What are the economic consequences for Bermudian reinsurers after being pushed out of the Florida market? Roger Crombie explains why it will be a year of two halves.
The Bermuda market was rocked by the decision to socialise property insurance in Florida. The sheer audacity of the move, following on two years in which the Bermuda reinsurers had pumped some $50bn into the US economy, much of it covering Florida losses, was breathtaking. The impracticality of Governor Charlie Crist's "bold stroke", and its catastrophic potential for Florida and other US residents, has wagged more tongues than any possible economic consequences to the Bermuda market. So how does 2007 look now to the major Bermuda participants?
The picture became clearer when the full-year financial results for 2006 began to emerge. Overall, the Bermuda market will show retained earnings somewhere north of $10bn for 2006, with the 40 largest companies naturally scooping most of it. 2006 was the kind of year that the Bermuda market might have hoped for after 2004 and 2005, with those who did not cut back their interest in Florida and the Gulf Coast doing best of all.
The 2006 results mean that those who invested in sidecars will have done especially well. Hedge fund managers will probably take some of their money and run, especially following the Florida announcement. Many of the sidecars will thus not renew when their limited term expires. No need. This view is shared by AM Best in a recent report. "Sidecar formations and start-up operations that arose in 2005 and 2006 will significantly decline due to the unexpected increase in reinsurance capacity," the rating agency predicted. Governor Crist has inadvertently completed the work of bringing the larger reinsurance companies' capital profiles in line with the new rating agency paradigms.
2007 will therefore be a tale of two halves. Since the majority of Florida cover does not renew until 1 July, those who underwrote the region last year ought to have a very solid first half. European storm Kyrill was not a major event for most Bermudians. That would place the Bermuda majors at 30 June at the end of an 18-month period of significant growth and further consolidate their developing stranglehold on the global reinsurance market.
If, as expected, the Florida decision takes $2bn to $3bn out of the Bermuda book, where will it go? That's what the most highly-affected companies were working out in the days and weeks after the shock announcement. Their choices are somewhat limited.
Europe was the most obvious destination, although such a move could be problematic. For one thing, Lloyd's has been one of the most serious players in the Florida market, and it too will be looking for a new home for a good piece of its capacity in the second half of one of its largest stamp years. European rates are therefore probably bound to fall, whether or not the Bermuda companies boost their capacity in that market. The more they do, the less attractive the market will be to them. No easy way out there.
But then the alternatives are not entirely palatable either. Share buybacks, extraordinary dividends, straight return of capital - all might solve the problem, but none is especially attractive. Investors generally don't want their capital back because of a market swerve; refunds defeat their object.
An averagely active Florida hurricane season, at a time when above average is the forecast, would produce a swing back towards a hard market in property, providing the Bermuda companies with the opportunity to use more capital, not less.
Come what may, what will separate the best from the rest is underwriting discipline. Jim Bryce, president and chief executive officer of IPC Re Holdings, put it this way: "Important decisions will have to be made (in the industry) regarding the need to maintain underwriting discipline, which might require companies to undertake capital management actions to sustain adequate returns to shareholders. The alternative is for the industry to forget or ignore the size of losses that were incurred in 2004 and 2005, and allow market forces to put downward pressure on pricing. Hopefully, recent winter storm Kyrill will have served as a reminder that catastrophic events can occur at any time, anywhere in the world, and pricing levels that will enable us to pay for such events occurring with increased frequency need to be maintained."
The likeliest outcome is that the big Bermuda players will hold fire until the third quarter and see how the land lies then. Accelerated share repurchasing - such as the $1bn buyback announced by XL in February - will bolster per share earnings, and Everest Re and Odyssey Re had already begun the elevated dividend programme by press time, both with a 100% increase, but these are comparatively minor moves.
The 2007 outlook is very different, depending on which seat you see it from. It is fair to say that the Bermuda market has the lion's share of the relationships with the Florida insurers, but the spread of those relationships is critical to understanding who will be most affected. The easiest way to analyse how the companies will fare is by "class".
Start-ups to struggle
Among the companies established prior to 2000, Florida business is fairly widespread, but not at a level that would significantly affect their books of business. Twenty good years have turned ACE and XL into multi-line carriers far removed from their origins as pure excess-of-loss writers. Plus, they have achieved a size that will enable them to ride out the 1 July Florida storm.
Not much of the Class of 1993 remains on a standalone basis. PartnerRe and IPC Re are not heavily committed to Florida. RenaissanceRe is more involved, as is its managed pool, DaVinci Re and, to a lesser extent, its subsidiary Glencoe. ACE Tempest Re did not enjoy 2006 as much as others, financially speaking, but that means that its 2007 performance will already have come under the planning microscope.
The Class of 2001 has not concentrated on Florida to an extent that the cutback might hurt them greatly this year. Allied World Assurance Company has very little Florida exposure; Arch Capital and Endurance have some; and Montpelier Re, which had booked heavily into Florida to begin the haul back up after Katrina, is the exception - but when was it not?
Of all the Bermuda groups, the Class of 2005 will be the most affected, if exposure to Florida is measured against total book. Not a great deal of information is released by these mostly privately-held companies, but in conversation, their executives have referred to the way in which they moved into the Florida market in 2006 as a means of jump-starting their businesses. Flagstone Re probably leads the pack in this regard; Harbor Point is at the least-exposed end of the spectrum. As a group, this class will have to diversify away from Florida to a greater extent than any other.
Their decision to write a lot of Florida business made sense at the time. Premiums were hardest there and in the Gulf Coast market. A neutral storm experience in 2006 would make these companies look good; the reverse and their performance would hardly stand out. As it was, they probably had as good a year as, or better than, most of their competitors in 2006, dollar for dollar. Now, what went up has to come down, and these companies will be seeking to enter other markets in a relatively larger way than any of the other groups.
A degree of irony is present. Before the Class of 2005 companies could be tested by Mother Nature, they are being tested by Governor Crist. The "glass half full" approach suggests that this could be good for these companies. One or two may have taken the path of least resistance by looking to Florida initially. Sooner or later, they intended to broaden their range. Now we know that it will be sooner.
Of those companies not formed in one of classes, Catlin, with its roots at Lloyd's, has exposure in Florida, but conversely, has reach in other markets. Aspen Insurance has some Florida relationships; Platinum Underwriters more so.
Boil it all down, and what do we have? A tougher 2007 structurally than had been expected, regardless of the second half storm experience. Of course, an above average Florida storm season would work to the displaced Bermuda companies' advantage and simultaneously reveal the flaws inherent in Governor Crist's populist approach to problem solving. Another year like 2006 would make Crist look good, but it would represent no more than a stay of execution for his scheme.
In the long run, being booted out of Florida may redound to the Bermuda companies' advantage. There are other markets, and if underwriting discipline is strong throughout the sector, 2007 will likely be a less good, but by no means disastrous year.
- Roger Crombie is a freelance journalist.