As the founding investors increasingly bow out, has Bermuda's reinsurance market lost its position atop the fund manager's wish list? asks Lindsey Rogerson

At first glance the Bermuda-based reinsurers have been ticking every box on a fund manager's "wish list" of late. They have been shoring up balance sheets, being increasingly selective when writing new business, participating in sensible borrowing and most importantly returning cash to shareholders, either by way of share buy-backs or special dividends.

However, this is tempered by the fact that most of the original backers of the post-9/11 reinsurers have now bowed out of their holdings, a possible signal that they think returns may dip going forward - a point noted by Chris Klein of Benfield Group in his recent quarterly outlook for the market.

He explained, "Slower growth and enlarged balance sheets accelerated the return of capital to shareholders. Replacement of equity with cheaper debt was also a feature as management sought to maintain returns through increased gearing. Montpelier Re's special divined and a large share buyback by AXIS effectively returned 22% and 11% of their respective capital to shareholders. Meanwhile, the exodus of original post-9/11 investors continued during 2004 suggesting they have called the peak of the current cycle."

Montpelier though views the exit of investors - Cypress Associates II (Cayman) LP and DLJMB Overseas Partners sold more than 3.7 million shares at $41.80 a share to Goldman Sachs in March - as part and parcel of its business plan.

Tony Taylor, chief executive, said, "These actions demonstrate that we are delivering on the promise we made at the time of our IPO, namely that we would manage capital prudently relative to our risk exposure with a view to maximising sustainable long-term growth in shareholder value. We prefer sticking to the tenets of our business plan and sharing its rewards with our shareholders."

Arch Capital acknowledged that premium growth has all but stopped for the time being. Paul Ingrey, chairman, explained, "Following three years of generally rising premium rates, prices for many property and casualty lines reached a high in the second quarter of 2004 and then began to decline. Our premium growth rate slowed significantly in the second half of the year as we maintained underwriting discipline in a changing market. Substantially all of our premium growth in 2004 came from our insurance operations."

But Nick Martin of Hiscox Investment Management which holds Arch in its Hiscox Insurance Portfolio fund has confidence in the reinsurer's new chairman Ingrey who took over on 1 April 2005.

Martin said, "88% of first half 2002 premium was from reinsurance headed by Paul Ingrey, founder and former chairman and chief executive of F&G Re. He had superb underwriting results at F&G Re where his results were some 25 percentage points better than the industry."

He is equally upbeat about the prospects for life and health reinsurer Scottish Re, which he believes will soon see its return on equity grow beyond its present 9% - the market average is currently 13.3% - after having spent the last few years putting in place its underwriting and marketing infrastructure.

Bermuda reinsurers have been comparatively unscathed by the exceptional storms, hurricanes and typhoon of 2004. Most crucially none have reported an exposure out of line with their peers so ratings have been left untouched by the likes of Standard & Poor's, AM Best and Moody's. This is good news for companies as far as ratings determine the level and cost of borrowing open to them and consequently impact on a reinsurer's ability to gear up.

The sector remains alluring to the hedge fund industry. Chicago-based hedge fund manager, Citadel Investment Group, which accounts for almost 1% on all trading activity on the New York Stock Exchange and has $10bn under management, set up CIG Re to offer collateralised catastrophe reinsurance products.

One possible problem on the horizon is the uncertainty caused by investigation by the New York State Attorneys office. RenaissanceRe which was issued with subpoenas with regard to an investigation into its part ownership of Channel Re at the beginning of April 2005, has said it will co-operate fully with the authorities.

But coming so soon in the wake of the restatement of its accounts for the past three years, and a subpoena from the US Securities and Exchange Commission, coupled with the temporary reduced workload of president William Riker due to ill health, and a level of uncertainty that may not sit well with investors emerges. Many analysts are reserving judgement until after the company's first quarter conference call on 3 May 2005, although the company has already been placed on credit watch by both Standard & Poor's and AM Best.

However Arch, which bought in law firm Cahill Gordon & Reindel LLP to carry out an investigation in the wake of the New York Attorney General's investigation into non-traditional insurance products believes that ultimately the whole affair could prove positive for those reinsurers able to prove their business ethics.

Ingrey said: "It is unfortunate that the misconduct of a few in the industry has caused so much negative publicity and so much damage for so many. We believe the strong ethical standards and accountability we have established at Arch continue to serve the Company and our clients well. Moreover, we believe that the additional transparency resulting from the investigations will promote a more level competitive playing field, which will benefit Arch and other companies that have maintained high ethical standards."

But will investors agree with him?

- Lindsey Rogerson is a financial journalist.

Figure 1 Bermuda quarterly gross premium growth rate

Total gross premium written increased by 15% to $54bn in 2004, half the rate of increase in 2003. Further evidence of declining premium growth was revealed by analysis of the average quarterly year-on-year premium growth rate, which decreased from 41% in 1Q 2003 to 1% in 4Q 2004. The most substantial reductions in growth rates were among the new reinsurers established in 2001, which started with a growth rate of 151% compared to 27% for the pre-9/11companies. They experienced an average reduction in year-on-year quarterly growth rate from 151% to 18%, although this bounced back from a trough of -1% in 2Q 2004 due to spurts of growth from Montpelier and Endurance in 3Q 2004 and AXIS and Arch in 4Q 2004. The pre-9/11 companies decreased from 27% to -4% having peaked at 29% in 2Q 2004.

Figure 3 Reinsurance recoverable gearing

Aggregate reinsurance recoverable asset (RRA) gearing shows a steady decrease from a 2002 peak. RR as a percentage of gross non-life technical reserves (GTR) decreased from 34% to 22% between 31 December 2002 and 30 December 2004. Against shareholders' funds (SHF), the ratio of the RRA decreased from 82% to 50% over the same period.