Rush-in roulette: a dozen startups steam into Bermuda and pump more than $8 billion of fresh capital into the industry by the end of the fourth quarter. But rising to the surface, in the midst of the January renewal season, are questions about their credit quality and commitment to the market
The fourth quarter of 2005 in Bermuda was like a pot of oil at its furious boiling point, all sizzle and spit, fizz and pop. Frantic energies were unleashed, billions of dollars were in the air if not, necessarily, in the bank. Heads were spinning as the wild dance unfolded. In Bermuda, “this year,” more than ever, is an anagram of “hysteria.”
The 2006 Bermuda renewal season, acted out in the fourth quarter of 2005, sparked comparisons with two epochal developments. The Island’s future, people began to acknowledge, is to become the Singapore of the 21st century. The present, however, felt like a rerun of the past: the California Gold Rush.
The tally to date: half a dozen companies lost or presumed lost; existing giants badly wounded; a dozen new companies; staff poached more regularly than eggs, leaving underwriting departments depleted, housing tighter than the skin on a hot dog; capital rushing in to grab a share of the action.
THE WALKING WOUNDED
The shake-up was preceded by a doleful period when Katrina and Rita–and the unexpectedly expensive coup de grace, Wilma–did in the smaller companies in the Bermuda market. Almost everyone with less than $1 billion in capital went down.
Alea entered into runoff and sold its renewal rights to various companies in the United States and Europe. Olympus Re, which had capital of about $650 million on Dec. 31, 2004, owed its principal treaty partner, White Mountains, $706 million nine months later. Rosemont Re, the rump of Goshawk in London resurrected as Ariel Re (see story on page 21 for details on new companies). PXRE Re Group recovered from the brink with a $300 million CAT bond and a subsequent $700 million shelf registration. Quanta Capital Holdings stopped writing property catastrophe altogether to rethink its business model. The firm promptly lost senior staff.
And finally, Western General Insurance, owned directly or indirectly by the Pritzker family of Chicago, entered into runoff, knocked out by Katrina.
Interestingly enough, not one of the companies exiting the market or restarting from scratch was from the Class of 1993 or 2001, the two waves of capital that established Bermuda as the world’s go-to reinsurance market. But that is not to say that companies in either class escaped punishment.
Some well-regarded big fish took a shellacking. XL Capital followed a third-quarter billion-dollar hurricane loss with an expected fourth-quarter loss of $830 million. The cause of the first was Katrina. The second, more punishing, loss was the result of arbitration with Credit Suisse over the valuation of the reserves of Winterthur International, which XL had purchased in 2001 and for which it had apparently overpaid.
Worse off mathematically was Montpelier Re. It lost a net $972 million, about two-thirds of its capital, to Dennis, Katrina and Rita. Montpelier raised an emergency $600 million to tide it over, even as it counted its losses of $75 million to $85 million from Wilma. Fitch marked the company down a total of three notches to BB, but Montpelier president and CEO Tony Taylor, seeking refuge in relativism, was philosophical.
“It does rather depend on what happens to the whole market,” he says. “If the whole market (were) B-rated, then it would be a good rating.”
RenaissanceRe extended its miserable recent run. After 10 flawless years during which the company was the very paradigm of sound reinsurance management, the company found itself bereft of financial and intellectual capital. CEO Jim Stanard and Senior Vice President Stephen Cash departed under the threat of civil prosecution.
XL Capital, RenRe and Montpelier had been exemplars, within the waves of insurance companies that arrived in Bermuda in 1986, 1993 and 2001, respectively. All three will probably recover in one form or another, but considerable ground has been lost.
XL and Renaissance have their own giant buildings in Hamilton, and Montpelier’s is almost complete, reinforcing the traditional dictum that companies will do just fine until they build a brand-spanking-new home office. Only then do they start to sputter.
For the survivors, one- and two-notch downgrades, with credit watches all-around, were the order of the day, sometimes even after capital had been recharged. None of the Bermuda majors will, by the looks of things, turn a profit in 2005, and very few, if any, avoided ratings downgrades.
Four hurricane landfalls in 2004, followed by four more in 2005, albeit in a less condensed timeframe, have proved to be an industry-changing event.
Among the survivors, ACE appears to have fared as well as anyone. Arch Capital Group fared less badly than many, as did White Mountains Group. Everest Re said it would produce a “modest” loss in 2005. Overall, with the exceptions noted above, the bigger the company, the better it coped with a traumatic quarter. The surviving majors raised about $10 billion in the fourth quarter, and will add to that total in the first quarter of 2006 as their loss reserves worsen.
In 1993, eight property-catastrophe companies were formed in Bermuda and provided the world of commerce with a valuable service. Twelve years later, property-catastrophe insurance is regarded as a liability. Perhaps the nature of reinsurance has changed, after all.
Nigel Clark, president of Carvill (Bermuda), thinks so. “New and dynamic forces are being applied from various outside sources that will change the face of parts of our business forever,” he says.
