April 21st, 2009

Bermuda Update: Earnings

Posted at 1:00 AM ET

Market Information Department

The Guy Carpenter Bermuda Composite posted an aggregate comprehensive net loss of USD7.8 billion for 2008. The decline was driven largely by realized and unrealized investment losses of USD10 billion. Most reinsurers were able to generate underwriting profits, though they were substantially lower than in 2007 because of high losses from a busy catastrophe year and falling reinsurance rates. Fifteen of the 19 companies in the Bermuda Composite posted underwriting profits for the year.


The Bermuda Composite’s combined ratio increased 9 points to 94.6 percent, staying below 100 percent in 2008 only because of the release of prior year loss reserves. This does reflect deterioration from 2006 and 2007 levels - 84 percent and 85 percent, respectively - but is still a strong performance given industry insured losses and general financial market conditions. The first half of 2008 was particularly active for individual risk losses. The second half, of course, involved Hurricanes Gustav and Ike, the latter alone causing insured losses of USD11.5 billion and registering as the second largest hurricane in history.

Exposure control and product line diversification contributed to last year’s demonstration of the Bermuda companies’ abilities to generate underwriting results and showed a platform for growing future earnings.


As the largest company in the Bermuda Composite, XL Capital tends to drive the aggregate results. XL Capital’s combined ratio of 95.7 percent in a difficult year reveals its strong underwriting performance.


The Bermuda companies continue to release reserves from prior years. The releases were greater for the “Class of 2001″ companies, whose loss experience is now maturing to a point where they can start to rely on their own loss trends rather than those for the broader industry.

Bermuda Composite companies with higher Florida hurricane exposures reported favorable results last year, since Florida managed to escape the storm path once again. Other parts of the United States, however, sustained considerable damage. After causing losses of USD9 billion in insured losses in Texas, Hurricane Ike continued inland, adding USD1.1 billion of losses in Ohio, USD500 million in Kentucky, and USD330 million in Indiana — as well as other mid-western states. Pennsylvania, nowhere near the coast, incurred USD75 million of Ike losses! Hurricanes Gustav and Ike added 11 points to the Bermuda Composite’s combined ratio.


Writing primary insurance has helped stabilize earnings for Bermuda Composite companies. In four of the last five years, the reinsurance loss ratio was lower than the loss ratio for primary business. The loss ratio for primary businesses was below that of the reinsurance sector in 2005, offsetting the impact of disasters for companies with diversified primary and reinsurance books. In 2008, the insurance loss ratio increased six points to 66.8 percent while the reinsurance loss ratio increased 12 points to 62.6 percent.

The fact that the reinsurance loss ratio remained below the insurance ratio in 2008 was influenced by several factors. Insurance premiums for the composite companies grew by almost 9 percent in 2008, as many Bermuda companies continued their expansion and diversification into primary lines, while reinsurance premiums contracted 7 percent (some of which would have been rate declines). Further, many of the Bermuda companies suffered storm losses in their primary results, and reinsurers had a smaller share of the storm loss than in 2005, because Ike spread out and hit industry insurance companies within their retentions. According to the Insurance Information Institute, reinsurers paid 40 percent of hurricane losses in 2008 compared to 45 percent of losses in 2005.

Investment Returns

Aggregate Bermuda Composite investment income (as a percentage of premiums) more than doubled — from 9 percent in 2004 to 20 percent in 2007 — but the trend reversed in 2008. Investment income fell to 16 percent of net premium earned (NPE). This trend will continue in 2009, as lower investment yields impact full-year results in addition to carriers’ preferences for having a greater amount in cash and short-term investments on hand (albeit at lower yields) because of financial market uncertainty.


Capital gains as a percentage of NPE, which slid from the 2004 high of 2.6 percent to a slight loss in 2007, experienced a sharp drop in 2008 to 14.4 percent. As respects the Bermuda Composite investment section, Bermuda companies were of course impacted by both realized and unrealized mark-to-market losses of both equity and fixed income securities. The Bermuda Composite posted realized and unrealized investment losses of USD4 billion and USD6 billion, respectively.


Return on Equity

Most groups in the Bermuda Composite have a minimum target return on equity (ROE) of 15 percent. Before 2008, this objective seemed attainable. Two of the past five years were negative, though, which pulled the five-year average ROE from 14.5 percent (2003 to 2007) down to 8.7 percent (2004 to 2008). Only one of the fifteen companies included in the five year weighted average was able to achieve an ROE of above 15 percent.


The average ROE for the Bermuda Composite dropped to -3.7 percent in 2008, down from 17.4 percent in 2007 and 21.9 percent in 2006. In 2009, lower investment returns and the divesting of high-risk assets at a loss will continue to put pressure on underwriting results to carry any possible return to a more favorable ROE.

The Agenda for 2009

Undoubtedly, 2009 will be challenging for the companies in the Bermuda Composite. With the first quarter behind us, it is clear that capacity remains constrained, and the focus will be on the judicious management of available capital — rather than the quick restoration of balance sheets to late-2007 levels. Financial market volatility remains a concern, and the shift to more conservative investment assets — as a result of realized and unrealized investment losses in 2008 — will require heightened underwriting discipline to offset lower investment returns. A return to the 15 percent ROE target will require careful risk selection and a prudent hedging strategy.

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