The state of the union
An inaugural panel discussion was one of the highlights of the Ernst & Young (E&Y) conference at the Fairmont Hamilton Princess Hotel. The Property/Casualty Year-end Outlook 2009, now in its 12th year, saw key figures from the Bermuda re/insurance market discuss the Island’s next chapter. Topics included the state of the industry, the challenges it faces, how it has dealt with the events of the past couple of years and what Bermuda needs to do to maintain success.
The following is a summary of the debate, which was moderated by Jonathan Reiss, a partner at E&Y’s Bermuda office.
Jonathan Reiss: How do you see the future for the Bermuda model, and what are the emerging alternatives?
Don Kramer: The real Bermuda model started in 1985 with ACE and XL. They were formed to write lines that people in the US and the UK wouldn’t write because of the volatility and because of the capital. So capital poured into the Island.
A big part of Bermuda is that we write that high-volatility business. In fact, Bill Berkley [chief executive officer of W.R. Berkley Corp.], who is now the leading enemy of Bermuda, lobbying for taxation for what he calls a ‘level playing field’, has admitted that he won’t write the high-volatility business because he doesn’t like the risk/return. But here we are at the end of the financial crisis and the Bermuda model has survived better than the other financial services, and our companies are now poised for what looks like a record year.
There are others that covet our success, but look how the Bermuda model has emerged. The greatest strength—and greatest weakness—of the Bermuda model was ease of entry. That’s good for the world market, because whenever there’s a tight market, capital flows in. When the market gets soft, we give back capital.
What’s happening now is that Lloyd’s, which was once hostile to Bermuda, is now integrating with Bermuda. Every one of the major Bermuda companies now has a Lloyd’s syndicate. Bermuda companies have branched out from writing the heavy-duty cat stuff. ACE has become one of the biggest insurance companies in the world.
The Bermuda model still has value, but at this point, with share prices so low, it’s difficult to see where new capital will come in. Market values for insurers are below book value and it would be very difficult to raise money—even after some form of heavy catastrophic loss. Those of us who came in after Katrina in 2005 have done well, but it’s unlikely that we’ll see new capital flow right now.
If you look around at others that covet us, there are Switzerland and Dubai—which really wanted to get something like the Bermuda model. But they were missing something that we had and that’s a pool of talent located there. And the key to sustainability of that model will be the talent housed here in Bermuda. If you lose that, then you’ll lose the capital flow and you’ll lose the business.
But right now, I feel confident. We’ve had the US tax threat from Berkley and the Neal Bill, but I think we’ll overcome that. The evidence so far is that we’ve done well, although we can’t take it lightly.
They think they can’t get extra money from us and they think we’re a tax-free jurisdiction. We just had the British foreign secretary David Miliband here. A group of us from the industry met him and we tried to point out that we have an economy here of 65,000 people and a government with a billion-dollar budget—the money has to come from somewhere. Although the taxes are collected in a different way, we’re still raising the revenues to support the Island.
David Brown: If you look at how Bermuda has succeeded, it’s been in response to shortages. In times past, the only way to do it was to set up new companies, and Bermuda was the quickest and most efficient place to do it. I have a feeling that the Class of 2005 was one of the last big waves like that. The barrier to entry now is not so much regulatory and speed; it’s now rating agency-driven. The rating agencies are much tougher now with new companies; standards have been raised and it’s going to be more difficult.
The other thing is that there are other ways for capital to enter the market, through sidecars, for example. So when we have a demand, capital may flow in through sidecars, rather than new companies.
Jonathan Reiss: Bermuda has traditionally been the jurisdiction of choice for new company formations and new capital to address supply/demand imbalances. What will the responses to the imbalances of the future look like?
Neill Currie: The key to any of the questions we’re likely to hear today is the same: it’s the people. The reason why Bermuda is successful today is because we have good infrastructure and good people. If you look at some of the other jurisdictions—they don’t have the infrastructure, the underwriting talent, nor the distribution network that we have here. When you add it all together, the key is that we have talented people.
If there is a market dislocation, are people going to come and set up new companies here? Probably not. These guys that set up in 2005 are very good companies. But you look at RenaissanceRe, and we are selling at a very paltry 1.08 times book value, while some of my brethren in here are selling below book value—that’s crazy. These companies ought to be selling at a multiple of book value. With that being the case, Ithink it will take a very large dislocation for people to go out and start a new company. I think people will set up special purpose vehicles themselves and sell fully collateralised insurance or reinsurance—and they’ll do that because of the rating agencies. A specific monoline approach is not going to get you a good rating. But they can say: “Forget about the rating, because we’ve put up collateral—and people will buy our product because there’s collateral.”