“Such changes will undoubtedly produce challenges for many, but the opportunities to help manage this transition are many and varied.”
The late arrival and unexpected ferocity of Wilma chewed up the reinstatement premiums, which are the cost of an insured’s contractual right to renew coverage if an event, such as a hurricane, exhausts a policy’s original cover.
Few companies, if any, offered reinstatement on their reinstatement policies, so many insureds thus ran out of coverage after Wilma and spent the last six weeks of the hurricane season–and the rest of the year–naked, desperately hoping that an earthquake did not hit.
One underwriter who discussed this curious aspect of how insurance works added: “And, of course, you know that December is earthquake season.” Earthquakes have no season, but things were so crazy, we almost believed him.
What are other causes of all this mayhem? The cycles are off: crises in 1993, 2001 and 2005 have produced three hard markets in 12 years. Either history is speeding up, or the very notion of one-in-100-year, or even one-in-250-year events appears flawed.
Not too long ago, much of reinsurance was calculated on the back of a cocktail napkin. Today, computers outnumber people at many of the biggest reinsurers, yet the outcome is little better.
“The modeling is very sophisticated,” John Berger, CEO of startup Harbor Point Ltd., told Risk & Insurance[R] in December. “The mistake is that people believe the model output. The model is a way of testing a hypothesis, but there is always the chance that it’s wrong. It’s very difficult to model property per risk, for example. (With the use of the models), the level of mathematical intellect is clearly up; now the users have to take a step up.”
It was widely bruited by other reinsurers that the commercial catastrophe models were broken. Bad data, they said. The inability to wiggle the approach vectors built into the models hampered accuracy, they argued, and led to widespread underestimating.
The modelers defended themselves vigorously, of course. Deductibles at many giant commercial enterprises are tiny and desperately need resetting, they said. Our position, 10 years into the upcurve of a 30-year hurricane cycle, calls for at least a 40 percent rate hike, the rating agencies weighed in, just to compensate for the increased frequency.
The initial talk in September was of premium increases in the 300 percent to 400 percent range. The salivating slowed somewhat when a capitalist mob appeared from London and New York to cash in on the boom.
GOLD IN THEM THAR BILLS
Just as Wilma hit, taking catastrophe losses for 2005 above $50 billion, Jeffrey Greenberg, who had resigned from broker Marsh & McLennan as New York Attorney General Eliot Spitzer’s first big scalp, announced that a new reinsurance company, Validus Holdings, would involve him in Bermuda, where his brother Evan runs ACE.
Even their father, the recently deposed AIG supremo Maurice “Hank” Greenberg, was rumored to be “in the market.” At first, he was supposedly buying XL Capital. He owned $14 billion of shares in AIG, the math went, and had control of $18 billion of AIG stock via Starr International Co. That much money could only mean that he would form a new giant in Bermuda, people said. The general view was that he must be up to something–well, he would, wouldn’t he? At the age of 80, even after being deposed from AIG, Greenberg remains the most interesting man in the business, even if he is not actually in the business.
After the announcement from Validus, Don Kramer came out of retirement to announce the formation of Ariel Reinsurance.
Then another new company was announced, and another, then some more and, finally a full-out charge: About a dozen new companies or configurations have thus far appeared on the Bermuda stage in the fourth quarter, each promising to deliver clean capital. Much of it, when it arrives, will be hedge-fund money.
The obvious question was whether all this new capital was too much, and whether it would dampen rate increases.
“The jury is out on whether the substantial rate increases (will stick),” Harbor Point’s Berger said. “Demand is going up; there are new pressures from the ratings agencies; people are doubting the assumptions on frequency, severity and demand surge. It’s too early to say.”
The new companies formed in Bermuda late in 2005 are expected to add 250 staff, and maybe more, on the island by next year. With most Bermudians who might be interested in the reinsurance sector already employed there, most all the additions will be expatriate workers, on two- and three-year contracts.
By early November, the rush was on with a vengeance.
Everyone who wanted to write into the renewal season had to have their feet on the ground and their underwriters at the desks, burning the midnight oil as soon as possible, or sooner.
Underwriters don’t grow on trees, but they are thick on the ground in Bermuda–thicker, per capita, than anywhere else on the face of the planet. Some were even underground, two at least staying in Bermuda executives’ basements, telecommuting while their work permits wormed their way through the immigration labyrinth.
Buying a few underwriters did not present much of a problem to anyone offering sign-on bonuses, 30 percent salary hikes and the lure of stock options in a potentially explosive new enterprise. Career-changing offers were good for two or three days at most: sign up or make way for someone who would.
IS THIS FOR REAL?
Not everyone observing this scene took the long view. Two main objections were front and center.
First: How much of all this is real, here to stay? Standard & Poor’s was not rating the new companies until their financing was in place. The argument, not made directly by S&P but inherent in their stance, was that maybe some companies were announcing their intent before the money was on hand, in the hopes that a snowball effect might encourage yet more investors to jump in.
