Roger Crombie reviews 2002 on Bermuda.

Although 2002 has been a period of intense activity for Bermuda's insurance and reinsurance sector, it cannot be said to have been the landmark year that was expected towards the end of 2001. A rising tide has not raised all the island's insurance vessels.

It is hard, now, to recall the conditions in which the Bermuda market found itself on 1 January 2002. For some time, the property and casualty (p/c) sector had been in a curious form of stasis. Continuing over-capacity meant that coverage was widely available and therefore relatively inexpensive, despite the end of the 13-year soft market. The life and annuity sector meanwhile - a less important element of the Bermuda market - was approaching the doldrums, with stock markets, interest rates and client interest (outside Europe) all down.

The events of one appalling morning in New York City appeared to have changed everything in Bermuda's favour. Many major insurers, notably in Europe and to a lesser extent in the US, had closed their doors for the second half of September. Some of the larger companies have yet to reopen those doors as wide as they were before September 11. Money - big money - had poured into Bermuda. The talk was of rates hardened by 30%, 50%, or more - as much as 400% more in certain lines.

A lack of federal terrorism backup insurance prompted some of the Bermuda players to offer limited covers at greatly elevated prices. In the last days of 2001, Bermuda's underwriters, old and new, had been busily trying to match their new capital to demand. Working flat out, they saw 1 January come and go with considerable unused capacity. January was busier than December as the renewal season ran into the New Year. Clients were stalking the streets of Hamilton. Everything looked set fair for a bumper year in the Bermuda market.

Perhaps expectations were too great, because an executive summary of the Bermuda market in 2002 would mention that is was, indeed, a banner year for top line growth, but generally the bottom line proved harder to manage.

Property casualties

At the end of an annus horribilis for the company, Mutual Risk Management's shares trade at pennies and what is left of the company has been restructured under a former subsidiary. Its founders and former managers have taken to the sidelines.

Commercial Risk Reinsurance, the SCOR subsidiary, reported $100m unexpected losses and is a candidate for serious restructuring.

Trenwick, to judge by a dismal wave of depressing press releases, spent much of the second half of 2002 staring into the abyss and had not emerged whole by press time.

Max Re - and the company's swift action probably pushes this into the good news column - has faced the fact that its original alternative investment strategy will need more time to come to fruition than was initially thought and changed gears, adding traditional p/c reinsurance to the mix.

A victim of the Zurich Financial Services debacle, Centre's Bermuda operations have been cut back to the core. If the traditionally wildly wrong rumour mill were to be believed, Centre will be closing its Bermuda doors before much longer.

In a sector in which Bermuda has not traditionally been a lead player, Annuity & Life Re, the island's flagship foray outside the p/c business, has had a catastrophically bad year and is struggling to stay afloat. CEO Larry Doyle is gone and the company's future, management optimism to the contrary, looks bleak.

Companies fail for a variety of reasons, chief among them poor management. Without specific reference to any of the corporate examples cited above, companies that fail often feature an overly dominant chairman and CEO, in a situation where those roles are not separated. Weak financial controls and a CFO who does not curry favour or earn the respect of the board may be a factor. Perhaps the board lacks balance or does not understand its business. In insurance, of course, the quality of the underwriting is critical.

All year long, the brouhaha over corporate inversions (the practice of US companies relocating their headquarters to Bermuda to mitigate their US tax bills) has tarnished Bermuda's reputation internationally, even though the villain is the US tax code rather than Bermuda's indirect taxation system. Bermuda has made no attempt to attract such companies. Given the heat the issue generated, it is worthwhile remembering that only 26 companies have taken the inversion route in the past ten years, most of them outside the insurance sector.

Finally, as if everyone in the offshore community were not entirely brassed off with the intrusive, ill-informed and mostly counter-productive efforts of the Organisation for Economic Co-operation and Development (OECD), the Paris-based organisation has somehow concluded, with little apparent justification, that insurance and reinsurance are nothing but fronts for money-laundering. The unfolding investigations of the OECD will doubtless distract re/insurers from their main purpose as the bureaucrats slowly come to the inevitable conclusion that they have been operating on a faulty premise.

The number of incorporations in Bermuda fell in 2002 compared to a year earlier. The overall number of companies on the register also fell. Whether 2002 has been a breathing space or the start of a more worrisome trend remains to be seen.

If the year has taught us anything, it is that insurance, even when combined with Bermuda's natural advantages and the hardest of markets, is not an automatic banker.

On the other hand ...

That said, there is good news too.

