Lloyd's: from competition to co-operation
When the Class of 2005 was formed in the aftermath of Hurricane Katrina, backed with a record $12 billion of new capital, firms were faced with a different set of challenges than those waves of start-ups that had gone before them. The companies that set up post-Hurricane Andrew—including IPC Re, Partner Re, Renaissance Re and Tempest Re—and those that set up post-9/11—including Allied World, Arch, Aspen, Axis, Endurance and Montpelier Re—were set up to focus primarily on US property catastrophe business, at least initially.
Class of 2005 firms—including Amlin Bermuda, Ariel Re, Flagstone, Harbor Point (now part of Alterra), Hiscox Bermuda, Lancashire, Omega Specialty and Validus—needed to spread their wings from the start. As they looked for opportunities in new markets, Lloyd’s was quickly identified as a platform from which to access non-correlated business and a wide number of international markets. A number of strategic acquisitions took place in 2007, with Alterra, Ariel, Validus and others moving into the market.
“Diversification was quite a low priority for the post-Andrew companies,” says George Rivaz, chief executive officer of Ariel Holdings. “I was involved in Tempest and was one of the founding team there. Although we did contemplate adding other lines, it wasn’t a core strategy. It was just something we evaluated during the course of business.”
“The 2001 companies in part may have had an increased desire,” he continues. “They certainly had better opportunities for diversification than the 1993 companies, in that they were born into a hard market for property catastrophe and also a very hard market for a wide range of casualty risks; [they] therefore had good opportunities to build businesses or acquire businesses at the right time.”
After Katrina, rate hardening was mostly limited to lines that had exposure to US catastrophe. Property, catastrophe, retrocession and energy reinsurance prices rose substantially, by 100 percent on some lines. Yet, primary rates and casualty reinsurance rates remained soft. While the opportunities were not as great to diversify into longertail lines as they had been for the Class of 2001, the pressure was nevertheless on to diversify. The magnitude of the loss in 2005, which cost the industry in excess of $40 billion, took many by surprise.
The catastrophe modelling vendor companies released near-term hurricane models to reflect a period of heightened hurricane activity and the rating agencies increased their capital requirements for catastrophe-exposed business. The net result was pressure to build a well-diversified book of business by writing a spread of business and looking to move into new territories.
As companies submitted their business plans for approval, they were required to demonstrate intent to build balanced portfolios right out of the blocks. “It was clearer to companies by 2005—particularly given the capital treatment of catastrophe exposures that came out of the key rating agencies and, for the public companies, the limited appetite for catastrophe risk after the experience of Katrina, Rita and Wilma—that [pressure] put an emphasis on looking for opportunities outside pure property cat and would make it difficult for a company to adopt a strategy as a pure-play property catastrophe reinsurer,” says Rivaz.
It was not just the post-Katrina start-ups that were expected to build a balanced book of business. Existing Bermuda players also felt the pressure to find classes and markets that would complement their US property catastrophe exposures. Of the new capital that flowed into Bermuda after Katrina, much was put to use building up capacity in new areas. Some companies opted to enter the US excess and surplus lines market, while others turned their attention to the rest of the world, entering established markets such as Lloyd’s and Europe, and emerging markets in the Middle East and Asia.
"It was not just the post-Katrina start-ups that were expected to build a balanced book of business. Existing Bermuda players also felt the pressure to find classes and markets that would complement their US property catastrophe exposures."
At such a pioneering time for Bermuda companies, Lloyd’s began to look more and more attractive. The new appeal began with the resolution of Equitas. In late 2006, the market announced that it had done a deal with Berkshire Hathaway to transfer all Equitas’ liabilities to the US reinsurer, headed by the chairman of Berkshire Hathaway, Warren Buffett, the ‘Oracle of Omaha’. Under the deal, Berkshire subsidiary National Indemnity would provide initial cover of $6.2 billion, followed by a further $7 billion of reinsurance cover. The firm took on the staff and operations of Equitas, and responsibility for its orderly run-off.
For many, the deal signified the successful conclusion of a long and difficult legacy at Lloyd’s. At the time, Buffett observed: “Putting Berkshire Hathaway’s Gibraltar-like strength behind the remaining problems—which will take many decades to resolve—eliminates any remaining worries for all concerned”.
