How will the injection of new capital into Bermuda affect the island's original jet set? Asks Lindsey Rogerson.

Bermuda is now acknowledged as the third most important reinsurance market on the planet, behind Lloyd's and the US. But what the influx of new money into the island's reinsurance market will do to the existing players is as yet anyone's guess.

Citigroup has pre-2001 reinsurers Max Re and Everest at buy and hold respectively, believing both have good prospects for producing return on equity, at least, if not superior to their fellow Bermuda reinsurers. Analyst Joshua Shanker praised Max Re for having written a profitable casualty book in the last few years and said that despite the company's management having expressed disappointment at the level of property rates at January renewals, the reinsurer was well positioned to capitalise on any post Katrina hardening.

Shanker said, “With the infusion of capital from the Q4 2005 equity raise and the increased foray into property lines, Max Re expects that its aggregate exposure to Southeastern United States hurricane risk will double…While premiums written may not appear very different in terms of volume, mix of business is presently on course to change.

In addition to increasing its exposure in property categories Max Re is responding to what it calls a ‘soft market' for casualty business.” However, it is important to note that these comments were made before Max Re announced its internal review of three finite risk retrocessional contracts written in 2001 and 2003, and this outlook is therefore likely to change.

Indeed, not enough exposure to hurricane-affected lines of business is being viewed as a bad thing – relatively speaking – in some quarters. In an analyst's note last month, Credit Suisse said that while it considered Arch Capital had “capable management and favourable prospects” because it had less exposure (25% of it book) to hurricane-affected property lines than its peer class of 2001 reinsurers, it would not be able to benefit as much from any rate increases.

The analysts also expressed concern that with 75% of Arch's book in casualty risks it could be adversely affected by any further market softening. The note said, “Casualty rates are currently flat to down 5% and could further soften in 2006 in our opinion, due to competitors' (both incumbent and the Class of 2005 reinsurers) need for diversification away from volatile property lines.”

Non-investment professionals could be forgiven for thinking the above view is harsh for a company that has admittedly outperformed its peers in what was the worse year for catastrophe losses in US history. However, of more concern and immediate relevance to fund managers is possibly the lack of any dividend – or prospect of one – in the near future.

Downgrade doom
Concerns over dividends were also cited by analysts over at Citigroup when issuing a sell note on Renaissance Re. Joshua Shanker raised concerns about the reinsurers ability to capitalise on any hurricane triggered rate rises. “RenRe has less capital than it did one year ago, and it has not raised additional capital and perhaps may be impeded from doing so while Wells Notices and shareholder suits remain in place,” he continued. “We believe that RenRe is overweight in the markets where the greatest price increases will be seen. While the company stands to benefit from these rate increases, we do not believe that the rating agencies will allow it to expand in these markets.”

The issue of ratings, or more precisely falling off the ratings precipice, in the wake of Katrina, Wilma and Rita was noted by broker Benfield in its quarterly review of the Bermuda market. Alea, PXRE and Quanta have all found themselves on the wrong side of ratings changes in the first three months of 2006 (see table 1). Alea has gone into run-off while the latter pair are currently exploring strategic alternatives after finding themselves unable to raise capital after having their ratings cut below “A-”.

Rating agency AM Best also expressed concern that the influx of capital post Katrina could trigger an even faster softening in the casualty market if early indications that rate rises in the hurricane-affected lines will be limited prove founded.

Explaining its negative stance on the whole of the Bermuda reinsurance market AM Best said, “The markets have already demonstrated that while property rate increases attained for January 2006 renewals were favourable, they were nonetheless narrowly focused and limited to those covers affected by recent losses. Casualty business has seen little if any benefit from the hurricane losses in 2005. Should companies seek to diversify the new capital into casualty, it could trigger additional softening for the casualty segment as well.”

However, Nick Martin an analyst on the Hiscox Insurance Portfolio fund believes the rating agency is being too harsh and that it is unfair to tarnish all reinsurers operating from Bermuda with the same brush, as there are clearly different tiers of quality. “We have always shied away from the newer [2001] companies and that has proved the right thing to do because you have had the likes of Montpelier and Aspen getting really battered by the hurricanes,” he explained. “Yes they have managed to get some new money but our view was there were some material underwriting flaws in these companies and they may have tightened them up somewhat but it is difficult to know, and from where we sit we do not think it is worth the risk.”

He believes that Montpelier et al will pick up business in the June and July renewal season but that the best business will go to companies with superior balance sheets and track records, including Hiscox holding Partner Re. However, with regard to the 2005 start-ups Martin feels they may fair better having learnt from the shortcomings of the immediate 2001 predecessors.

For the time being at least it will be difficult for investors to get direct exposure to the majority of the 2005 ventures, funded as they are by an array of hedge funds and private equity houses. However, given the often short-term horizons of such sources of capital coupled with the historic precedent of previous Bermuda reinsurance start-ups, both Montpelier and Platinum (Class of 2001) floated on the stock market less than a year after they opened to business. Of the Class of 2005 Martin singles out Harbor Point as the only venture Hiscox would consider taking a stake in if it could.