January 7th, 2009

Bermuda-Based Firms Persevere

Posted at 1:00 AM ET

Market Information Department, Guy Carpenter

Property and financial catastrophes, combined with earlier stock buybacks, reduced Bermuda-based (re)insurer shareholders’ equity over the first three quarters of 2008. Even with a 7.5 percentage point increase to the Guy Carpenter Bermuda Composite’s combined ratio and an 86 percent drop in underwriting profits, this group of 17 companies appears to have resisted much of the force of the financial crisis and Hurricanes Gustav and Ike. These carriers remain well-capitalized heading into 2009.

Shareholders’ Funds Fled, a Little

The Bermuda Composite lost 10.5 percent of its aggregate shareholders’ equity in the first nine months of 2008. Yet, within this group, results varied. Allied World Capital gained 1.5 percent and was the only firm with an increase in shareholders’ equity. Max Capital sustained the largest loss, 19.5 percent. During the January 1, 2009 renewal process, the Bermudian reinsurers were notably the most stubborn group when demanding more favorable prices, terms, and conditions (from the sellers’ perspective). This appeared to be due to the fact that the decrease in their capital was due more to catastrophe losses rather than the asset losses arising from the financial crisis.

Several factors contributed to the decline in shareholders’ equity. As a whole, the Bermuda Composite experienced a small net loss from underwriting results that were less favorable than expected. Net capital losses of close to USD2 billion and unrealized losses of more than USD1.3 billion also dragged this group’s performance for the first nine months of 2008. Financial market liquidity caused a substantial portion of the Bermuda Composite’s investment losses. Also, higher yield spreads for corporate and asset-backed bonds (relative to U.S. Treasury securities) have impacted shareholders’ equity.

The net outward flow of common shareholders’ capital in the first nine months of 2008 reversed an inbound trend that has lasted for several years. Members of the Bermuda Composite sent USD2.4 billion back to investors, edging out the total capital raised by this group. XL Capital accounted for most of the capital raised-USD2.2 billion in common equity and USD500 million in preferred shares-despite having repurchased close to USD2.4 billion of common shares over the same nine-month period. Since the end of the third quarter, though, most Bermuda-based reinsurers have suspended their share buyback programs because of financial market conditions.

Since XL Capital’s total assets accounted for 26 percent of the composite’s assets, its unique need for financing during 2008 produced a disproportionate effect on the composite’s aggregate financing activity. Without XL Capital, the net change in debt for this group of reinsurers was only USD22.3 million for the first nine months of 2008, net cash from preferred stock didn’t change at all, and net cash used to repurchase common stock was nearly USD2.5 billion. Yet, with XL Capital, net changes in debt and preferred stock were noticeable: USD325 million and USD500 million, respectively. Net change in cash from common stock pulled back to a decline of only USD221 million as XL Capital’s issuance of stock offset most of the Bermuda Composite’s buyback activity.

XL Capital reported total assets of USD44.6 billion and shareholders’ equity of USD8.7 billion at the end of the third quarter - representing 26 percent of the Bermuda Composite’s asset base and 17.4 percent of aggregate shareholders’ equity. The firm acquired such large amounts of capital this year because it needed to fund the execution of a master agreement to terminate reinsurance agreements and guarantees with Syncora Holdings’[1] subsidiaries.

Underwriting Stays Profitable, Despite Storms

Landfalls by Hurricanes Gustav and Ike late in the third quarter did not cost the Bermuda Composite its aggregate profitability. Even with losses avoided, however, underwriting profits are down 86 percent for the first nine months of 2008 relative to the same period in 2007.

Compared to the past five years, the Bermuda Composite’s underwriting results are not abnormal. Unusually low catastrophe losses in 2006 and 2007 make the first nine months of 2008 seem extreme. Material loss and loss adjustment expense redundancies were unusually low in 2006 and 2007 as well. Reserve redundancies reduced the Bermuda Composite’s combined ratio by 2.2 points in 2006, 6.3 points in 2007, and more than 7.5 points for the first nine months of 2008.

The effects of the financial catastrophe and the 2008 storm season are likely to increase demand for reinsurance cover. According to Highline Data, U.S. property and casualty statutory surplus dropped 6 percent through the first nine months of 2008. This has caused a loss of flexibility among carriers in this sector.

Increased demand for reinsurance, particularly after Bermuda’s 2008 share buybacks and dividend payments - and the year’s impairment of investment assets -┬ámay require firms in the Bermuda Composite to raise capital in 2009 (though the group believes it is well-capitalized already). If there is a spike in demand, adding cash to balance sheets could be an expensive proposition, with more than half of Bermuda Composite firms trading at or below book value.

Financial Catastrophe Averted, for Now

The 10.5 percent loss of shareholders’ equity is certainly uncomfortable, but it shows that the firms in the Bermuda Composite were able to withstand the full force of the global financial catastrophe. Bermuda exposure to volatile asset classes was relatively low. Rating agency requirements on the levels of capital at risk protected the carriers, ensuring that investment losses would not compromise underwriting activity for firms with major books of catastrophe business (and, thus, substantial liquidity needs).

The Bermuda Composite had about 23 percent of its fixed income securities in agency and non-agency mortgage-backed securities at the end of the third quarter, with another 6.4 percent representing other asset-backed securities (ABS), such as auto loans and credit card debt. As a percentage of total fixed income securities, ABS were down approximately 3 percent from year-end 2007. Subprime and Alt-A holdings represented just under 10 percent of the total mortgage-backed debt held by the Bermuda Composite (only about 2.4 percent excluding XL Capital).

Cash and short-term investments reached their highest levels since 2008 - in both absolute and percentage terms - by the end of the third quarter. The Bermuda Composite had 8 percent of its aggregate investments in this asset class at the end of 2003, an amount that reached 11.6 percent at the end of September 2008. Assets held in bonds dipped slightly from 55.8 percent to 53.3 percent, returning to 2003 levels. However, the duration of fixed income investments has shortened as we have learned from earnings calls and meetings with Bermuda Composite management teams.

Forays into the alternative investment space have been modest, and reinsurers in the Bermuda Composite are not heavily exposed to investments in vehicles, such as hedge funds and private equity funds. Alternative investments comprise a portion of the 3.8 percent of assets held in “other investments.” While this category has doubled since 2003 - alongside the boom in alternative investments - it declined slightly through the first nine months of 2008. If the financial catastrophe claims more hedge funds in 2009, as many expect, Bermuda-based reinsurers will likely not feel a large direct impact.

Overall, the reinsurers in the Bermuda Composite remain well-capitalized, even after a tumultuous year in the financial markets. Consequently, Bermuda-based reinsurers appear to have sufficient capital available to accommodate increased demand for cover this year.

Read Cats and Credit Push Prices Up: Global Reinsurance Review January 2009 >>


  1. Syncora Holdings was formerly known as SCA Holdings.
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