S&P Report on Bermuda’s Re/Insurers – Cautious, but Optimistic

Analysts from Standard & Poor’s Ratings Services have pit together an analytical report on Bermuda’s insurance and reinsurance industry, following what S&P sees as “another excellent year,” as Bermuda companies have “enjoyed very strong earnings and operating performance as well as increased capital” over the last few years.

However, S&P notes that “the market has been changing, and these companies – as well as the re/insurance industry as a whole—are finding themselves in the midst of softening conditions.” S&P said that is “cautiously optimistic that the Bermudian re/insurers have positioned themselves to face the challenging time ahead with enhanced enterprise risk management (ERM) practices, a focus on profitable underwriting, and prudent capital management.”

The report also points out that “despite numerous natural disasters in 2007—such as Windstorm Kyrill, U.K. and Australian floods, and Atlantic hurricanes—the interactively rated Bermudian companies collectively had one of the strongest operating results on record in the first nine months of 2007, with a weighted average combined ratio of 83.2 percent and a weighted average ROR of 29.2 percent.”

The strong results for the first three quarters of 2007 to some extent reflect the “rate increases in 2006,” S&P continued. “Moreover, favorable reserve development from recent underwriting years (2002-2005), strong investment income, and—in some cases—less reserve strengthening for prior accident years (1997-2001) have helped boost earnings and strengthen balance sheets.

“Assuming there are no end-of-year surprises, 2007 results should be very strong. This peer group’s investment exposure to the subprime market disruption has been minimal, which is in line with that of the rest of the insurance industry.” (See S&P’s report on the issue on the IJ web site, Aug. 30).

However, S&P did warn that “because of the possibility of subprime-related litigation, some of these companies could be exposed to losses stemming from underwriting professional liability coverage, and the full effect might not be clear until 2008 or beyond.”

The rating agency also noted that, although 2007 has “been without relatively major catastrophe insured losses,” the frequency of loss events “has been higher than usual. The monetary effects of these disasters have not been material for reinsurers, nor for this peer group, save a few, as the bulk of the losses have been contained within the primary insurance market.” S&P doesn’t expect this to change in the near future.

However, for the island’s reinsurers to maintain the premium price discipline they have so far observed may be far more difficult in 2008, “following another year of record profitability.” The January renewal season “will provide a far sterner test of resolve,” S&P observed; noting that “so far in 2007, prices have softened across all lines, with decreases of 5 percent-15 percent depending on the region, coverage class, and account size. In addition, terms and conditions have been increasingly under pressure; this has been most prominent in the primary market, but there has also been some evidence of it along the edges of the reinsurance market.”

In addition S&P said “casualty reinsurance rates have fallen at low double-digit rates. On the property side, including U.S. property catastrophe, rates have also been declining, though to a lesser extent than in casualty lines, and we expect similar trends in 2008.”

Florida’s decision to increase the capacity of its Florida Hurricane Catastrophe Fund (FHCF), hasn’t had the impact originally feared. It’s even provided some reinsurers with opportunities to provide coverage “in the layers below the fund, alongside it, and for multiple events and aggregate events after the first two or three occurrences.”

S&P said that some companies “have begun to pull back writings, while cedents are increasing their retentions or shifting to excess-of-loss treaties.” It also indicated that Bermuda’s reinsurers seem to be heeding the call to observe market discipline and profitable underwriting, rather than chasing market share.

The re/insurers are also making better use of risk-modeling tools and have improved their enterprise risk management (ERM) overall. “This sensible approach should enable the Bermudian companies to mitigate some of the effects of the softening cycle. In general, reinsurers have behaved rationally in the marketplace. However, if these companies’ ERM practices don’t hold-up and they start leading the market down by providing cheap capacity, the insurance market could quickly slip into more competitive levels similar to those seen in the late 1990s.”

The Lloyd’s market also seems to have become more attractive, as shown by the recent acquisitions of Talbot Holdings Ltd. and Atrium Underwriting PLC by two new “Class of 2005 companies,” Validus Holdings Ltd. and Ariel Holdings Ltd., respectively. Other reinsurers expanded geographically or diversified in emerging markets (e.g., South America, Middle East, and Far East) or channels (e.g., direct, primary, and excess and surplus lines). “The underwriting and pricing in these new territories could be challenging given that some of these companies have limited track records, “S&P indicated, “and their ability to execute a profitable international expansion in the long run remains unproven.”

Shareholders in Bermuda companies have benefited from the year and three quarters of record profits with shareholders’ equity up by “a healthy 13 percent to $72 billion as of Sept. 30, 2007,” said S&P. “Like the rest of the industry, these players are flush with capital at a time when profit opportunities are dwindling. Most of them have started buying back their shares, with more substantial buyback activity expected in the fourth quarter of this year and beyond. Year-to-date, this group bought back about $2.7 billion of its shares, which constituted 3.7 percent of shareholders’ equity as of Sept. 30, 2007. On an aggregate basis, these Bermudian companies still have approximately $3.4 billion (4.7 percent of shareholders’ equity as of Sept. 30, 2007) under existing share-repurchase authorizations. We do not see any rating implications to the share buybacks that are underway provided that the risk-adjusted capital at these companies remains within our expectations.

“M&A could be an alternative to share buybacks, as it provides a conduit for some of these players, particularly among the Class of 2005, to deploy surplus capital as we continue into a softening market. Nevertheless, we do not anticipate widespread M&A activity across the reinsurance sector.”

Despite what it characterized as “challenges in the coming years,” S&P indicated Bermuda’s insurers are well positioned to face them. “The current ratings on this group are expected to be relatively stable over the next six months and reflect our view that they have positioned themselves to weather the soft part of the cycle through enhanced ERM, disciplined underwriting and cycle management, and prudent capital-management strategies. Our cautious optimism for this group, as well as for the reinsurance industry as a whole, could be questioned if we see these practices deteriorate or fail to live up to expectations.”

For more information contact S&P at: www.standardandpoors.com

Source: – Standard & Poor’s