With close to a billion dollars in losses, Montpelier Re moved quickly to restock capital, but were they quick enough? asks Ronald Gift Mullins

Being slammed in one quarter with catastrophe losses close to a billion dollars representing about two-thirds of surplus would send most reinsurers staggering into run off, or begging for a friendly partner or merger. But not Montpelier Re. Instead, the Bermuda-based reinsurer set about astutely replenishing its capital, adjusting its underwriting criteria and reviewing its reinsurance practices to certify it as a prudent reinsurer, and re-enforce its viable standing with clients and investors.

Montpelier Re, formed in November 2001 with capital of approximately $1bn supplied by White Mountains Insurance Group, Benfield Group and other investors, had for about three and a half years operated very profitably in a favourable insurance pricing environment, mainly in the short-tail property market. It intentionally bought little reinsurance. But when the devastating US hurricanes of 2005 struck, especially Katrina, the company found itself with close to a billion dollars in gross losses at the end of the third quarter 2005, compared with losses of about $80m for previous quarters last year. Its combined ratio for this catastrophic quarter leaped to an astronomical 422.6%; while for complete year 2005 it was 200.7%, compared with 77.8% for 2004.

Anthony Taylor, chairman, president and CEO of Montpelier Re, explained that the reinsurer had always been a gross lines underwriter, purchasing only a limited amount of reinsurance. "The reinsurance we did purchase," he said, "was structured to work most effectively for storms of a lesser magnitude than those of 2005. This approach worked very effectively for Wilma and all of the 2004 storms, but not for Katrina. While our gross loss or market share for Katrina was not out of line with our peer group, our net loss was on the higher side due to the lower amount of reinsurance protection as per our plan." He added that the company had communicated quite clearly to Montpelier Re investors that the company's strategy had the potential for large losses following such extremely unusual events.

Robust plans instituted

Faced with a staggering shortfall of surplus, Montpelier Re management moved quickly to replenish lost capital and establish reserves for hurricane claims. In September 2005, the company sold close to 25.5m shares of its common stock, which netted it almost $600m. At the beginning of 2006, the company issued $100m of trust preferred securities. At year-end 2005, the share dividend was slashed from $.34 to $.075, saving additional funds for capital reloading. As a result of these measures, William Pollett, treasurer and senior vice president at Montpelier Re, said, "the total capital currently stands at $1.4bn, which is 40% more than what was supplied at the initial incorporation of the reinsurer." It is, however, about $600m less than the $2bn at year-end 2004.

In January 2006, Montpelier Re Holdings Ltd, the parent of Montpelier Re, with other investors formed a new Bermuda reinsurer, Blue Ocean Reinsurance Ltd, to offer retrocessional protection in the property catastrophe market.

Blue Ocean has been capitalised with commitments for $300m, including a $133m investment by Montpelier Re Holdings Inc. In December 2005, Montpelier entered into two transactions providing $90m in catastrophe protection over a three-year period with Champlain Ltd, a Cayman Island company.

Taylor believes Montpelier Re's current capital is adequate to support the business "we intend to write at this time. We would certainly consider raising additional capital, either for the company or in a joint venture as appropriate, should additional market opportunities arise. We have been very adept at exploiting opportunities to leverage our skill sets utilising third-party capital, as demonstrated by Blue Ocean and Rockridge." Montpelier with other investors participated in the founding of Rockridge Reinsurance Ltd in the Cayman Islands in mid-2005. "These ventures provide attractive returns to investors," he said, "in addition to providing us with fee income." With Blue Ocean and Rockridge, the total capital Montpelier Re has to underwrite against is closer to $1.7bn.

Remembering the pay out to shareholders of a special dividend of $390m on 31 March 2005, Taylor said that with hindsight, it "would have been nice had that capital remained with the company as it would have decreased the amount we later needed to raise." But given the circumstances at the time, he believes the return of excess capital to shareholders was the right decision.

Rating agencies weigh-in

While Montpelier Re went about restocking its capital, Donald Thorpe of Fitch Ratings in a November 2005 report wrote that infrequent large losses are expected from insurers focusing on property catastrophe reinsurance.

However, the magnitude of these losses indicate that Montpelier Re had a high concentration of risk that was far beyond Fitch's expectations.

"Fitch considers such a concentration to be inconsistent with the profile of an insurer in the "A-" range," Thorpe wrote. The rating agency downgraded the financial strength of the reinsurer to "BBB" from "A-" and kept its rating watch negative. In February 2006, Thorpe said that Fitch intends to address "the status of ratings and rating watch after reviewing Montpelier Re's fourth quarter and full year 2005 financial results."

