Where do we go from here? (Ernst & Young outlook)
Twenty eleven was the type of year which used to spur the formation of a wave of new reinsurance companies in Bermuda. Tens of billions of dollars in industry capital were destroyed in a string of catastrophic events, most notably earthquakes in Japan and New Zealand, a brutal tornado season in the US, Hurricane Irene and floods in Thailand and Australia.
Despite the catastrophe activity, Bermuda did not see a ‘Class of 2011’, at least not in the traditional sense of conventional new reinsurers setting up shop on the Island. What did happen was the formation of a string of insurance-linked securities (ILS) in Bermuda. Perhaps a sign of things to come, in terms of how new capital willenter at times of dislocation, ILS was the hot topic of conversation at the Ernst & Young Ltd. P&C Insurance Outlook 2011 conference, held at the Fairmont Hamilton Princess on December 8.
The event, which was billed The Road Ahead and which attracted some 250 delegates, featured a panel of some of the ILS market’s major players, including Greg Hagood of Nephila and Beat Hollinger of Munich Re Capital Markets. Their fellow panellist Don Kramer is also getting involved in this side of the business, with his new asset management company ILS Capital Management Limited. When Kramer spots an opportunity, the Bermudians sit up and take notice. With his history as a serial starter of companies, including NAC Re, Tempest Re and Ariel Re, Kramer’s track record makes him something of an industry elder statesman in Bermuda.
According to Jonathan Reiss, former partner and insurance sector leader for Ernst & Young Financial Services in Bermuda, Kramer’s instincts appear to be spot on once again. “ILS is the area of growth in the market and we’ve seen a real uptick in activity since the summer,” Reiss said. “In the last five months, I’ve fielded more calls about potential new business activity than in the previous two years.
“There is interest in cat bonds, insurance loss warranties and also in traditional reinsurance structures built by hedge funds. When you combine all of this activity, there is real growth potential.”
"Bermuda is claiming a bigger share of new business, helped by the new SPI classification and its unparalleled on-island concentration of catastrophe reinsurance expertise."
The catalyst for this growth was a change to Bermuda’s regulatory regime in 2009, which added the ‘special purpose insurer’ (SPI) classification. This created a solid legal and supervisory framework for ILS vehicles. SPIs are reinsurers that fully fund their obligations in advance, usually for a single transaction or a single customer. They can be used to facilitate insurance-linked securities, including catastrophe bonds, or sidecars. Financial regulator the Bermuda Monetary Authority (BMA) had licensed 23 SPIs as of mid-December last year, a marked acceleration from the eight licensed in 2010. Many of them have listed on the Bermuda Stock Exchange, the world’s largest offshore, fully electronic securities market. Listed ILS were expected to exceed $3 billion by 2011 year-end.
The Cayman Islands had previously been the biggest offshore draw for ILS, but now Bermuda is claiming a bigger share of new business, helpedby the new SPI classification and the fact that it has an unparalleled on-island concentration of catastrophe reinsurance expertise. What may add to investor confidence is the boosting of the island’s international reputation through the Bermuda government’s signing of tax information exchange agreements with 30 jurisdictions, including all the G7 nations.
Reiss says Bermuda is still the best place to put insurance capital to work in a timely fashion. “Bermuda has a brilliant reputation and speed to market, and there is no other jurisdiction that can offer that combination,” he said. “Some have one of them, but nobody else has both.”
Among the sponsors of cat bonds issued in Bermuda in 2011 were major property and casualty insurers such as Chartis and Munich Re. Also on the list was Electricite Reseau Distribution France, the company responsible for the distribution of 95 percent of France’s electricity, and the California Earthquake Authority, which issued the $150 million Embarcadero Re cat bond.
Hedge funds including Third Point also declared to investors their intention to set up Bermuda reinsurance companies perhaps in anticipation of a hardening in rates following the erosion of industry capital. CatCo, which was established in late 2010, is also operating in the convergence space and reported strong growth in its first year. CatCo manages assets that it invests in collateralised reinsurance.
“Bermuda continues to play a major role when there is a need for new capital,” Reiss said. “There has been capital erosion and there is certainly less capital in the market than there was 12 months ago; the pricing environment is not necessarily great. The next time there is a crisis that demands a new addition of capital, then Bermuda will still be the best place to do that.”
Could a break-up of the eurozone be the upheaval that causes the next capital crunch for the industry? “It is impossible to predict what will happen in Europe, but there will probably be some destruction of wealth and some dislocation,” Reiss said. “And Bermuda has always been the place to help solve problems.”
Another feeling evident at the conference was that this is a tough period for the industry, riddled with even more uncertainty than is normal for those dealing with catastrophe risk. A panel of actuaries threw up some interesting opinions on the macro factors that will influence 2012 for reinsurers.
XL Group’s global chief actuary Susan Cross specified growth, interest rates, inflation and the eurozone as matters on her mind. Low growth was putting pressure on insurers’ top lines, she said, and was effectively increasing competition in the marketplace. The sustained period of record low interest rates had squeezed investment returns and thereby put more pressure on underwriting operations. This created an environment in which insurers could differentiate themselves through their underwriting excellence.
Cross was mindful of the risk posed by the threat of inflation, with central banks around the world printing money to inject life into their flagging economies. “We are seeing a low level of social and judicial inflation, as well as price inflation,” Cross told delegates. “But those trends can change almost overnight and that’s what caused the last big liability crisis in 1985.”
Cross said there was enormous uncertainty surrounding the future of the eurozone, but added that insurers should “take the time now to plan for various contingencies such as if one or more country defaults on its debt” and the implications for the assets and liabilities sides of their balance sheet.
Solvency II is another European factor that will have implications for Bermuda. The new rules for insurers, due to be introduced in the European Union in 2013, are causing headaches and expense for companies, some of whom have formed teams working exclusively on Solvency II compliance. The BMA has made good progress with its efforts to earn “third-country equivalency” with Solvency II, and should it achieve that aim, Bermuda companies ought to avoid being competitively disadvantaged in the EU market.
Michael Barkham, London-based partner in Ernst & Young’s Property and Casualty Actuarial Group, spelled out the industry’s feelings that Solvency II involved “massive cost and massive effort” and that “everybody’s pretty fed up with this”. “There’s a cost-benefit issue,” Barkham said. “Everyone is spending a lot on this, but I’m not sure we will get the benefits, particularly in the short term.” The strong focus on Solvency II projects was diverting the industry’s attention away from the major and emerging risks it had to deal with and that “cannot be good risk management”, he added. While striving to understand risks better was a positive feature of Solvency II, Barkham warned that an over-reliance on models could be a consequence. “It’s important that we don’t get seduced by models,” Barkham said. “Just look at what happened to the banks. Models are not a substitute for good risk management.”