The absence of major catastrophe losses has meant another fantastic year for most Bermuda players. Investors should remain bullish despite softening reinsurance rates, argues Lindsey Rogerson.

Bermuda produced some clear winners and losers in 2007. XL Capital was downgraded on the back of its exposure to the US subprime mess, while Axis and Ace faired far better. All told, as a group, Bermuda’s reinsurers had their best year ever in 2007, clocking up a combined net income of $9.2bn.

With all except the minority of Bermuda players reporting the reinsurance proportion of their businesses as flat or declining, with weakening terms and conditions on many renewed P&C contracts, 2008 is likely to be more challenging. Weather forecasters are predicting a tougher hurricane season this year, which is particularly worrying after 2007’s near misses.

Downward spiral
Taking the issue of declining reinsurance proportions first. The players themselves seem remarkably relaxed about the dwindling numbers: Ace, the largest of the Bermudian group (see pie chart) saw reinsurance shrink by 26% and Endurance by 20%. Indeed only Axis managed to grow its reinsurance business – by 8% - according to broker Benfield. Neil Currie chief executive at RenaissanceRe summed up market sentiment with his “seen it all before” line. “We are often the first market to shrink, as we did in the late 90s and conversely we are often distinguished by how much we grow in hard market, such as 2002, and more recently in 2006.”

Viewed in this light the double-digit drop off in reinsurance business suggests that the Bermudian groups are simply pruning back to a position of greater strength. Commenting at forth quarter results briefing, Evan Greenberg, chairman and chief executive officer of Ace Limited, was certainly confident of prospects for 2008. He said: “Looking ahead, we are well positioned to manage through an increasingly difficult environment marked by continuing volatility in the financial markets, deteriorating economic fundamentals and a softening property and casualty market.”

“Bermuda's reinsurers had their best year ever in 2007, clocking up a combined net income of $9.2bn

Against the odds
His optimism is supported by analysts at Citi Investment Research, who have put Ace at “buy”. Joshua Shanker and Yaron Kinar point out that the announced losses in fourth quarter results because of Ace’s investment in Assured Guaranty and life reinsurance business – of $178m combined – amount to “cat losses in a benign-to slightly-above-average year”. Greenberg commented: “All areas of the company performed well, and the financial markets crisis had a relatively modest impact on our results.”

Shanker and Kinar also believe that recent acquisitions for Ace (CICA and the Atlantic Companies) announced in December 2007, will not be the last. They said: “We believe that ace will continue to explore additional M&A opportunities. The combined price of both [December] deals amounts to less than $2.5bn, by our calculations, and we believe that both deals have immediate accretive value, indicating that additional capital will not be tied up… We note that management has shied away from share repurchases, preferring to maintain the option of deploying capital through organic or M&A growth opportunities.”

Citi calculates that Ace’s share price return for 2007 will be 23.1%. Such growth will have offset any investor frustration at the lack of a buy-back programme, but with rates continuing to soften, broker Benfield believes pressure will mounting for buy-backs.

In its most recent review of the Island's reinsurers it points out that already 50% of the group have announced or already carried out share buy-back programmes. Montpelier Re, which bought back 11% of its stock last year, promised more of the same in 2008 at a conference call last month. While RenaiaanceRe opted for another investor favourite – when it announced that it would be increasing its dividend for the thirteenth year in a row, at its results briefing last month.

“The Bermudian groups are simply pruning back to a position of greater strength

Nick Martin, co-manager of the £37.7m Hiscox Insurance Portfollio Fund, which has 19.72% of its fund in Bermuda, believes that reinsurers will be able to follow through on these pledges. “I think it definitely will [continue]. The key metric for insurers is the growth in book value per share. A quality company would pursue things like share buybacks in order to enhance their return on equity and growth in book value per share and particularly with the [stock] markets struggling in the second half of last year.

“A lot of companies have got a lot more aggressive on their share buybacks and we would always welcome that as good way to deploy capital. And I think with the industry valuations were they are I think it is around about 1.2 1.3 time book it is very attractive for companies to buy back their shares rather than try to grow their business into a softening market.”

Uncertainty for XL
Investors looking for certainty about the prospects for XL Capital will not find from the rating agencies. Fitch and Best downgraded XL in January, but S&P said it believed the groups underlying performance (not counting its $550m charge for its investment in Security Capital Assurance and exposure to subprime litigation on some of its D&O policies) was strong.

XL has allowed for 29 potential claims on its insurance book and a further 22 clients on its reinsurance book but if it ends up not having to pay out on these claims then its bottom line will look a lot rosier. Although only time will tell which of the rating agencies has called it right.

“Investors looking for certainty about the prospects for XL Capital will not find from the rating agencies

One factor, which could have serious implication if US catastrophe losses do go up this year, would be if conditions were eroding on policies. Unquestionably Bermudian groups have benefited from below average cat losses, especially in US in 2007 (see chart 2) but if luck turns this year and storms hit, how will their fortunes fair?

Several of the Bermudian group reported a worsening of terms and conditions at the 1 January renewals. However, Nick Martin believes they have been holding up well on reinsurance books, although he agrees it is a crucial factor for investors to keep watch over. “If terms and conditions weaken and your price stays the same, you are giving away for business for nothing. Basically, in the event of a loss, your loss would be higher. [Investors] have to keep a very careful eye on underwriting terms and conditions, which can be very hard if you are one step removed, as what you don’t know – unless you monitor it carefully – is if they are giving away a lot more cover for that same premium. If they are, then their expected loss ratio would be a lot higher and in the event of a loss the chickens would certainly come home to roost.”

Lindsey Rogerson is a freelance journalist.