April 23rd, 2009

Bermuda Update: Capital and Leverage

Posted at 1:00 AM ET

Market Information Department

The Guy Carpenter Bermuda Composite companies persevered in 2008, emerging comparatively unscathed from a turbulent year for financial services companies. In order to understand why, it is necessary to take a five-year view. From 2004 through 2007, the Bermuda (re)insurers managed capital and risk effectively … and were rewarded with healthy balance sheets and the ability to absorb the financial and natural shocks of last year.

Capital Depletion

The realized and unrealized losses included in net income and other comprehensive income were 13 times greater than the combined realized and unrealized gains reported in the preceding four years. Even under these conditions, the Bermuda-based carriers have shown continued strength over the past five years. The companies in the Bermuda Composite grew capital and surplus by approximately USD17.4 billion since 2004, with much of it coming from retained earnings. High returns in the low cat years 2006 and 2007 made the use of retained earnings to increase capital levels possible.


Capital levels declined for the first time in half a decade for the Bermuda Composite last year. In the past, carriers would have compensated for lost capital by raising more, but fallout from the worldwide financial catastrophe made this nearly impossible in 2008. Yet, the Bermuda Composite companies entered 2009 sufficiently capitalized, largely because they had had such robust balance sheets 12 months earlier. A steeper decline was obviated by this group’s cautious — though selectively optimistic — stance on current underwriting opportunities.

A Relative Increase in Leverage

The amount of debt carried by the companies in the Bermuda Composite did not change materially in 2008 Shareholders’ equity, on the other hand, fell 15.7 percent year-over-year. Consequently, the average debt-to-capital ratio grew to 17.6 percent - from 15.6 percent in 2007. The 2008 level is nonetheless fairly conservative.


Total liabilities dropped 3.7 percent last year, causing the ratio of liabilities to capital and surplus to reach 2.8 — up from 2.4 in 2007. This substantial increase in relative leverage is again the direct result of the decline in shareholders’ equity. Though 2008’s leverage position was much higher than that of 2006 or 2007, it is generally consistent with 2004 and 2005 levels.


Loss and Loss Adjustment Reserves

The adequacy of loss and loss adjustment expense reserves — overwhelmingly the largest component of net technical reserves — has been of particular concern in this capital-constrained environment. Though lower in dollar amount than in past years, some believe that any redundancies have been wrung out of these reserves in recent years. The largest redundancy reported in the last five years was USD3 billion, recognized in 2008 for the 2007 year-end loss and loss adjustment expense reserves. This far exceeds the USD2.1 billion for 2006 and USD728 million for 2005. Overly optimistic estimates of loss reserves may mute future profitability.

Poised for 2009 and Beyond

The loss of capital last year was undoubtedly serious, and the companies in the Bermuda Composite suffered alongside others from around the world. A strong capital position at the beginning of the year, though, prepared these (re)insurers for what turned out to be a tumultuous year. At the beginning of 2009, equity holdings were down, rendering these carriers more heavily leveraged than they have been since at least 2005. And, balance sheets will not be restored as easily — or as quickly — as in the past. For the near-term, at least, the companies in the Bermuda Composite will need to focus on managing the capital they have.

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