Benchmarking: Bermuda reinsurance analysis
The first thing that strikes the eye when reviewing the data from Standard & Poor’s on global reinsurers—the agency provided us with the accompanying tables, but the commentary that follows is all our own—is the extent to which Bermuda can no longer be said to be merely a reinsurance centre: it is now, surely an insurance and reinsurance centre.
The impetus for that change of state was the destruction of the World Trade Center in 2001. If anything “good” can be said to have come out of the almost 3,000 murders that day, in Bermuda’s case, it would be the broadening of what had been, until then, pretty much a monolithic reinsurance book. The majority of the members of the “Class of 2001”, without communicating with each other, came to much the same conclusion: that the devastation wrought in the markets by the events of 9/11 had led to an opportunity to rewrite the rules of insurance.
Almost all the companies decided not to specialise in insurance or reinsurance, but to write both, with separate divisions operating alongside each other, deriving from the data they collect the ability to insure and reinsure separate sectors of the market. Other, longer-established Bermuda companies have followed suit.
Today, the decision feels mundane, because it has worked so well. The credit for the making the leap of faith first goes to Bob Newhouse, Jr., the ‘father’ of Bermuda’s reinsurance sector, who turns out to have ‘sired’ its insurance sector, too. In the days after 9/11, Newhouse met with Marsh and John Charman “to give them my idea that it was a unique opportunity to write both insurance and reinsurance,” Newhouse said. “So we broadened the concept of AXIS to be a specialty insurance and reinsurance company.” Although others were thinking along exactly the same lines at exactly the same time, AXIS was first to market.
From the perspective of the third quarter of 2009, the financial results for 2008 feel a little like ancient history. So dynamic are the Bermuda and global re/insurance and financial markets that an enormous amount has happened, or was expected to happen but didn’t, since the 2008 numbers were finalised and released.
Nevertheless, what can be learned from an analysis of the numbers?
The 24 Bermuda entities listed by Standard & Poor’s wrote 4.4 percent less in net written premiums than they had in 2007. Although business at each company is varied and so different from that of the others, one or two generalisations are possible. Following Hurricane Katrina, 2006 and 2007 had been relatively quiet Atlantic hurricane seasons. Prices, if not soft, were not especially firm. The fall in net written premiums represents, in part, a general reduction in the global economy, but the main driver was continued underwriting discipline.
When the Classes of 2001 and 2005 were formed, just about every chief executive officer underlined his or her company’s intention to practice such discipline. A cynic might have remarked that the road to hell is paved with good intentions. Yet, from an operational standpoint, underwriting discipline, so notably hard to find in the industry in the 20 years before 2001, might be said to be the hallmark of the Bermuda market—probably the best possible discerning factor imaginable.
In fact, 11 of the 24 listed entities increased the amount of net written premiums in 2008. Absent the special situations, relocations and refocusing, though, Bermuda companies have indeed been living up to their promise to walk away from business that they consider inadequately priced.
2008 operating income
In brief: for the listed entities, operating income fell in 2008 by 43.4 percent from its 2007 level. The cause: Hurricane Ike and the otherwise elevated level of claims in 2008, compared to 2007. The good news: the 24 entities reported total net operating income of $3.6 billion in a difficult year. Without exaggerating, that is no small achievement, the dividend of the market’s scale, solid underwriting practices and the introduction of increasingly sophisticated computer modelling and the efficiency it instills.
Not one of the listed entities was able to report increased operating income in 2008, but that is essentially as it should be. In years when claims rise, reinsurance companies’ operating income naturally falls. The acid test is whether the company can absorb the claims out of current year earnings. Of the listed entities, all but two reported positive operating income for 2008.
Combined ratios for 2008 rose to 79.3 percent from 65.4 percent. That they rose is unremarkable; that they remained, in aggregate, below 80 percent in so tough a year is extraordinary. The reports we hear about the quality of Bermuda’s pool of intellectual capital appear to be true. It is also worth pointing out that 2007 was a year in which claims were unusually low, inflating operating income and therefore the yardstick against which performance in 2008 was measured.
2008 shareholders’ funds
The total shareholders’ funds represented by the 21 listed entities fell in 2008 to $33.3 billion from $37.4 billion, a drop of 11 percent. Of the 18 entities reporting shareholders’ funds, five managed to increase their total.
The causes of the fall in capital are as a varied as the number of companies, but one thing all the companies faced in 2008 was the fall in asset values worldwide during the year. The results of operating income can be said to be a test of the liability side of the reinsurance business; the asset side is usually not a major factor in reinsurance, given the conservatism inherent in the companies’ investment strategies.
In 2008, reinsurance emerged as, more or less, the safest haven for capital in the world. The companies’ portfolios are stocked, largely or completely, with ‘unexciting’ investments: fixed income, often ‘AA’ grade or better. The point is to not take risk on the asset side of the balance sheet. Especially in an environment such as Bermuda, where the emphasis is on property catastrophe reinsurance, companies are already subject to a high degree of volatility of earnings.
