As the chart above highlights, the principal events affecting the market can be categorised into the following three areas:
Mergers and acquisitions
A number of significant proposed mergers and acquisitions were announced during 1999 and early 2000.
The highlights were clearly ACE's completed Cigna deal under which it acquired the bulk of Cigna's P/C operations, and XL Capital's acquisition of US reinsurer, NAC Re.
Probably the most significant of the other deals was the announcement in January 2000 that US based Trenwick Group and Bermuda's LaSalle Re Holdings plan to merge, with the shareholders of both companies to receive shares in a new Bermuda company, Trenwick Group. While the proposed merger will not be confirmed until later this year, it is estimated that their proforma combined 1999 gross written premiums would be close to $1 billion, so the new organisation will rank among the top 25 reinsurers in the world.
ACE's purchase of Capital Re, completed on 30 December 1999 - for consideration of approximately $110.3 million in cash and the issue of $20.8 million ordinary shares - further evidences the group's development of an increasingly diversified product base. The acquisition has provided ACE with the opportunity to compete in products that bridge insurance and financial markets, in particular with regard to financial guarantee reinsurance, trade credit reinsurance and structured financial products.
The news has not been all positive. We have also seen a number of start up ventures fail to raise their target capital. Notable among these were Gemini Re and Greenwich. We have seen the slow withdrawal from the Bermuda market of Odyssey Re as a result of other acquisitions within the Canadian Fairfax group that prompted a general reorganisation.
In addition to this, Markel, the speciality insurer which completed the acquisition of Terra Nova in March, 2000, has recently announced its intention to close its Bermuda underwriting operations.
The Bermuda market has been the recipient of a number of high profile redomestications of large, publicly traded US reinsurers. Between September 1999 and March 2000, Everest Re Group, PXRE Group and White Mountains Insurance Group completed restructuring plans, which resulted in their becoming Bermuda based, publicly traded parents of their respective groups.
In addition, the merger of Trenwick Group and LaSalle Re Holdings will similarly result in a Bermuda based public company. Each of these companies has also established a Bermuda based reinsurer to allow it to pursue new opportunities, products and international growth.
The redomestication to Bermuda of previously US based reinsurers, and the purchase of US reinsurers by Bermuda based companies have led certain US companies to protest that the Bermuda companies have an unfair tax advantage over US domiciled reinsurers. While the proponents of this argument have raised some Congressional support for a draft bill attacking premiums ceded to related offshore reinsurers, a number of the offshore companies are now working hard to redress the balance of the argument. Both the Bermuda market and (re)insurers worldwide will follow keenly the results of these discussions, as the implications could be far reaching.
New formations/new product development
The impact of the soft market, significant catastrophe events in recent years and an increasing emphasis on efficient employment of capital have led to a series of developments in Bermuda markets through the creation of innovative new products and entry into new markets.
We have begun to see increasing use of insurers' balance sheet strength through the development of financial guarantee products in which participants use the existing ratings framework to arbitrage their cost of capital. This works to mutual advantage, enabling customers to raise finance more cheaply and insurers to achieve leveraged investment returns.
While the financial guarantee concept is not new, these products provide clear examples of the increasing awareness of the need to use capital efficiently, to leverage the competitive advantages inherent in a strong capital base and, perhaps more importantly, to use these advantages to participate in the capital markets.
Examples of recent activity by Bermuda based companies in the financial guarantee market include the following:
Other examples of market participation include the following:
Combined with a growing perception that, in the event of a truly enormous catastrophe loss event, the existing capital in the insurance markets would not be sufficient, this convergence trend has resulted in the development of insurance based securitisation products which serve as access to a new source of high layer capacity.
Catastrophe bonds have been the most common insurance securitisations. Instead of purchasing coverage from reinsurers, an insurance company establishes a special purpose vehicle (SPV) as a reinsurance company. The insurance company then purchases reinsurance from the SPV, to which it pays a premium. The SPV in turn sells bonds, typically to institutional investors. Interest on the bonds is paid from the investment income. The return of principal, interest or both is tied to the promise of repayment by the SPV, usually if catastrophe costs do not exceed a predetermined threshold.
Other examples of securitisations include:
Initially, this alternative means of transferring fortuitous risk was seen as a potential threat to the Bermuda high excess layer carriers, and it was feared that, in the event of another wave of catastrophic, the capital markets would be in a strong position to take a large portion of this market. However, the relatively disaster-free years from 1995 to 1998 allowed reinsurers to replenish their capital bases. Although the capital markets were willing to take the risks, it was difficult for securitisation transactions, which are generally more expensive to underwrite, to compete with the reinsurance carriers in the resulting soft market.
During this time, the reinsurers, including those in the Bermuda market, have embraced the capital markets as another tool at their own disposal for spreading insurance risk. In March 1998, the Bermudian government amended its insurance legislation to allow companies that are not registered insurers to invest in insurance derivatives, which put Bermuda on more equal footing with other offshore jurisdictions.
In July 1997, LaSalle Re first entered into a plan that provides for two $100 million layers of capital in the event of successive catastrophes. The first layer was through reinsurance coverage and the second layer through a catastrophe equity put. In 1998, Centre Solutions (Bermuda) sponsored $83.5 million retrocessional capacity against Florida hurricane losses from capital markets investors through Trinity Re, an SPV. Also in 1998, XL Mid Ocean entered into a financial swap securitisation covering its own hurricane and earthquake exposure in the US and its territories and possessions in the Caribbean. During 1999, Centre Solutions (Bermuda) entered into another $56.6 million retrocessional capacity contract providing coverage against Florida hurricane losses from capital markets investors through Trinity Re.
