Almost as soon as the initial losses from Hurricane Katrina were reported many reinsurers had the wheels in motion for capital raising initiatives Helen Yates looks at how successful they were.
In the six weeks following Hurricane Katrina reinsurance markets succeeded in raising $5bn of capital. The final figure, including new capital being used to set-up what could be as many as 12 new Bermudan reinsurers, could be in excess of $15bn (not including capital raised by Lloyd's syndicates), according to the Insurance Information Institute (III). Given the massive losses forecast by most reinsurers, which many expect to climb further, is this rapid response recapitalisation something new? Not necessarily, says David Mendelsohn, chair of the Insurance and Reinsurance Transaction Practice at DLA Piper, "I think all you're seeing right now is part of the traditional cycle and the creation of new capacity in the marketplace."
According to Chris Waterman, senior director in Fitch's Insurance Group, the hardening of rates following any major catastrophe should see reinsurers increasing their capacity as a result. Indeed Lloyd's has announced it expects capacity to grow by 7% in 2006. "I think it is quite reflective of some of the capital raising efforts we saw after the World Trade Center attack in 2001," said Waterman. "In 2005 we've experienced the worst and third worst insured losses from natural catastrophes on record. That certainly creates some expectations that there will be significant positive rating movements during the January 2006 renewal season, particularly for those lines of business that have been directly impacted by the hurricanes. There will certainly be opportunities for insurers and reinsurers."
RACE FOR CAPITAL
One of the first off the mark in the capital raising stakes was Montpelier Re. Expecting losses from Hurricane Katrina of between $450m to $675m it quickly raised $600m from the issuance of common shares on 16 September (Montpelier has since revised its Katrina loss estimate up to $809m).
In October, capital raising really kicked off with ACE raising $1.5bn of common equity, followed by Aspen $404m, Everest Re $475m, PXRE $115m, Endurance $200m (in a block trade), Max Re $250m, Odyssey Re $100m, Kiln $126m, and Glacier Re $100m. Preferred offerings were completed by Axis $250m, Odyssey $100m, PXRE $360m, and Endurance $200m. Shelf registrations, including one from Montpelier Re for $1bn, were also filed in earnest indicating the intention for further capital raising initiatives. (See table on opposite page for more details.)
In November, counter to many earlier predictions, a new class of start-ups began to emerge in Bermuda, bringing with it new capital and new capacity.
"One statistic I've seen is that probably $8bn of new capital is associated with these ten start-ups," says Mendelsohn. Noteworthy is how much of that new capital is coming from hedge funds and private equity investors, which according to the III is likely to be as much as 30%.
According to Stuart Bridges, chief financial officer at Hiscox, while it is not unusual to see this level of capital raising following a major catastrophe, the speed at which some of it was raised was unexpected.
"In the UK we have pre-emption rights so if I issue shares I'm obliged to offer them to all my shareholders first. In America they don't have the same rules and that allows them to act very very quickly. I have to say I was surprised by the speed at which some of these Bermudan reinsurers issued shares and how easy it was for them to do that."
The reasons behind this post-catastrophe capital raising should be fairly obvious and for many reinsurers it is a simple case of re-establishing capital positions. Others are raising capital to position themselves to take advantage of the renewal season, and in many cases the capital is intended for both purposes. Avoiding downgrades is also a key driver.
While capital is just one issue the rating agencies look at, the onus is on capital raising as a protection against rating downgrades following large losses. "Capital is not the only rating factor, but is an important part of the overall rating process. A very strong level of capitalisation can act as a buffer to mitigate additional risks that exist within an insurance or reinsurance company," explains Waterman.
The ability to raise capital not only improves the capital position but also demonstrates investor confidence in that organisation and in future reinsurance pricing. But capital raising on its own isn't always sufficient to protect a rating as PXRE and Montpelier Re have both discovered. Fitch resolved the rating watch negative on Montpelier Re and downgraded it to "BBB" (from "A-") despite successful capital raising. "The $1bn in losses sustained by Montpelier Re from the 2005 hurricane season highlighted to us that the company had a high concentration of risk that was beyond Fitch's expectations and not consistent with an 'A'-range rating," explains Waterman. "Simply filling balance sheet holes with capital is sometimes not enough to maintain a rating, especially if there has been a change in the perception of a company's risk profile." AM Best downgraded PXRE to "A-" from "A" and made the observation that "the replenishment of capital alone may not be sufficient to sustain a company's previous rating".
The new capital seeding the now familiar names of Harbor Point, Arrow Capital, Amlin Bermuda, Validus, Ariel, Lancashire, New Castle, Hiscox Bermuda and Omega Specialty Insurance, comes from a number of different sources but all with the same intention. As Mendelsohn puts it, "When there are catastrophes which result in the tightening of available capital in the marketplace, that creates opportunities for new companies to come in and take advantage of increased rates." And this, says Bridges, is exactly what Hiscox has done. "We raised the money to take advantage of what was a very good opportunity. Rates are going to be strong for a number of years and we had been looking at Bermuda but needed something to trigger us going in, and actually Hurricane Katrina was that trigger."
Hiscox raised $500m through a combination of a rights issue and bank funds. "Obviously there's also venture capital and other money around but we feel that it's wrong to use that because the benefit doesn't then go to the shareholders," explains Bridges. While this may be the clear choice for a Lloyd's syndicate, other start-ups - including Harbor Point, Validus, Lancashire and New Castle - have either been partially or fully capitalised by hedge funds and private equity funds.
While hedge funds have been investing in reinsurance for some time, Mendelsohn thinks this involvement has now been taken to another level. "Former senior industry executives are starting up new companies and I think that's the same - we've always seen that. We've also always seen established companies say 'here's an opportunity'. Probably a difference we are now seeing is the involvement of hedge funds or private equity funds that are really bringing a substantial amount of capital to the marketplace."
Hedge funds look upon reinsurance as an attractive investment because it helps to spread their risks, as there is a lack of correlation between the risk associated with reinsurers and with the other investments in their portfolio. "It's a non-correlated business, but equally it's quite a volatile business and I'm not sure if it balances (hedge funds') books and if they can make a profit out of it," warns Bridges. The question of whether Citadel, Capital Z, Greenlight Capital, West End Capital, Cyprus and Trident III LP among others are in it for the long haul is raising concerns. "One of our big questions on that new capital would be what the expectations are for the shareholders, what their exit routes are, are they in for the long term and what is the appetite like?" says Waterman.
Previous investors in Bermuda start-ups, particularly those backed by the broking community, have had permanence by virtue of their all-round involvement in the industry. Hedge funds and private equity investors don't have that same commitment whilst having the ability to move rapidly into and out of opportunities as and when they arise.
But perhaps questioning the long-term intentions of these investors is not the key issue the industry should be concerned about. With many climatologists predicting that frenzied hurricane seasons will become a fact of life perhaps the real question is: will investor confidence remain and the capital continue to flow if market-changing losses become a yearly occurrence?
- Helen Yates is deputy editor of Global Reinsurance.
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