Tony Bibbings discusses why prospects for consolidation in Bermuda are something of a spotted banana-- ripe for consolidation in places, but not in others.
The Bermuda insurance industry was radically affected by the rapid hardening of insurance rates following the casualty crisis of 1985, Hurricane Andrew in 1992, the events of September 11, 2001 and Hurricanes Katrina, Rita and Wilma in 2005. One notable difference between the years, was that the events of 1985 and 2001 affected casualty premiums and resulted in new company formations focused on casualty risks, whilst those events of 1992 and 2005 affected property premiums, resulting in new companies primarily formed to target property catastrophe treaty business.
Examining where we stand today, it is evident that we are in a not greatly dissimilar position to where we found ourselves in the late nineties. Property premium rates have been soft for years, there is too much capital in the market and there have not been enough recent natural catastrophes to prompt any kind of turn. It seems likely that consolidations may well be on the horizon.
The class of the nineties
Hurricane Andrew passed over Homestead, Florida on August 24, 1992 causing more insured damage than any previous natural disaster in US history. The result was a significant hardening of insurance rates. Those rate increases were not just because $25 billion was about to leave the balance sheets of insurers and reinsurers, but because the new estimates of what could happen in terms of future cat losses had significantly increased. In the aftermath of Hurricane Andrew, a number of reinsurance companies were formed to take advantage of the new strengthened premium rates in property catastrophe treaty business, namely:
Centre Re, Global Capital Re, International Property Catastrophe Re (IPC Re), LaSalle Re, Mid Ocean Re, Partner Re, Renaissance Re, Tempest Re
Each of these companies was formed quickly, with hundreds of millions of capital, but for the rest of the 1990s they witnessed a much lower number and severity of natural disasters, with this new flow of competition resulting in ever lower property catastrophe premiums. By the end of the decade, property rates had reduced considerably and many of these companies affected their exit strategies. Today, only two remain independent—Renaissance Re and Partner Re.
"Share prices are suppressed... [meaning] shareholders of potential sellers may well be reluctant to lock in such a low share price."
Renaissance Re always had a different business model from the competition. Due to their early successes and perceived superior modelling capabilities, they were able to underwrite business on behalf of other players. Top Layer Re and DaVinci were later formed and Renaissance Re ceded a portion of their business to them. This not only allowed Renaissance Re to have more influence on pricing by virtue of taking larger positions on the treaties, but it also allowed the company to earn ceding commission to complement their existing risk-based income.
In its case, the pedigree of Partner Re made remaining independent rather easier, whilst the remaining players were obliged to consolidate into other companies.
Katrina and the new class
In 2005, Hurricane Katrina overtook Andrew as the most expensive hurricane in US history. It hit near New Orleans on August 29, with maximum wind speeds estimated at 125 mph, causing approximately $75 billion worth of damage, not all of which was insured. Again, like Andrew, the resulting meaningful increase in property catastrophe premiums was not just because of the billions paid by insurers and reinsurers. The damage done by Katrina and the two following hurricanes, Rita and Wilma, made the modelling agencies change their estimates regarding what could potentially happen in the event of future storms.
This situation led to the creation of a number of players including Ariel Re, Aspen, Flagstone, Ironshore, Lancashire, Montpelier and Validus. While all of them may remain independent—and Validus for their part look as though they will, having recently acquired IPC Re - it may be getting to the point where shrinking property premiums no longer support the capital allocated to the business. It seems that M&A activity could well be on the horizon, with mergers providing a number of potential benefits for those that go down that route:
• Cost savings in removing staff and office space redundancies.
• Enabling the combined company to take on larger lines on desirable risks.
• A quick means to achieve geographic diversity of risks if the existing books are not correlated.
• Ratings improvements, as was the case for Max Re when they merged with Harbour Point to become Alterra.
And it would appear that there will be a number of companies looking to consolidate in the current soft market. One major hurdle to such a move however is that many share prices are suppressed at present. As of October 1, 2010, the price to book ratio was below 1 for Montpelier Re (at .76 of book value), Validus (at .82 of book) and Flagstone (at .69 of book). Such a situation may well be appealing to buyers, but shareholders of potential sellers may well be reluctant to lock in such a low share price. However, in some instances, mergers of equals may make sense too.
Ripe in places
The reason I believe that the “ripe in some places and not in others” banana metaphor fits, is that consolidations can be slippery prospects, particularly when considering long tail casualty business, which is much of what the class of 2001 write. September 11, 2001 led to the formation of companies like Allied World Assurance Company (AWAC), Arch, Axis, Canopius and Endurance. But as XL found with NAC Re, ACE found with CIGNA, and many others before them came to realise, merging with or acquiring casualty companies is very different to property companies. Estimating their reserves, an integral part of agreeing on a transfer price, can be a major stumbling block when it comes to offer and acceptance.
So, maybe those casualty companies born out of September 11 are not good candidates to be acquired. On the other hand, they may well be very good candidates to do the acquiring. They have a lot of cash, casualty premiums are as suppressed as property premiums and diversity is rewarded by rating agencies and most analysts. I suspect that they are all looking to see to what extent the four merger benefits listed above are applicable to them.
Finally, I noted that the chief executive of Allianz, Michael Diekmann, was quoted recently in the Financial Times as stating that Allianz has 1 billion euros set aside to acquire property and casualty companies to balance their life insurance business. It will be interesting where he opts to take his money. He may well want to consider Bermuda.
Tony Bibbings is the senior vice president at Artex Risk Solutions. He can be contacted at: email@example.com
M&A, Bermuda, reinsurance, Artex Risk Solutions