Separating the wheat from the chaff

The annual Ernst & Young Property/Casualty Year-end Outlook Conference was opened by a panel of CEOs who noted that now is a tough time to be managing a Bermuda re/insurance company. Despite having achieved respectable profitability in 2010, Bermuda firms face such an array of challenges that self-preservation until better times, rather than aggressive growth, is likely to dominate management thinking.

Indeed, that was the impression reinforced by CEOs in a panel discussion at the event, staged at the Fairmont Hamilton Princess Hotel on December 9, 2010. The panellists—who included representatives from Alterra Capital Holdings Ltd, Endurance Specialty Holdings Ltd and Platinum Underwriters Holdings, Ltd—made it clear that there are times in the cycle when it is wiser for property/casualty companies not to pursue growth and this is one of them.

Companies’ margins are being squeezed from different directions. A copious quantity of surplus capital in the industry is exerting a downward pressure on pricing and industry premium revenue has been shrinking over the past couple of years. That makes underwriting profi tability a real challenge, while no one can rely on investment income to make a signifi cant contribution to earnings in these times of record low interest rates.

For reinsurers, there were certainly no signs of a turn in the market at the January 2011 renewals. According to broker Guy Carpenter, pricing for these renewals was down by an average of 7.5 percent, even after a year that had seen signifi cant insured losses from earthquakes in Chile and New Zealand, and the loss of the Deepwater Horizon oil rig.

Jonathan Reiss, a partner at Ernst & Young’s Bermuda offi ce and the moderator of the CEO panel, said: “Rates are still declining, but we know it has to turn at some point. When it will turn is a great topic of debate. A major catastrophe could do it, but it would need to be extremely large.”

"In order to stand out, companies need to show over time that they can underwrite safely, while simultaneously demonstrating an ability to grow."

Another factor in the mix for the Bermuda companies is the likely drying up of reserve releases from previous years. Ratings agency A.M. Best reported that during the fi rst nine months of 2010, the 18 publicly traded Bermuda companies it tracks recorded an overall combined ratio of 93.5 percent, indicating healthy underwriting profi tability. “The real story, however, is revealed by adding back the 7.1 percentage points of favourable loss-reserve development, increasing the combined ratio to 100.6 percent and cutting the return on equity to the mid singledigit range,” Best’s report adds. The CEOs who took part in the conference discussion panel likewise touched on the subject, with the consensus being that these reserve releases would dry up sooner rather than later.

The panellists see the current challenging period as a time that may separate the wheat from the chaff. And, in order to stand out, companies need to show over time that they can underwrite safely, while simultaneously demonstrating an ability to grow. Firms that achieve this are most likely to gain the confi dence of investors.

The shares of most Bermuda companies have been trading at a substantial discount to book value—another of the challenges evident throughout 2010. But, as the group agreed, the clouds are starting to clear as institutions that are the biggest stakeholders in most Bermuda insurers are starting to appreciate sustained success.

“It is still a fragile business environment,” said Reiss. “Bermuda faced—and continues to face—signifi cant challenges in maintaining its position as a leading insurance domicile. But we’ve witnessed an industry’s resiliency.” Two examples of this resiliency cited by the panel included the threat of potentially damaging changes to the US tax code, exemplifi ed by the Neal Bill and proposals by the Obama administration, which has probably waned since the US midterm elections, and the misdirected criticism of offshore fi nancial centres in the wake of the 2008 fi nancial crisis, which is not nearly so apparent now.

According to Reiss, Bermuda has addressed the criticism effectively by signing tax information exchange agreements (TIEAs) with more than 20 countries, under the auspices of the Organisation for Economic Cooperation and Development (OECD).

“There were many questions aimed at offshore financial centres, but most people understand that they were not the cause of the crisis,” Reiss added. “The actions of the OECD have led to a greater level of understanding of Bermuda. We are signing TIEAs because we want to be as transparent as possible. The more people have understood that, the more the external threats have subsided.”

However, there are also internal concerns for the Island’s international insurers. Reiss noted the cost of doing business continued to rise in 2010, particularly because of a hike in the rate of payroll tax from 14 to 16 percent, which adds considerably to the cost of employing people. Questions have also been raised about government spending and fiscal prudence.

Over the past four years in particular, Bermuda’s national debt has signifi cantly increased to around $1 billion. For a country with a population of little more than 60,000, that represents a signifi cant sum. However, the new Premier, Paula Cox, has promised to cut spending by $150 million— around 13 percent of the total government budget—in her fi

rst year. “Premier Cox has said a lot of really encouraging things,” Reiss said. “In recent months, we have seen many indications that the government is looking to make cost reductions.”

Corporate departures from the Island continued in 2010, with Flagstone Re and Allied World Assurance Company moving their holding companies to Europe. Regulatory challenges, particularly the imminent Solvency II rules being introduced in 2013 in the European Union, are part of the concern. However, the Bermuda Monetary Authority has made great progress in gaining third-country equivalence, and Bermuda’s selection as one of the fi rst wave of non- EU countries to be assessed on this score was seen at the conference, which was attended by some 230 delegates, as a very positive sign.

The panellists were also upbeat about Bermuda’s future, mentioning that the two key products sold in Bermuda—catastrophe reinsurance and large-risk insurance—remain among the most profi table in the industry, and that in turn sustains Bermuda’s viability, not just as a market but also as a domicile. In fact, the tone of the comments could have been called ‘bullish’ when it comes to Bermuda and many see things moving in a positive direction.

From Reiss’s viewpoint, Bermuda just needs to maintain its special ingredients. “The CEO panellists have been clear that the key for Bermuda’s success is to not lose what has made it special: fi rstly, its regulatory environment, which has a high degree of dialogue with business, and secondly, that it’s a true talent hub and an unparalleled place to live and raise a family.”