Lloyd’s attractiveness was further enhanced when Standard & Poor’s upgraded the market’s rating in April 2007 from ‘A’ to ‘A+’, citing “Lloyd’s strong competitive position, strong operating performance,strong capitalisation, and strong financial flexibility”. These endorsements helped to convince many Bermuda companies of the market’s solid position.
“Lloyd’s went through a lot of problems in the early 1990s, and then reconstruction and redevelopment absolutely changed its complexion,” says Adam Mullen, chief executive officer of Alterra at Lloyd’s. “With rating concerns, the market was under a lot of pressure. That’s gone away and the market has gone from strength to strength. The Franchise Board has done a great job in monitoring performance.”
At a time when the traffic between the two markets was increasing, many in the press were speculating about growing competition between them. Many of the Bermuda firms entering the market in 2007 chose to do so through strategic acquisitions. Validus and Ariel bought Talbot and Atrium respectively, both at multiples of book value. Class of 2001 firm Montpelier Re also entered the market in 2007, setting up Syndicate 5151 to underwrite non-marine property and engineering classes, and a limited amount of specialty casualty business.
Lloyd’s and Bermuda are complementary markets in many ways, believes Mullan. “If I was looking for two comparable markets, I would say Bermuda and London are very similar. People talk to each other in these markets—there are good communities. There are more deals being done in Bermuda than there ever used to be and the same applies to London—it’s just that London is on a far greater scale.”
Lloyd’s continued to draw new capital despite the onset of the financial crisis, with deals taking place in 2008, including Argo Group acquiring Heritage, Max Capital (now Alterra) buying Imagine, Ironshore acquiring Pembroke, and Flagstone buying Marlborough Underwriting Agency.
In May 2009, RenaissanceRe launched Syndicate 1458 in partnership with managing agent Spectrum Syndicate Management Ltd. RenaissanceRe then announced in June that it had agreed to buy the agency and its parent, Spectrum Partners Ltd. “Lloyd’s offers an established, strong brand, great access to business and efficiencies of operation, so having a presence there was very appealing to us,” says Ross Curtis, senior vice president and chief underwriting officer of European operations, RenaissanceRe.
“The desire of insurers and reinsurers to diversify has been reflected in the Lloyd’s market,” noted Aon Benfield in its report, Lloyd’s Update: Capital Positions. The report noted that Lloyd’s diversification of product line and geography, and its unique distribution capabilities were some of the attractions for buyers. “Diversification is always a topic of discussion within RenaissanceRe,” adds Curtis. “We are always looking for ways in which we can improve the efficiencies of our portfolio and capital management.”
When Max Capital completed the acquisition of Imagine Group, it gained access to a portfolio of specialty risks, including property catastrophe, financial institutions, personal accident, employers’ and public liability, and professional indemnity business. “There’s substantial distribution of business lines in Lloyd’s,” says Mullan. “It’s a huge market from a capacity standpoint and you can almost cherrypick the lines you want to enter, although you’ve got to be careful that you get the right teams.”
“The real benefit is the global distribution that you’re getting through Lloyd’s, and Lloyd’s has done a great job over time in actually making sure that those channels are open and they’re working,” he continues. “We’ve set up operations in Brazil through our Lloyd’s platform, and Lloyd’s really facilitated that and did all the negotiations with the local market.”
Port of entry
The choice to buy their way into the market, rather than set up a platform from scratch, made a lot of sense at the time, explains Mullan. “When we were looking at setting up from scratch, it was tough to get into the Lloyd’s market, and acquisition looked like the most obvious route. We considered prices to be generally high, but we believe we did a very nice deal acquiring the agency we bought. It was small and specialist and that’s what we liked—from that starting point, we’ve been able to expand out quite quickly.”
Acquiring an existing Lloyd’s business was also a convenient way of avoiding the headaches associated with the long notice periods that exist in the London market. It is not unusual for experienced underwriters to have an 18-month notice period, and that can prove limiting when looking to hire new staff. Those buying into an existing business have the option of finding existing synergies or acquiring a Syndicate with the intention of building out.