As late as the middle of December, what was sorely missing from the barrage of press releases was confirmation that the money was in place.
Weighing in on the Class of 2005, Fitch Ratings says it would be difficult for the majority of the Bermuda startups to achieve ratings in the ‘A’ range as premium rate hikes for catastrophe-exposed property were not expected to occur outside a handful of specific geographic areas.
In addition, Fitch says, it’s not clear that such rate increase in the property sector will last very long.
“Thus, to the extent the market opportunity leading to the formation of the Class of 2005 is narrow, and ultimately proves to be short-lived, this adds greatly to the uncertainty these reinsurers face in successfully executing their business plans,” Fitch writes.
For its part, A.M. Best was willing to rate the newcomers, but only after a visit to the new companies’ offices. An unseasonable cold snap on the Eastern Seaboard may not have been the only factor in this decision. Risk & Insurance[R] tried visiting a few offices, too, to discover that one or two of the new names were simply that: names on wooden plaques.
Robert Childs, the chief executive officer of Hiscox Bermuda, was the only one to make the rounds and introduce himself to the local media, lie had offices, desks and some people, but candidly admitted that he didn’t yet know how to operate his new telephone system, which was more than could be said for a few other CEOs, who weren’t even answering their phones.
The Bermuda Monetary Authority does not issue licenses until a portion of the funds are in the bank, but the stark truth is that if you have the money, you make sure everyone knows it. That did not seem to be happening beyond a few companies. It is fair to assume that reputable insureds will be asking for proof of financial capacity.
The other doubt in some minds was expressed in a perennial question asked about new arrivals that may have greater relevance this time around: how strong is their commitment? A view widely expressed, in light of the sheer quantity of new companies, was that some of them might be short-term plays. Get started; write a bunch of short-tail business, especially catastrophe risk, in the hope of a relatively light year or two; make a bunch of dough; close.
Indeed, ratings agencies and some consultants have already questioned whether Bermuda has the requisite depth of managerial talent, or can attract it, to keep companies afloat over the long term.
“The biggest issue will be the availability of good reinsurance underwriting executives who have the experience necessary to produce profits from the reinsurance business that is offered to them,” says Andrew Barile, a reinsurance industry expert retained to evaluate investments in reinsurance company startups.
Many executives with the new startups are coming from large reinsurers and don’t have much experience with dean slates.
“The next issue is, can they succeed in a market of dislocation where they need to execute with speed as existing reinsurers are getting downgraded?” Barile also says.
The Class of 2001 was funded by venture capital, insurers and banks. Venture capital is a naked play: it arrives, it grows, it leaves to carry on its important work elsewhere.
The $8.5 billion promised by the 2005 crop of companies so far has been seeded in good part by hedge fund managers, following a strategy established earlier by Moore Capital (Max Re), Ritchie Capital Management (Ritchie Re), Soros Fund Management (Glacier Re) and Citadel (CIG Re).
But hedge funds have been broadening their appeal for several years now. Ten years ago, few outside financial circles had even heard of them. Now, following some spectacular successes and even more egregious failures, hedge funds have $1 trillion in assets and in the process demonstrated an appetite for more traditional risk.
Hedge fund managers, some burned by significant claims from the 2004 and 2005 hurricanes, will likely not be shy about using their clout, perhaps in some form of equity participation in straight reinsurance.
At the same time, reinsurers have suffered through several years of sideways markets and lousy interest rates. Their appetite for risk had increased too, right up to August 29, 2005, when Katrina started undoing all the industry’s preconceptions.
In 2004, Bermuda’s reinsurance market wrote more gross premiums than the London market for the first time. That condition must now be considered permanent, with a fistful of London companies, armed with old and new capital, thinking about moving to Bermuda.
“The (British) government has never made one move to do anything but tax the insurers,” says Robert Hiscox, chairman of Hiscox pie. “They’ll never back a winner, and now the London market is drifting away to better financial and regulatory climates.”
All these new companies and historical precedent suggest, however, that a wave of consolidation and merger and acquisition activity must
follow in 2006. For the smaller arrivals and probably for some of the larger ones as well, a feeding frenzy will erupt in the warmer months next year.
Here’s why. The eight property-catastrophe firms incorporated in Bermuda in 1992 and 1993 after Hurricane Andrew were acquired down to three in a process that began four and a half years after their formation. The post-Sept. 11 companies are now four and half years old as well.
Add to that stiff staff and housing markets on the Island; the general operational strain this season, which may take until February to complete; and the likelihood of worsening reserves for the 2005 hurricanes in the fourth- and first-quarter results ahead.
Second-level Bermuda companies such as PartnerRe, Arch, AXIS and others have grown their old money and added new, and are or will soon be ready to make the jump to level-one status with major acquisitions.
A wave of consolidation is a likely outcome.
ROGER CROMBIE is a columnist for Risk & Insurance[R]. He also covers issues on alternative risk. He can be reached at email@example.com.
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