"We had not established a formal relationship with Fitch," Montpelier Re's Pollett explained, "and as such it did not have access to all of the information that we had shared with other rating agencies. Obviously, Fitch is entitled to draw its own conclusions from the information that was publicly available at the time it voiced concerns. However, we believe Fitch's conclusions might have been different had they had a better understanding of the company."

Standard & Poor's in a report in November 2005 brushed aside Montpelier Re's close to one billion-dollar loss from hurricanes, and said its ratings on the reinsurer would remain "A-" /Negative. "Montpelier's capital adequacy, though materially affected by losses from these catastrophic hurricanes," Steven Ader of Standard & Poor's noted, "remains marginally appropriate for the rating." Standard & Poor's believed the company would continue to take material steps to reduce the inherent volatility of its book of business.

AM Best in December 2005 affirmed Montpelier Re's financial strength rating of "A-" but removed the ratings from under review with negative implications to a negative outlook. Best observed that Montpelier is currently implementing a prudent underwriting strategy to better manage the potential accumulation of losses from a single large catastrophic event and will forego making any rating upgrade until these new strategies and risk mitigation procedures have been fully tested.

Taylor believes the rating agencies need some time to observe how the changes "we have made to our business model have reduced the inherent volatility while providing adequate returns."

Models only a tool

For the insurance and reinsurance industry, Katrina accentuated the significant amount of modeling risk and non-modelled risk inherent in catastrophe-exposed property/casualty products. As a result, the commercial modelling vendors have been pushed to revisit frequency, severity and other critical assumptions affecting modelled output, all leading to major re-versioning that will be soon hard-wired into their models.

"We have learned lessons from the storms," Taylor said, "and as a result have made changes to the frequency and severity assumptions of our own proprietary models. However, we have never used models as a substitute for good old-fashioned underwriting. Models are only one tool in our underwriting process."

In the fourth quarter 2005, Montpelier Re wrote $106.8m of gross premiums, with net premiums a paltry $8.3m. Compared with previous quarters in 2005 - first, $306m/$279; second, $276m/$231m and third, $290m/$238m, the drop in gross and the precipitous decline of net premiums signalled a sharp shift in the company's underwriting strategy and reinsurance placement.

"In early 2005, we had begun cutting back in areas where pricing was starting to soften and no longer met our risk-adjusted return hurdles," Taylor said. "Following Katrina and the other storms of 2005, we quickly adapted to the new environment we operate in, taking significant steps to reduce our risk profile by lowering our aggregate exposures in most peak zones, declining inadequately priced business and obtaining improved terms and conditions. In addition, we have purchased additional reinsurance and issued our first cat bond."

Though reducing writing in some lines, Taylor added that the company is always on the look out for any potential opportunities which crop up to write different types of risks by "leveraging our skill sets to provide acceptable risk-adjusted returns". However, he was adamant that this did not mean that the company planned to diverge from its specialist property focus. "We will only write business when it meets our risk-adjusted return hurdles, so to the extent that pricing deteriorates we would write less business and vice versa. The changes will result in reduced exposure to extremely large industry events per dollar of capital at risk. Our target return on equity remains unchanged, but we believe the potential outcomes around that target are less volatile. We hope that any decrease in premiums resulting from this initiative will be offset by increased pricing on the business we choose to write." Taylor pointed out that while the company has chosen to exit the marine and retrocessional markets, Montpelier was still active in the retrocessional market through its investment in Blue Ocean.

"In the meantime," Taylor continued, "we are seeing important changes in the way certain classes of business are structured and priced as the market adjusts to increased modelling loads and rising industry capital requirements. Although 1 January renewal pricing in international property classes did not meet our expectations, the equivalent US pricing broadly did and overall demand for many of our key products has increased significantly.

We expect the market in these products to tighten and pricing to continue to increase as the year rolls out. We believe we are now well positioned to take advantage of the substantial opportunities we see in the market place."

As for seeking a friendly partner to merge with, Taylor empathically declared, "We don't have any plans or any need to find one."

- Ronald Gift Mullins is an insurance journalist based in New York City.


- Anthony Taylor is chairman, president and chief executive officer of Montpelier Re, and also served as chief underwriting officer from January 2002 through February 2004. From 1983 until December 2001, he was associated with Lloyd's Syndicate number 51 "A Taylor & Others", which was initially managed by Willis Faber Agencies and, after a management buy out, by Wellington Underwriting Agencies of which he was a founding director. From 1998 until 2001, Taylor was chairman of Wellington Underwriting Inc, as well as underwriting director of Wellington Underwriting Agencies Ltd. During 2001, he was chairman of Wellington Underwriting Agencies Ltd and deputy chairman of Wellington Underwriting plc. Prior to 1998, Taylor served as the active underwriter of Lloyd's Syndicate Number 51. He is a Fellow of the Chartered Insurance Institute and has held various committee and board positions for the Lloyd's market.