One or two of the listed Bermuda entities had some exposure to equities, hedge funds of funds and corporate paper that suffered in 2008. Until that year, buying Lehman Brothers’ commercial debt had not seemed to represent much in the way of risk. We know better now, and some of the Bermuda companies, notably XL, have further ‘de-risked’ their investment portfolios since 2008 ended.
Everything is relative, and seeing one’s net worth fall by “only” 11 percent in 2008 would have warmed many hearts. That the Bermuda companies are increasingly good stewards of the capital with which they are entrusted is plain.
The analysis that follows refers either to the cited reinsurance entity or to the group to which it belongs, as indicated.
ACE Tempest Reinsurance Ltd.
ACE Tempest Life Reinsurance, Ltd.
ACE’s move to Switzerland has resulted in a declining presence in Bermuda, not just because the corporate headquarters left the Island. Business at ACE Tempest Re fell precipitously, but the margin and combined ratio remained exceptionally high. If Representative Neal’s bill, containing clauses that would tax companies doing business in the US at what amounts to the same rate as domestic insurers, were to pass, Evan Greenberg’s move onshore would have failed to bring to ACE the stability he sought.
Amlin Bermuda Ltd.
Growth at Amlin Bermuda, as the company builds out its Island base, was interrupted in 2008, with a 99.5 percent combined ratio and a fall in shareholders’ funds of six percent. If that sounds like bad news, it should not. In a year of extensive claims experience such as 2008, operating income of any sort, even in this case of just $2.7 million, is a win.
Ariel Reinsurance Company Ltd.
Don Kramer’s latest venture remains one of Bermuda’s smaller reinsurers, following significant dividends paid in earlier years. Given Kramer’s mastery of his art, the relatively small size of Ariel must be seen as strategic. Certainly, in interviews, he appears not to want it any other way. Ariel appears routinely on lists of companies considered vulnerable to takeover, but the company is privately owned; if it were to happen, it would not be by stealth.
Aspen Insurance Ltd.
Aspen grew net premiums in 2008 at a fair clip and was able to eke out a small increase in shareholders’ funds during the year. Aspen had some hedge fund of funds investments that dragged net income down by $97.3 million for 2008, despite which the company reported net income of $103.8 million. The average credit quality of the portfolio at December 31, 2008 remained ‘AAA’, with an average duration of 3.12 years.
Arch Reinsurance Ltd.
Arch had another solid underwriting year in 2008, with its combined ratio rising, but only to 83.5 percent, a more than respectable showing. The decrease in total capital during 2008 was primarily attributable to an after-tax decrease in the market value of the company’s investment portfolio and share repurchase activity, partially offset by net income and borrowings during the period.
AXIS Specialty Limited
For sheer consistency of earnings since the company was founded, no one beats AXIS. Odd quarters excepted—those containing the effects of Hurricanes Katrina or Ike, say—AXIS marches forward with an almost frightening efficiency, although 2008 was not a banner year. The company’s overall net income for 2008 was $351 million; net favourable prior year reserve development in the year was $376 million. A decline in the company’s book value per share during the year of 10 percent was primarily due to the global decline in asset values.
Catlin Insurance Co. Ltd.
Simultaneously with the release of news of a net loss of $46 million in 2008, the Catlin Group announced a £200 million ($288 million) rights issue, net of expenses. The new capital, which was fully subscribed, demonstrated the company’s belief that it was well-placed to take advantage of opportunities it foresaw in 2009.
Net losses relating to fixed income investments in 2008 amounted to $111.5 million, a situation unlikely to recur in 2009.
Endurance Specialty Insurance Ltd.
Overall, Endurance booked net income for 2008 of $98.6 million, after swallowing $111.6 million of losses related to its alternative investments and high-yield loan mutual funds, resulting from mark-to-market adjustments, primarily reflecting widening credit spreads and significant capital market volatility during 2008. Chief executive officer Kenneth LeStrange continues to grow Endurance as he had promised he would: company-wide, gross premiums written in 2008 rose by 26.1 percent to $2.2 billion and net premiums written rose by 13.3 percent to $1.8 billion.
Everest Reinsurance (Bermuda) Ltd.
Company-wide, Everest wrote $3.74 billion of gross premiums, down by 7.6 percent from a year earlier. Net realised capital losses of $695.8 dragged the company into a loss of $18.8 million for the year, but could not mask the depth and solid performance of its core businesses. Operating activities provided $662 million of cash flow during 2008.
Hannover Re Bermuda Ltd.
Hannover Re Bermuda’s pretax operating income for 2008 was $181.2 million, a decline of only 15 percent on 2007’s performance, despite the industry facing much larger claims in 2008. The Bermuda operation’s return on revenue was 60.3 percent on 2008, three percentage points better than its 2007 performance, showing just how well it manages its book.
Harbor Point Re Ltd.