To accentuate the positive: the companies formed a year ago are all still standing, some of them growing at the speed of sound in an industry where progress is traditionally measured in inches, rather than yards. The word from the new kids on the block is that they are committing their capital a little more slowly than they might have wished, but only a little. Some are much further ahead than they had planned to be at this stage.

Several of the Bermuda companies in existence before September 11, have made truly worthwhile strides. IPC Re, the only one of the eight p/c reinsurers formed in the wake of hurricane Andrew that still writes little else ten years later, doubled its capital just before 2002 got under way, and is having a banner year. PXRE's model is beginning to pay handsome dividends, metaphorically as well as in cash. Max Re, as noted above, has executed a 90-degree turn and is in the process of becoming a major player across the sectors.

Renaissance Re continues its intelligent march up the charts and graphs; it is tough to think of a single decision the company has made in its ten-year history that requires second-guessing. Its side business as an underwriter for hire, in joint ventures with others, has enabled the company to bring real meaning to the word `partnering'.

Speaking of that word, PartnerRe, another of the `Class of `93', has become a multi-line re/insurer. The company estimates its losses from this summer's European floods at $120m, but CEO Patrick Thiele is confident that PartnerRe, which has a strong European presence, is well positioned to take advantage of the turmoil in Europe. Total assets exceeded $8bn at 30 September 2002; the company will celebrate its tenth anniversary in hale and hearty condition.

ACE and XL Capital have become truly global players. ACE produced positive cash flow of $1bn in its third quarter and now has assets in excess of $40bn. It has broadened its interests in China this year, laying the seeds for the future. XL's third-quarter combined ratio was 91%, its gross premiums exceeded $7bn for the nine months and its assets at 30 September 2002 were $34bn.

Then, too, Bermuda has effectively been recognised as the most vibrant jurisdiction in a global industry relentlessly battered by events outside its control. The Bermuda-bound decision in mid-year by Wellington Underwriting and the move in mid-November 2002 by Catlin Westgen Group to raise $482m in new equity capital from a consortium of private equity investors, as well as a $50m loan facility, suggest that the Bermuda market is by no means played out.

Even though Bermuda's unassailable lead in the captive market is clipped a little each year, the island's share remains above 30%. Growth in interest in captives has soared since September 11. Despite strong competition from Cayman and the 19 US states that now offer some sort of captive haven, Bermuda has not given up the fight. Late in November, it was revealed that it is on the brink of signing a treaty with Mexico that would open up that country's captive market to Bermudian influence. Pemex, the largest Mexican oil producer, already has a significant Bermuda captive operation; others are considered likely to follow.

The Bermudians have raced in to fill the capacity gap left by European reinsurers, which are preoccupied with reserving for old liabilities. Gross premium income in Bermuda is way up in 2002, retentions are increasing and, generally, hitherto-unrecorded volumes are being achieved. Bottom lines have not grown as dramatically, but much of that relates to legacy underwriting, which is beginning to be replaced by the effects of smarter thinking and harder markets in the past 18 months.

The restaurants, schools and roads are full, and increasing numbers of private planes line the runway at Bermuda International Airport. If overall economic activity were any measure, Bermuda must be doing well.

Opportunity knocks

As in so many places, 2002 began in Bermuda with a lingering sense of loss, anger and incomprehension. Two Bermudian lives were lost in the World Trade Center attacks. In a community as tiny as Bermuda's re/insurance sector, the effect was intensely personal.

Events conspired to distract the island, however. The influx of more than $15bn in new capital, and the establishment by the end of 2002 of eight - now 12 - major new companies revitalised Bermuda's re/insurance sector. An immediate debate was sparked as to whether the owners of the new capital were in it for the long run, or merely carpetbaggers, with Warren Buffet leading the group that assumed the capital that had arrived so quickly would depart just as fast.

So far, so good. With the exception of a $200m initial public offering by Montpelier Re, all the Bermuda investors are still on board. The new companies have, in the main, powered ahead and taken full advantage of their clean balance sheets, extraordinarily lean management structures and ability to cherry-pick the best deals on offer.

Endurance Specialty, under the impressively calm Kenneth LeStrange, has expanded from just him to more than 100 people in 12 months. The company quickly moved from its original premises and is now expanding into yet other offices around Hamilton. The company's 2002 acquisition of much of the business and most of the staff of LaSalle Re looks like a smart move, and has acted as the spur for Endurance's continuing forward motion.