At RenRe, we’ve been very fortunate in setting up partnerships, joint ventures and sidecars. We have a joint venture with State Farm, Top Layer Re, where we write international reinsurance. We’ve just had our 10th anniversary with that venture and we think it’ll be here forever. We also have DaVinci Re and that’s a neat vehicle, because people can come in and out at book value, based on their needs. That’s got about $1.2 billion, but we can increase the capital based on need. And we also have special vehicles such as Starbound I and II and Tim Re, which were put together just to help solve a problem for our clients.
We embrace volatility and a lot of our clients want to get rid of volatility, so it’s a happy marriage. I doubt that new ventures will be started—I think we’ll see more special purpose vehicles or people will come to one of us and utilise our talents for a short period of time.
Peter Porrino: We were talking earlier about ease of entry, but ease of exit may not be so easy. So that’s just one more reason why Neill’s exactly right—don’t expect to see a lot of formations.
David Brown: When we started up our first company, we didn’t need a rating. You’d get one after three or four years, but nobody really cared. As an industry, we’ve put this power in the hands of the rating agencies and it’s impossible to get it back.
Jonathan Reiss: With big regulatory changes coming with Solvency II, the Bermuda Monetary Authority (BMA) is striving to achieve regulatory equivalence. Is this a threat to the efficiency of the Bermuda market? Are we shooting ourselves in the foot?
Peter Porrino: I don’t think there’s any choice. I’ve never talked with any company that’s thinking about redomiciling because they think the regulatory environment is going to get too stringent. A lot of industry pundits talk about rating agencies being the de facto regulators. And to some extent, that’s true, because of the amount of capital they require to be held. That is much more onerous than anything regulators are requiring, so what is there to be afraid of?
It’s essential that the BMA keeps to the path it’s going down. Ease of regulatory burden is not what the companies that this Island can be most proud of are focused on. It’s about being in a place that people from around the world see as being a stable environment with a great regulatory structure.
Regulatory equivalence will only succeed if the marketplace works with the BMA and does not view this as a compliance exercise, but as something that needs to get done. As long as major companies embrace the BMA’s efforts, I think this is going to get done.
David Brown: There were concerns a few years ago about the regulation here. The response was that we have the best-run companies and the most solvent companies—let’s have the regulation to reflect that. It was the ABIR (Association of Bermuda Insurers and Reinsurers) that said to the BMA: “Let’s make our regulation the best in the world and the most forward-thinking.” So we were not just participants, we were initiators. There’s a very different atmosphere with the regulators here compared to other jurisdictions.
Peter Porrino: I don’t know how this is going to work out, but I think it will be pretty hard for the Europeans to say that Bermuda isn’t up to standard but the US is—because US regulation will look pretty antiquated by that time.
Jonathan Reiss: Many Bermuda companies that used to have the majority of their workforce in Bermuda, have an increasingly global footprint. Is this inevitable in an increasingly globalised economy? And what are the challenges for the companies and for Bermuda arising from this?
David Brown: There are three major factors involved. First, globalisation of the business. In the Bermuda model of the past, you could operate a monoline company here and the business you wrote was business that came to Bermuda. That’s not necessarily good use of capital and, certainly, the rating agencies don’t consider it efficient any more. So there’s been a tendency for companies to diversify their business. A lot of business you can’t write in Bermuda—you can do it from Switzerland, London or the US, and you have to be there to write it. Once you have an office in another place, when it comes to adding an accountant or lawyer, you can put those people in either office.
The second thing is that technology has become so enabling. I remember as recently as 2003, we formed something called ‘Bermuda Connect’, so that companies could communicate with each other by email. We didn’t use the Internet because people didn’t trust it. Nowadays, you get submissions electronically from brokers; all kinds of information comes in by email. So it matters less where you sit when you process that information. Also, the way you can relate to people through video-conferencing and smartboards has made a huge difference to how you interact with people. Just a few years ago, it was basically the phone that you were using.
Cost has made a difference. Just a few years ago, I remember standing on this stage begging the government to do something about telecommunications. At my company—we had about 120 people globally in those days—we spent $3.8 million on telecommunications globally. Fully half of that was the cost of the lines out of Bermuda. What we spend today is a fraction of that.
The third thing is that the talent pool we can access now is enormous. With my previous company, the pool was all the people who lived in Bermuda, all the people in our business who had the skills and were prepared to come and live in Bermuda, and who could get a work permit. It was a relatively small set of people. We compete against the world, so we need world-class talent. Now we can get talent from around the world.