When Ariel acquired Atrium, its remit was to carry on doing what it had been doing (although Ariel subsequently changed direction and sold Atrium). For Validus, Talbot’s focus on specialty risks, including marine and energy, war, terrorism and political risks, direct property, financial institutions, contingency, accident and health, bloodstock and livestock, and treaty underwriting, was a complementary book of business that required little interference. “It would have taken a long time to put a team in place at Lloyd’s to do the same thing,” says Rupert Atkin, chief executive officer of Talbot. “It would have taken Talbot a long time to establish a presence in Bermuda.
“There is little overlap; it is very complementary,” he continues. “What we have added to our business is the ability to use ‘A’ or ‘A+’ paper (Validus is rated ‘A-’) and the ability to write direct business, because Validus is not licensed to do so. Half of the top-line income of the group is done through Talbot.”
"In terms of starting a new Syndicate, it's recently been an unwritten rule that people have to demonstrate that they are providing something fresh and exciting to the market, and they are not just recycling business at a lower price."
An additional challenge for entrants to the market looking to start from scratch is that they must convince Lloyd’s that they are bringing something new to the table, rather than simply adding capacity to classes where it is already plentiful. “In terms of starting a new Syndicate, it’s recently been an unwritten rule that people have to demonstrate that they are providing something fresh and exciting to the market, and they are not just recycling the business at a lower price,” says Atkin. “I think it’s very important that this principle is adhered to, because people are getting very cheap access to Lloyd’s licences and security.
“The opportunity to do another Talbot/Validus is very restricted,” he continues. “We were lucky with our split. The valuations probably don’t recognise the value of business at the moment. There are just not that many Syndicates of size that are willing to work for a Bermuda business.”
While the market has always kept capacity and pricing in check, there were undoubtedly fears that Bermuda companies coming into the market might poach teams of talent from other London market players and drive down prices in a bid to win new business. This is where the Lloyd’s Franchise Board comes in, with its remit to safeguard high standards of underwriting and risk management. “The opportunity for us is to leverage the hubs,” says Atkin. “It’s not to undermine the London underwriters.
“It’s important that Lloyd’s does continue to admit new entrants,” he continues. “I have my own view about how those new companies are charged for the right to do business, because I think we let people in quite cheaply. But it’s a very difficult issue, because working out the right price is virtually impossible.”
While many Bermuda companies now have a presence at Lloyd’s, the appetite for entry shows little sign of waning. In 2009, Montpelier Re formed a new Lloyd’s managing agent and, in June 2010, Allied World announced that it had gained Lloyd’s approval for Syndicate 2232 to begin underwriting. The Syndicate is managed by Capital Managing Agency.
“Lloyd’s wants to see something that is an additive to the market,” says Alterra’s Mullan. “They are not that excited at all about people looking to hire other Lloyd’s underwriters and taking business from other parts of the market. They also have fairly strong views on certain segments of the market and when someone comes in with a new business plan, they have to provide a convincing case. The most attractive initiatives bring non- Lloyd’s business into Lloyd’s—they’re more excited if you’re bringing in a type of business that Lloyd’s isn’t currently doing or a certain block of business that’s currently being written outside of Lloyd’s.”
As Bermuda re/insurers continue their love affair with Lloyd’s, the two markets will remain complementary, thinks RenaissanceRe’s Curtis. “Lloyd’s does occasionally have a more ‘transactional’ feel to it than Bermuda, but that also gives the market a natural vibrancy. Both markets have a strong appetite for risk, and given the number of companies that have a foot in both jurisdictions, it’s clear that the platforms can co-exist successfully.”
The flip side
The traffic between London and Bermuda has long been a twoway affair. As the lines between the major reinsurance markets increasingly blur, Bermuda Re asked Susan Patschak, chief executive officer of Canopius Bermuda Ltd and Canopius Underwriting Bermuda Ltd, and Barbara Merry, chief executive officer of Hardy Underwriting, for their perspectives on the importance of domiciles and moving in the opposite direction—from Lloyd’s to Bermuda.
Are the days of the exclusively Bermuda property cat reinsurer over for good?
