The credit crunch, unpopular policies and the ever-looming threat of a major catastrophe loss are just some of the challenges facing Bermuda reinsurers. Some say Bermuda is losing its shine and yet the market has enjoyed two years of record profits. Helen Yates takes stock.

There is no escaping the fact that Bermuda reinsurers have had it good for the last two years. Record profits in the absence of major catastrophe losses have more than replenished balance sheets dented after Hurricane Katrina, Rita and Wilma in 2005. There may be challenges ahead – a softening market, the global credit crunch, political uncertainty and 2008 hurricane season – but at least for now, most reinsurers are still wondering what to do with all that excess capital.

Yet flick through the pages of many a magazine or newspaper and you could be forgiven for thinking that Armageddon was nigh. Last year’s election between the Progressive Labour Party (PLP) and United Bermuda Party was bitterly fought. Premier Ewart Brown and the PLP may have won a third term but there has been lasting damage. Allegations of corruption and unpopular new rules governing expats led to off-record whispers of dissatisfaction at the September 2007 reinsurance gathering in Monte Carlo.

When the Financial Times published a story in December 2007 entitled “Paradise lost for short-trousered philanthropists” it summed up the general mood. “Bermuda could soon be dancing to a very different tune,” the article concluded. Reinsurance prices were coming down and some of the capital that had washed into Bermuda in 2005 was leaving. Proposals to make work permits contingent upon training up a Bermudian to take over that role were also proving unpopular, it noted.

In great shape

For all the talk about “paradise lost”, last year’s figures stack up nicely. Bermuda’s insurers had aggregate total assets of $440.4bn in 2007, which represents a 33% increase over the $329.9bn achieved the previous year. The market also continued to write profitable business, according to the Bermuda Monetary Authority. Gross premiums written amounted to a total of $115.8bn for the year, surpassing the $100.7bn written in 2006. The combined ratios came in at 83.6% and 82.9% for 2006 and 2007 respectively. Investment capital continued to flow into Bermuda last year, suggesting some opportunity remained in the post-Katrina market. A total of 71 new insurance entities were set up, including two Class 4 reinsurers.

Bermuda reinsurers have enjoyed the “best of times” in 2006 and 2007, according to AM Best. “The overwhelming conclusion is that the majority of carriers on the island are financially strong, benefitting from record earnings produced by the fundamental quality of underwriting operations” reports the rating agency. “As can be expected, balance sheets with few exceptions are in the best shape in years.” Managing excess capital is now a major challenge. “While people are more sophisticated, companies have got too much capital and they don’t know where to put it,” confirms Don Kramer, CEO of Ariel Re.

Sadly, the good times can’t last, warns Best. “The longer term view is that industry fundamentals will continue to deteriorate, barring any industry-changing event.” As the first quarter results trickle in it is clear that the dual effects of a softening reinsurance market and the credit crunch sting are already denting profits on both sides of the balance sheet (see table). “Who is going to be really disciplined?” as Kramer puts it, is the question on everyone’s lips.

Most reinsurers are keen to demonstrate where they have walked away from unprofitable business. Declines in gross and net premiums in the first quarter suggest most are maintaining price discipline. Based on Q1 most carriers “seem to be acting rationally”, confirms Best. “Insurers in Bermuda seem to sense they’re on thin ice, and none wants to be the one to break it.”

While most reinsurers are anticipating making an underwriting profit in 2008, margins will inevitably be lower than the past two years, predicts Max Capital CEO Marty Becker. “Excluding the impact of KRW on 2005, we have had five profitable years in a row to strengthen balance sheets,” he says. “They are as strong now as in recent memory. With that comes a softening pricing environment.” The easing of prices at the 1 January and 1 April renewals supports his view that there is a mismatch between capacity and demand.

Mid-year renewals

Ahead of the 1 July “Florida book” renewals the expectation is that prices will soften by 15%. “Prices are coming under a certain pressure but aggregate demand for capacity did not show any dampening,” explains Graham Pewter, president and CEO of Catlin. “We have a fairly strong history of putting our foot on the brakes during down periods. We’ll walk away if we’re not getting the proper technical rate.” He adds that there is still margin in most of what Catlin writes.

Last year’s fears that there would be less business in Florida due to the expansion of the Florida Hurricane Catastrophe Fund (FHCF) were largely unfounded. This year, a further $2bn to $3bn of exposure has come back into the market. The FHCF fears its ability to issue bonds post loss due to the credit crunch and has therefore reduced its capacity. In theory at least, there should be more demand for reinsurance this year.

“If the FHCF does not provide as much reinsurance as before, we believe that Florida clients will still have to purchase that protection and will do so from the commercial market,” says David Cash, chief underwriting officer of Endurance. “If that happens there will be more demand for reinsurance than there has been in the past and that extra demand will be met by a market that has more capital than last year. People are crossing their fingers and hoping the two offset each other to produce flat pricing in 2008.”

Fierce competition

The influx of new capacity in the form of start-ups and non-traditional reinsurance vehicles has exacerbated the competitive reinsurance environment. At the same time there has been a trend towards cedants retaining more risk. Efforts to diversify into new markets and longer-tail lines of business have also created competition. The popularity of Lloyd’s seems undiminished. Validus bought Talbot, Ariel bought Atrium and more recently, Argo Group bought Heritage. Montpelier Re and Aspen have ditched the M&A route and simply set up new syndicates at Lloyd’s.

Other reinsurers have opted to enter the US insurance market, buying up excess and surplus lines insurers. Endurance, Max Capital, AXIS, Ironshore and Montpelier Re have all entered the market this way. Others have grown their presence in Europe. Here, Zurich (ACE, Endurance, Flagstone, Aspen, Catlin and Arch Re) and Dublin (XL, Max Capital, Allied World and Partner Re) are proving popular centres for Bermudian re/insurance companies (see our article on Switzerland on page 52 for more).