AXIS Specialty has equally refused to let the grass grow under its feet. Its late 2002 acquisition of surplus lines insurer Connecticut Specialty Insurance, since renamed AXIS Specialty Insurance, offers entry to the US market without the nine-month delay traditionally occasioned by far-flung regulatory authorities. AXIS Specialty Insurance will specialise in large commercial property business, with an initial emphasis on high excess and buffer layer excess programmes. Primary placements will also be entertained.

Urbane AXIS CEO John Charman is not a man from whom one might expect understatement, but when AXIS was set up, he forecast that the company might have two dozen employees within a few years. The complement now exceeds 80, and few would bet against AXIS expanding further still in the medium term.

Allied World Assurance, another heavily-capitalised September 11 entrant, has also grown dramatically. CEO Michael Morrison, who came out of retirement to head up AWAC, has demonstrated a predatory attitude for opportunity. AWAC is also approaching 100 employees and Mr Morrison has filled a number of key positions with Bermudians. Writing primary covers as well as reinsurance, AWAC has also exceeded its initial forecasts and returned impressive results for the first nine months.

Arch Insurance, a subsidiary of Bermuda start-up Arch Capital, has also performed well in its first nine months. It recently signed a ten-year lease for 45,123 square feet on the top floor of One Liberty Plaza in lower Manhattan, earning plaudits from that city's Mayor and other bigwigs.

Far from cashing out, Arch's shareholders increased their involvement in October. Principal shareholders, private equity investment funds affiliated with Warburg Pincus and Hellman & Friedman, and other investors, exercised for cash the Class A warrants that they purchased as part of the capital infusion in November 2001. Chairman Robert Clements exercised 120,000 of his class A warrants for cash. Payment for these warrants increased shareholders' equity by some $74m.

Amidst all this gigantism, Olympus Re is following a different path. Led by Bermudian Sheila Nicoll, the company has signed treaty reinsurance quotas and decided to outsource all its functions other than operational management. The result is the leanest cost structure imaginable and a double degree of quality control that ought to augur well for underwriting quality and earnings. Capitalised at $500m, Olympus Re is giving the lie to the widely accepted notion that the price of admission to the reinsurance market starts at $1bn.

All these companies can be said to have delivered on the promise with which they started 2002. None has fully committed its capital yet, eschewing growth for its own sake, turning down deals that fail to meet scrupulous underwriting standards. The `fourth wave', as this group has become known (the 1960s captives, the mid-1980s formation of ACE and XL Capital and the `Class of `93' being the first three waves) has broadened Bermuda's market and done away forever with the `insurer of last resort' appellation that once dogged a much smaller Bermuda market.

Legislative change

It is not only the re/insurance community that has changed through 2002, however. The Insurance Amendment Act 2002 came into force on 14 October 2002. The main thrust of the changes it contained related to the expansion of the powers of the Bermuda Monetary Authority (BMA) to obtain information from insurers, insurance managers and intermediaries registered under the Act.

The BMA can now obtain information from an insurer and others, either by requiring that it be provided or by demanding published or unpublished copies of reports containing the information. The BMA may also commission a report by a third-party professional on any aspect of the finances of any registered body. Any breach of law that the investigator may discover in the course of producing the report will not be protected by professional privilege. The BMA's powers extend to the parent or any subsidiary of a registered body.

The Act obliges the BMA to produce a statement of principles by which it will act in exercising its power to obtain information and documents. The statement is expected to have general application, but a strong focus on the largest (Class 3 and 4) and long-term insurers. It is also expected that the BMA will unveil a system of `prudential visits' every few years, spot checks by its ever-growing staff, who now number in excess of 60.

A better year ahead?

Talk of deflation and recovery are in the air in roughly equal measure, but crystal ball-gazing is an inherently unscientific pursuit. The consensus is that the hard market is here to stay for at least another year, with many expecting (and hoping) that tight conditions will last into 2004. The difficulties of the European sector do not look to be over.

War with Iraq would worsen global tensions. The introduction of federal terrorism backup coverage does not appear to extend to the Bermuda companies, although they have not sought such protection. Bermuda is little affected by the asbestosis and surety crises that have hogged the headlines this year, although directors' and officers' is something of a Bermuda specialty.

Perhaps the best that the old and new hands in the Bermuda market could hope for is more of the same next year, and the chance to continue to grow their businesses while focusing on internal management and underwriting controls and their effect on the bottom line.

By Roger Crombie

Roger Crombie is a journalist and chartered accountant who lives in Bermuda. He has written extensively for Global Reinsurance since 1994.