We have an office in India and we can get the best people there, and the same applies to Nova Scotia, London, Switzerland and Puerto Rico. That makes my access to talent far greater and, in many cases, far cheaper.
"Regulatory equivalence will only succeed if the marketplace works with the BMA and does not view this as a compliance exercise, but as something that needs to get done. As long as major companies embrace the BMA's efforts, I think this is going to get done."
What really matters for Bermuda is the talent that’s here already. The reason why people come here isn’t so much about whether companies are based here, from the capital point of view, or whether they’re using sidecars, or where their back office is, it’s that business keeps coming to underwriters sitting in Bermuda. That phenomenon is what’s paying the salaries of the people sat in this room. As long as business keeps coming here, that’s what’s going to keep Bermuda working.
Jonathan Reiss: In the aftermath of the economic crisis, governments are increasingly involved in your marketplace. How is that going to impact the business?
Neill Currie: I hate to admit that I was wrong about nine months ago. I thought we’d be sitting in a nice environment with pretty hard rates right now. But we’re in a somewhat soft market. The main reason I was wrong was that I thought the financial crisis would create all sorts of opportunities.
You’ve had a couple of good quarters where the assets have rebounded back. Plus you’ve seen the government backing of some organisations. Those organisations want to keep their business. Other companies want to take that business, but with the government backstop there, people will probably accept policies there that maybe they wouldn’t have done nine months ago.
The other side of it is that we, for example, deal with organisations such as the State Cat Fund in Florida. It is there. So we work with it. I’m pleased to see they’re weaning off it slowly, so that the Cat Fund is reducing the amount of coverage it offers and private enterprises are coming to the fore. There’ll always be an ebb and flow between governments and private enterprise, whether it’s in the US or internationally.
David Brown: Governments come and go, and their interests change. I’m sometimes cynical, but I think the one thing you can rely on governments to do is screw it up. When they get involved in health care, education and insurance, they always mess it up. Governments have illustrated everywhere in the world that they’re not very good at competition. Eventually, the private markets tend to take over. In the long run, it tends to devolve to the most efficient way of doing things, which tends to be people driven by capital market motives.
Don Kramer: There’s been a movement in the US towards a federal insurance office. Up until now, the US has had state regulation and that’s probably been one of Bermuda’s biggest assets, because state regulation is so dysfunctional, while here you can write global programmes. A few years ago, I remember Eliot Spitzer shouting at Congress: “You can do things in Bermuda that you can’t do in New York!” What he didn’t say was that you can do things in New Jersey that you can’t do in New York.
Peter Porrino: Right now, there is not as much momentum as there was six months ago. So I think state regulation for property and casualty insurance is going be around for longer than a lot of the big companies would like.
David Brown: If we get away from state regulation, I think that, as an industry, we’ll start to lower the cost of the product we provide right down the chain.
Neill Currie: State regulation just adds frictional costs. It’s archaic.
Peter Porrino: What you need to avoid is the worst of all worlds, which is if you split it so that prudential regulation is done federally, but consumer regulation is done state by state. That would be a mess.
Jonathan Reiss: What is the major lesson you’ve learned from the economic crisis?
Neill Currie: That you have to assume that bad stuff happens on your watch, not somebody else’s. I think that’s what happened to the Wall Street guys. They were leveraged at 35 to one. They’re usually more short-term oriented than the insurance and reinsurance types. We take pride in our ability to pay claims.
We at RenaissanceRe don’t do a lot of things, because we think something really bad might happen. I’ll give you an example. We fared pretty well after 9/11. Our losses were pretty low. That’s because we were concerned about the earthquake probability in New York City. So we limited our exposure in New York—not because we thought planes were going to fly into the World Trade Center, but because we were thinking of an event that does not happen very frequently. You just have to try to limit the number of bad things that can happen to you.
Don Kramer: What we all learned was that, for the first time, we had a confluence of financial meltdown and catastrophic losses. In the past, we had seen either one or the other. We came through pretty well, but we learned a lot about asset management. A lot of us had reached out into hedge funds and alternative investments, and many of us have pulled back from that. So I think we’re co-ordinating our investment risk and underwriting risk better going forward.
David Brown: The bad tail correlation was the lesson we learned. Of the 15 asset classes we monitor in our portfolio, 14 went the wrong way at the same time and that had never happened in 25 years. I don’t think that was built into anybody’s models.
Peter Porrino: You can’t delegate risk. The CEOs can’t delegate how they think about risk to their companies. The companies that have really commanded this crisis well—uniformly they had CEOs who owned the risk. They are the only ones who really see the whole corporation.