Harbor Point’s net written reinsurance premiums fell by 63 percent in 2008, compared to 2007, but the company’s total net written premiums fell by only 10.8 percent, from $506.8 million to $568.0 million. The shift signalled that the company’s build-out was essentially complete and its new direction established. Despite a net loss of $13 million for 2008, total shareholders’ funds increased at year-end to $1.691 billion from $1.579 billion a year earlier, largely as the result of conversion to equity of a note for $198 million.
Hiscox Insurance Co. (Bermuda) Ltd.
Hiscox has been pursuing a strategy of balancing its book. In 2008, the company shrank its international big ticket and reinsurance product lines. At the same time, it continued to invest in its domestic market businesses in the UK, Europe and the US. These actions allowed the group to generate sufficient underwriting profit, which together with foreign exchange gains (when considering the company’s results in Sterling), produced a pretax profit for the year of £105.2 million, compared to £237.2 million in 2007.
International General Insurance Co. Ltd.
International General is one of Bermuda’s smaller reinsurers. It grew its reinsurance book by 15.5 percent in 2008, but the year’s elevated losses took their toll.
In its final full year of business as an independent company, IPC Holdings booked net income of $75.5 million despite the high level of property catastrophe claims. The company’s combined ratio, usually best in class in less volatile years, rose to only 49.6 percent in 2008. IPC recorded a 40.2 percent loss ratio, in what is considered to have been the second worst year on record in terms of insured losses. Net losses on investments of $168.2 million hurt what would otherwise have been a first-class year.
Lancashire Insurance Co. Ltd.
Lancashire is another of those Class of 2005 companies that has settled into a niche that suits its management style very well. Its conservative underwriting style—a combined ratio of 50.5 percent on its reinsurance book in 2008 underpinning a company-wide 86.3 percent—combines well with its intimate knowledge of its markets, strengths and weaknesses. Under Richard Brindle and Neil McConachie, newly appointed president and long-standing group chief financial officer, the company has yet to put a foot wrong.
Max Capital Group Ltd.
Marty Becker was disappointed but philosophical about losing out to Validus in the battle for IPC Holdings. Max was founded as a hedge fund play and has since changed direction more than once, proving that flexibility can be a reward for a lack of scale, relative to the competition. Under Becker’s stewardship, Max has established an excess and surplus lines division and built a reinsurance division that was able to swallow its 2008 losses out of current earnings.
Montpelier Re Holdings Ltd.
2008 was a tough year for Montpelier, which writes essentially nothing but reinsurance. The company managed to return solid operating income of $94.2 million despite Hurricane Ike and the other claims it faced, but realised investment losses of $71.7 million and unrealised losses of $171.4 million, and produced a comprehensive loss for the year of $150.9 million.
MS Frontier Reinsurance Ltd.
Founded in 2002, the newer of Bermuda’s two major Japanese-owned reinsurers is proceeding cautiously to build a solid book of carefully managed risks. The company’s loss ratio in 2008 was 35.8 percent, a remarkable achievement for a company focused on property catastrophe risk in a difficult year for that line of business. Comprehensive income for 2008 was $45.3 million, compared to $73.8 million a year earlier.
Partner Reinsurance Company Ltd
With its acquisition of Paris Re, PartnerRe has become a top five player globally. Patrick Thiele (a mid-Westerner, not Swiss, as was erroneously reported in last year’s benchmarking exercise) has built a truly global franchise in what will probably one day become a Harvard study. Net income for 2008 was $46.6 million, despite net after-tax realised and unrealised losses on investments of $453.6 million.
Tokio Millennium Re Ltd.
Tokio Millennium had another exceptional year in 2008, as its parent shareholder’s funds passed the $1.0 billion mark for the first time. Under Tatsuhiko Hoshina’s leadership, the only flash is in the advertising; the company itself is the very essence of a conservative, research-heavy environment in which all the risk is taken on the liability side. The company lost not one cent on its investment portfolio in 2008.
Validus Reinsurance Ltd. (Bermuda)
The acquisition of IPC Holdings propelled Validus Holdings into Bermuda’s top five, and chief executive officer Ed Noonan will use the new scale to drive Validus forward. The addition of Talbot for the full year 2008 raised gross premiums written by 37.6 percent in 2008 to $1.36 billion; with IPC, on a pro forma basis, the total would have been about $1.7 billion. Comprehensive income for 2008 was $45.3 million.
White Mountains Re
White Mountains Re took its lumps in 2008. The 2008 combined ratio for the reinsurance segment included $156 million (or 16 points) of catastrophe losses, net of reinsurance and reinstatements. White Mountains Re also increased its prior year loss reserves by $80 million (or eight points). The largest contributor to a 15 percent decline in overall net written premiums in 2008 was in the casualty line of business, due to continuing pressure on rate levels.
XL Re Ltd
The continuing solid performance of XL Re was one of the core contributors to XL Capital that enabled the company to survive its difficulties in other areas. Holding its reinsurance combined ratio to 76.4 percent in 2008 was an indicator of how well the reinsurance segment did at XL during an otherwise truly difficult year that saw Mike McGavick replace Brian O’Hara as chief executive officer. XL is now back on track, which is welcome news for the Bermuda market.