“Bermuda has gone from being a narrowly focused monoline Bermuda-centric business to being a truly global diversified insurance and reinsurance market ranked second to none in the world,” says Henry Keeling, chief operating officer of XL Capital. “In three years since KRW we’ve seen a continuation of that. The companies established in 01 and 05 have continued that process of globalisation and diversification.”

Becker says it reflects that maturity of the Bermuda market, that it is no longer just a property catastrophe market. “At the moment the rating agencies seem to be encouraging diversification, but that has not always been their stance,” reminds Becker. “At some point it will probably change again.”

For Pewter, having a presence in different markets just makes good business sense. “Once companies like ours get to a certain scale it makes sense to have a physical presence in all trading markets,” he says. While diversification is ultimately a good thing, allowing reinsurers to hedge their risks across different markets and lines of business, there are risks when many competitors seek out similar opportunities, warns AM Best.

Election drama

Shock headlines about unhappy insurance executives considering their exit strategies makes for good reading. But as anyone involved in today’s reinsurance business knows, the real story is likely to be rather more complicated. In an effort to provide balance, Global Reinsurance did arrange to interview premier Brown in April at his office in Hamilton. Unfortunately, the interview was called off at the last minute, apparently upon the advice of his lawyers.

The cancellation was not a huge surprise. Brown has had an often strained relationship with the media. On 29 October 2007, the Bermuda government lost its legal bid at the Privy Court in London – the island’s highest court of appeal – to stop the press reporting on a damaging leaked police dossier on a multi-million dollar state-funded housing scandal. The dossier named top ministers and the premier himself. Brown argued that he had been fully exonerated by the police investigation into the scandal but his efforts to prevent the press from reporting on the dossier caused outrage.

Speaking on the record, most interviewees will tell you the election drama of 2007 is ancient history. “That’s all forgotten now,” says Kramer. “The government has a clear understanding how important the business is to the island’s wealth and wellbeing. Bermuda is still a very strong centre.” People confuse politics with business too easily, is Keeling’s verdict. He believes “Bermuda has got a terrific future”. Validus Re chief underwriter Conan Ward agrees. “A lot of it is just politics – some of the rhetoric wasn’t comfortable but nobody realistically thought the government was prepared to throw the baby out with the bath water.”

Others believe rival jurisdictions are to blame for some of last year’s headlines. “The election was controversial and emotional and it sparked press coverage,” says Pewter. “It gave ammunition to Cayman, Dublin and Switzerland to say that Bermuda was hostile to the international business community.”

Jan Woloniecki, head of litigation at Bermuda law firm Attride-Stirling & Woloniecki, accuses “Bermuda’s enemies” of talking down the market. “Most societies would welcome Bermuda’s problems,” he says. “There’s a huge amount of jealousy in other jurisdictions… Bermuda has to strike a balance between the interests of Bermudians and the interests of the international business community.”

Contrary to stories last year, Bermuda firms are not readying themselves to pack up and move out, insists Becker. “I’ve not heard of anybody leaving – there’s very little to gain from that.” ACE’s decision to redomicile from Cayman to Switzerland was due to tax and operational reasons and will not affect its Bermuda office, the company is keen to stress. Woloniecki points out that every business in Bermuda has contingency plans for all sorts of events – including sea level rise – and says their existence does not suggest something sinister. “They all have disaster plans. If the insurance industry can’t manage its own business risk then what good is it?”

Bermudian David Cash says the reason insurance firms are uneasy is down to the issues surrounding work permits. “Insurance companies will react if the government draws a line in the sand,” he warns. “If people want to turn it into a social experiment, we will leave the laboratory.”

All politicians overstate things, reassures Woloniecki, but Bermuda is not on the way out. “If you read some of the press reports you would think this was Harare – it is all nonsense but perception becomes reality.” Aon Global chairman Dennis Mahoney isn’t worried about Bermuda’s future. “If you assume I’m reasonably intelligent, why am I spending $4.3m buying a home here? I’m not worried. It’s a lot of hyperbole. It is exaggeration on all sides. I choose to live here and I intend to retire here.”

The fact that capital continues to flow into Bermuda should silence some of the critics. Credit crunch aside, Pewter predicts that the appetite of investors will continue in 2008. “There is a lot of money sitting on the sidelines right now,” he says. “CEOs should expect to field calls from investment bankers pitching opportunities as routinely as drinking the morning cup of coffee,” says AM Best, predicting that M&A will continue to be a major theme in 2008.

Should a major catastrophe loss occur in 2008, capital will flow into the market just as it did post Katrina, predicts Pewter. Where it will go is up for debate. “Investors have so many ways to participate in the market now – cat bonds, ILWs, sidecars – it’s not a given that we’ll see new companies.” New capital will be much more geared to capital market type structures, believes Keeling.

What is not up for debate is whether the Bermuda market can cope with a major loss in 2008. Yes they can, is the resounding verdict. “It takes a $10bn to $15bn loss to make Bermuda reinsurers break sweat,” says Pewter. “If there’s a $50bn event you won’t see companies get blown out of the water. Most companies are doing a good job.”

So has Bermuda lost its shine? All things considered – record results, reinsurers flush with capital, an innovative regulator and hungry investors in the wings – and the question seems absurd. The market is in great shape to take on the challenges of a softening market and whatever the 2008 hurricane season throws at it. Surely it is also resilient enough to weather a bit of bad press?

Helen Yates is editor of Global Reinsurance.