer be required to restate its results for 2001-2005 it is forecast that the impact on retained earnings would be a reduction of approximately $25m. While it is expected that the results will be filed in June, the company has already received a Nasdaq Staff Determination which threatens the delisting of Max Re from the Nasdaq National Market due to its failure to file its results "on a timely basis".

On the rocks

The rapid decline of PXRe was unexpected, reflected in the fact that following the reinsurer's capital raising exercises which saw it recapitalise to the tune of $474m, the rating agencies were quick to reaffirm its ratings and remove any negative outlooks, with Standard & Poor's analyst Steven Ader stating that the agency "views PXRe's capital adequacy as strong and well appropriate for the rating level." PXRe tumbled out of the ranks of the "A" rated and currently stands without a rating from AM Best, which was withdrawn in April. Accusations have been levelled that attempts were made to conceal the extent of storm losses (which virtually doubled from the original estimate to almost $800m) in order to ensure the smooth running of capital raising moves, and as such the beleaguered company is now the subject of a class action. Despite reporting "encouraging" first quarter results, PXRe is considering a range of strategic alternatives including sales, mergers and acquisitions, but president and CEO Jeff Radke warned that should the board fail to agree on a suitable strategy, then the run-off of its reinsurance operations would be the only viable option.

Quanta has now confirmed that it has bitten the run-off bullet, announcing at the end of May that it was placing most of its remaining specialty insurance and reinsurance lines into orderly run-off. Despite launching a series of volatility-reducing initiatives, including exiting property reinsurance and technical property insurance lines, and purchasing additional reinsurance on aviation and marine portfolios after unacceptable 2005 losses, the company failed to stave off a rating downgrade by AM Best to "B ". Chairman Jim Ritchie, commenting on the run-off decision, said "While Quanta had made progress in its transition to a specialty lines focused carrier, the decision of AM Best to downgrade Quanta below the 'A' level in March interrupted that effort and significantly impacted our ability to write attractive business." Quanta's Lloyd's syndicate will continue to operate.

2006 also saw both Alea and Rosemont succumb to run-off. Alea has succeeded in selling off its US primary renewal rights to AmTrust, with SCOR snapping up its European renewals and Canopius acquiring the London rights, while Rosemont's parent company GoshawK succeeded in selling the reinsurer's infrastructure to a consortium of investors, which has now been resurrected as Ariel amongst the Class of 2005, under the leadership of Don Kramer.

As Bermuda plots a course for what looks set to be yet another active hurricane season, there is confidence that the capital and risk reassessment endeavours which have been undertaken in the last six months have served to lash down the industry's balance sheets in preparation. But even if Bermuda succeeds in positioning itself so as to meet the storms head-on, that does not mean to say that the 2006 season will not see some washed overboard.

- Nigel Allen is editor of Global Reinsurance.

Putting down roots

The impact of the new start-ups has been relatively muted so far, due primarily to the failure of a number of the Kat Pack to be up and running in time for the January renewals. Ten new entrants brought just over $7.5bn of capital into the market, most sporting the "A-" entrance badge, but their late arrival limited their buyer appeal.

Concerns still remain about the perceived longevity of the Class of 2005, with the newly enrolled reinsurers not comparing favourably to other previous classes. With another active hurricane season on the cards, there are clearly question marks over whether the short-term high return mentality of the private equity and hedge fund backers will ride out the storms. Concentration risk is also a worry as the 2005 brigade are much more narrowly focused on catastrophe-exposed lines - although some are striking out into other sectors. Add to this the increased capital requirements for entities operating on such lines, and the fact that RoE forecasts are down by an average of 6%-8% on the Class of 2001, and for most the 2005 group runs a much greater risk of disbanding than any of their predecessors. However, attention should be drawn to the efforts being made by some of the new entrants to put down stronger roots.

For example, Lancashire, despite a slight decline in its gross premium targets for the year to between $675m and $800m, down from the projected $822m, due to a poor performance in the marine market, still remains on target for an ROE of 16%-20%. The company recently announced it had set up a $350m letter of credit facility, which according to Neil McConachie, CFO and COO, "boosts the long-term financial flexibility and strength we have committed to our clients."

Validus Re has also entered an LOC agreement to the tune of $300m, which chairman and CEO Ed Noonan described as, "a further testament to our goal of establishing a long-term franchise in the global reinsurance market." Validus further announced it had entered into a collateralised quota share retrocession agreement side-car with Petrel Re, a newly-formed Bermuda reinsurer, which will assume a 75% quota share of certain lines of marine and offshore energy reinsurance contracts underwritten by Validus Re for the 2006 and 2007 underwriting years.