Susan Patschak: I think they are and I also believe that if there is a big event, you will not see new start-ups, but you will see sidecars formed by current companies. Being resource-constrained and having the expertise already available in current companies, I believe the capital markets would prefer to give the money to established operations where it would be much easier to set up a sidecar.
The rating agencies and Wall Street do not want to support the monoline model anymore. However, diversifying into other lines of business is hard, because a cat event will not harden other lines of business. Our expectation after KRW [Katrina, Rita and Wilma] was that a hard market would be witnessed in all lines of business, but they did not harden because when the hedge funds came in, there was more than enough capital to support businesses. It was not a capital-constraining event for companies and, unfortunately, the casualty side of the business was not even affected.
Barbara Merry: Bermuda businesses are so well capitalised that if a cat focus works anywhere, it works in Bermuda. Pressure from shareholders (they are a rare breed if they understand and accept volatility) and rating agencies, and even regulators, that points towards diversification as a means of mitigating volatility, is much more the order of the day, and since a lot of business is now placed in local markets, a local presence is needed to secure access to diversifying risks.
Does a Lloyd’s reinsurer maintain its London flavour when it is headquartered in Bermuda or Luxembourg?
Patschak: For the agency piece of our business, we are tied to all of the Lloyd’s regulations, so in that sense, yes. It is as if we were sitting there in Lime Street. But in terms of brokers doing business with us here on the Island, we are viewed as a Bermuda market with the capability of writing on a Lloyd’s slip, if necessary.
I do not think of Bermuda and London as being in competition as much as in the past. Most of the markets here have a tie to London—today, it is much more of a co-ordinated effort.
Merry: I think it depends on two things, where the capital is and on the significance of the Lloyd’s presence. As far as the capital is concerned, if the Lloyd’s platform is being used and the Lloyd’s licences are being used internationally, then the focus would tend to be on Lloyd’s, whereas a separately capitalised reinsurance vehicle in an alternate jurisdiction would tend to detract from that.
Is market identity important for an insurance company’s brand?
Patschak: It was huge for us when we started and mainly due to the Lloyd’s affiliation, because the S&P and A.M. Best ratings that Lloyd’s possesses along with the ability of the Central Fund to pay claims were definitely a market advantage for us.
Merry: This links in very much with the previous question since a separate brand is largely not needed if the focus is on Lloyd’s. It might well be, however, if there is an interest in the retail market.
What factors are driving a reinsurer’s choice of domicile (or redomiciliation) and have they altered in recent years?
Patschak: They look at ease of entry and the ease of doing business. A lower tax regime makes it much more efficient for a company to use its capital. It is about having the extra capital available to utilise in building one’s business.
Merry: The key features are access to business and the business being well served by brokers. There is also the regulatory hassle factor and, of course, tax advantages.
Is competition between domiciles a good thing?
Patschak: Many of us on the Island participate in events that raise Bermuda’s profile because we want to support Bermuda. One of the big advantages of Bermuda is that we are a marketplace like Lloyd’s is a marketplace. Ireland doesn’t have that yet, nor does Zurich. Singapore does possess this characteristic. Even though you have the likes of Flagstone, ACE and XL moving their domiciles from Grand Cayman to Zurich or Ireland, their presence is still big here in Bermuda.
Merry: The basic principle is that competition is a good thing.
What are likely to be the most important reinsurance domiciles of the future?
Patschak: I think Bermuda is very sustainable with its proximity to the US and the large amount of expertise present here on the Island. As long as that marketplace exists, Bermuda is still going to be sought after, but if the US tax regime changes, that does not just change Bermuda, it changes all domiciles.
The client still wants to see who is reinsuring them, they want to see them face to face and they are going to go to the place where they can get the ‘biggest bang for their buck’. I was meeting with reinsurance brokers yesterday, and they were on the Island for a day and a half, and had 15 market meetings all within a mile’s radius.
The only place that could really become a new marketplace is Dublin. I do not know if their new regulator, who used to be here in Bermuda, will try and promote that in Ireland. Another new domicile that has been talked about is Puerto Rico. They have not however been able to market themselves as a truly viable alternative. They have the same tax environment that we have here in Bermuda and, again, they have the close proximity to the US and the connection to Europe.