Global investment banking giants Lehman Brothers and Goldman Sachs launched new ventures (Lehman Re and Arrow Re, respectively) in Bermuda in 1998. These ventures were formed to accept insurance risk and repackage (transform) it for the capital markets. Lehman Re made its first foray into the capital markets by writing a $150 million securitisation of California earthquake risk.
The Bermuda Stock Exchange (BSX) has also recognised the growth potential of the securitisation market. In 1996, the BSX combined with the New York Catastrophe Risk Exchange to create CATEX, an electronic exchange allowing companies to trade in catastrophe options. In 1998, the BSX announced that it had become the first stock exchange in the world to have a set of listing regulations that have been specifically designed for insurance products. To date, trading on CATEX has been slow to take off given the market competition between traditional reinsurance and the capital markets.
While there is no guarantee that Bermuda will be the natural home for these deals, both Bermuda's legislation and its reinsurers are preparing for it to be so.
As insurers have either participated, or watched others participate in the deals described above, the comfort level in entering the capital markets has grown. As a result, there has been increasing discussion and interest in the development of products which transfer traditional insurance risk (other than pure catastrophe risk as described above) into the capital markets, enabling players from both sides of the insurance/capital markets divide to participate in each others' back yards.
The most recent development is the growing interest among (re)insurers in weather derivative products, and we have seen increasing participation in the Bermuda market in such deals.
The weather derivative market to date has substantially consisted of the purchase/sale of calls, options and swaps based on an index of average daily temperatures to calculate either heating degree days or cooling degree days (HDDs and CDDs respectively). However, the measure could be any type of weather criteria, temperature, wind speed, rain, snow level etc. which can be verified by an independent body.
There are several advantages to entering into such transactions, including:
Against these are a number of factors which expose participants to increased risk:
In September 1999, the Chicago Mercantile Exchange (CME) established a marketplace for the exchange of HDD and CDD products. This has centralised the trading of homogenised products and provides a basis from which to increase liquidity in the market.
We have seen limited but increasing participation within the Bermuda market on an end-user basis, substantially all of which has related to options or swaps derived from HDDs and CDDs based on locations throughout the US. Participants include Commercial Risk Partners, ACE and XL Capital, and we expect this to increase over the coming year.
We perceive the opportunities for Bermuda based companies to be in product development and the (re)insurance of similar risks on a facultative basis. This is being driven by a number of factors, including developing technology, the continuing importance of underlying risk assessment and a regulatory regime which enables rather than hinders product development.
Success in this market will depend on a company's ability to develop specialist capital markets and weather related skills, gain access to primary and secondary distribution channels, and develop proprietary modelling systems capable of facilitating fast and competitive pricing to end-users and intermediary markets.
This capability will become increasingly important as next generation products are developed (seeking for example, the placing of humidity, snowfall and non-weather related products such as property risks), and the pace of deregulation increases in the US and other geographical regions.
Long term insurance
At the same time as the P/C market is redefining its own parameters, long-term business is becoming increasingly important in the Bermuda market. We see this through the establishment of new entities, both long-term and composite licensed, and the diversification of existing large insurers into the life reinsurance markets.
Although official statistics are yet to be released, we expect that the level of long-term and composite insurance entities established in Bermuda during 1999 will again demonstrate an increase in the rate of growth of long-term (re)insurance business compared to the mature P/C market.
Bermuda's large, under-utilised capital base provides a natural reinsurance outlet for the expanding market in the US for long-term products, created by an ageing population, increasing consumer awareness of the need for income protection and long term saving, and the relative tax advantages inherent in properly structured life products.
Allied to this are a number of factors which give Bermuda a competitive advantage, the most significant of which are:
As the global primary life insurance market continues to consolidate, the importance of reinsurance as a means of minimising the impact of new business strain, providing access to additional capacity and stabilising investment and mortality risk, is increasing. Larger, established Bermuda companies are developing an interest in the reinsurance of large blocks of long-term reinsurance business as a result.
Annuity & Life Re is perhaps the most prominent provider of this type of reinsurance with a focus on traditional life products. Its recent growth, combined with the increasing demand for life reinsurance, has led to the involvement of some of the larger P/C composites entering into the market, for example:
In addition, new entrants are emerging. Maximus Reinsurance Holdings (Max Re), which started operating from 1 January 2000, has come into the market with a significant capital base and premium income of $80 million in its first three months of operation. Max Re initially raised over $300 million and, following a second closing at the end of March, raising approximately $175 million more, is now capitalised at over $500 million. Backed by a hedge fund and wealthy private investors, Max Re has positioned itself as a finite risk life reinsurer, aiming to underwrite low volatility risks on the liability side to allow a higher risk strategy on the asset side. It plans to build relationships to enable clients to free up excess capital and share in investment yield from its sophisticated asset management strategies, through profit sharing mechanisms.
We are also beginning to see life companies utilising Bermuda's offshore status to centralise the provision of other traditional life products. For example, Scottish Equitable International (Bermuda) is a prominent provider of corporate owned life insurance which enables multi-national organisations to provide cover to their officers on a consistent basis world-wide.
To continue to compete in these markets, Bermuda based companies, we believe, will need to remain both cost conscious and keep up with the developing products offered by the larger primary onshore life (re)insurance companies. We are aware of developing interest in using Bermuda as a base from which to develop internet based enterprise, and watch with interest to see if Bermuda will establish itself as a provider of (re)insurance products associated with the variable annuity market.
Other new formations
Among the other notable new formations were Intrepid Re, (Class 4), Danish Re, (Class 3) and, early in 2000, Tokio Millennium Re (Class 3).