Standard & Poor's non-life insurance rating outlook

Standard & Poor's non-life insurance rating outlook
Although Standard & Poor's outlooks on the US property and casualty industry and the global reinsurance industry are both negative, the outlook on Bermuda is stable. Aggregate underwriting losses in Bermuda persisted in 2000, but most rated organisations have made strong cases for their improved positioning for future underwriting profitability. Standard & Poor's remains cautiously optimistic and believes the ability of the Bermuda-based competitors to improve overall performance is strengthened by Bermuda's flexible regulatory environment and highly competitive arena.

The largest market participants have sufficient scale and spread of risk, and – not unimportantly – they have demonstrated management acumen. These factors are expected to continue to allow above-average performance. The smaller markets are taking greater steps to hedge their exposures by using retrocession, consolidating with stronger parties and partnering with other companies that have complementary competitive advantages. Notwithstanding its limited scale resources and tight labour market, Bermuda's international (re)insurance market is robust and continues to evolve successfully and seemingly at a faster pace than the global average.

The insurance market
Bermudian insurers weather weak the global market better than most

Bermuda's place in the global (re)insurance industry continues to grow. Throughout the industry, the easy earnings and low catastrophe activity of the mid-1990s have been replaced with expansion and hard-won market positions in Lloyd's, global property reinsurance, finite reinsurance and other markets. However, although Bermuda's fortunes ebbed and flowed with the rest of the markets in 2000, one could conclude that Bermuda's fundamentals were more robust than the weak global industry conditions.

Bermuda is setting the stage for future growth in life reinsurance and, potentially, structured products with the implementation of the Segregated Companies Act 2000. In addition, Bermuda persists as the locus for innovation and creativity in what those in other segments of financial services might consider a less-dynamic sector. Bermuda has helped to make (re)insurance more interesting for investors, underwriters, service providers and other market participants.

In 2000, the entire market benefited from limited natural catastrophe activity worldwide. According to Swiss Reinsurance Co.'s sigma research, insured catastrophes in 2000 totaled $10.6bn (£ – ($7.5bn ($5.1bn) from natural causes) – which was about one-third of the $28.6bn (£19.4bn) of insured catastrophe losses in 1999 ($24.4bn (£16.5bn) from natural causes). In 2000, only the Tokai floods event is expected to cost insurers $1bn (£680,000) or more.

Notwithstanding, Bermuda was not immune to the adverse development from prior-year loss events. Some property writers bolstered reserves for the late 1999 storms Lothar and Martin; others corrected deficiencies from broad-based property and casualty premium underpricing for the 1997 to 1999 accident years. In addition, there were strategic repositionings and joint-venture undertakings in an attempt to build organisational strength and market presence while sharing risk.There were also problems – including a $460m (£312m) reserve strengthening recorded by Overseas Partners (OPL), the placement of Terra Nova (Bermuda) Insurance Co. into run-off, ongoing losses at ESG Re and the post-year-end announcement of changes at Heddington Insurance, which will cease operation as an independent company.

Market profitability has decreased significantly, especially in light of strong growth in premium volume and low catastrophe activity. Bermuda's aggregate underwriting loss in 2000 increased to $740m (£502m) from $507m (£344m) in 1999. Over the past two years, loss and loss expenses incurred have increased 151% from the 1998 level, with net premium earned up 120%. However, overall profitability is not actually as bad as the aggregates suggest – without OPL, the aggregate underwriting loss falls to $215m (£146m), about half that of 1999. Fewer than half of the surveyed companies are reporting underwriting losses in 2000, compared with 65% in 1999.

ACE and XL Capital (XL) continue to dominate the rankings of Bermuda's top reinsurers. ACE captured first place, with earned premium of $4.5bn (£3.05bn), total assets of $31.7bn (£21.5bn) and net income of $543m (£368m). However, XL continues to have the largest amount of shareholder's funds: $5.6bn (£3.8bn). The dominance of these two companies within the Bermuda market continues to grow and they now represent 53% of both earned premium and assets, 46% of capital and 89% of market earnings (61% excluding OPL). This is increased from about 40% of earned premium and net income and 34% of capital in 1997.

Line-of-business shifts flow from premium growth
Market line-of-business data is increasingly challenging to parse. Growth in 2000 was heavily skewed by the gross premium increase at ACE reflecting a full-year rather than a half-year contribution from the INA (CIGNA Corp's property and casualty operations) acquisition and a full year of revenue from the former Capital Re Corp. ACE is responsible for two-thirds of Bermuda's $3.8bn (£2.6bn) increase in net premium written, including most of the aggregate gross written premium growth in financial guarantee, marine and aviation, accident and health, property and workers' compensation.

Finite writings increased by 91% in 2000, with a strong contribution of $410m (£278m) from Max Re, one of the newest companies in the market, and a $170m (£115m) increase at Scandinavian Reinsurance Co., a seasoned participant. OPL also made a splash, with $62m (£42) of finite premium written. Life revenues are up nearly ten-fold from 1997 to 2000 to $424m (£288m), with Annuity and Life Reassurance, Partner Reinsurance Co. and Enterprise Re contributing to the growth over that period. Standard & Poor's cites the favourable regulatory and tax environment in Bermuda (as with other offshore markets) as a factor contributing to the growth in life reinsurance revenues in 2000.

ACE and XL both increased their excess liability writings markedly in 2000 after reductions in this line of business in prior periods. In the property sector, the large players dominate, perhaps signalling a flight to quality. The rate of growth of property premium at the three largest writers (ACE, XL and Renaissance Reinsurance) far exceeded that of most other participants.

Improved share prices driven by expected premium rate hikes
Earnings were down in 2000, but stock prices fared well and with premium rate increases flowing into earnings, the prospects are improved over where the market stood at year-end 1999 in the wake of the European storms and Y2K fears. The S&P Insurance Index advanced 37% in 2000, while the Bermuda Stock Exchange Insurance Index increased 88%, with all but the poorest performers benefiting from increased investor interest in the sector. Improved prospects have not yet translated into earnings. It remains to be seen whether the price increases and tightened terms garnered over the past 15 months are sufficient to restore underwriting profitability.

Growing number of registered insurers
As reported by Bermuda's Registrar of Companies, the market had a modest increase in registered international insurers in 2000 to a total of 1,538. However, there was a significant change in the composition of the registry, with fewer class 1 and 2 (single- and multi-owner captive) companies. These reductions were offset by growth in long-term and composite licensees, reflecting the emergence of Bermuda's life reinsurance market. Bermuda has attracted participants from around the world, including Brazil, the Netherlands and South Africa, though the US remains the dominant player. There were fewer re-domestications of professional (re)insurers in 2000, but new registrants included a wide range of captives (including “rent-a-captives”), finite companies and health care captives.

Wider geographical spread of risk continues
The North American reinsurance market is not declining. Rather, Bermuda companies that report geographic information are growing non-US premiums far more rapidly than they are within North America, with revenues from Europe, Asia, London and the rest of the world constituting 36% of 2000 premium volume, up from 20% in 1996. London market growth has also levelled off considerably. Following high expenses and poor results, PXRe disposed of its Lloyd's syndicate during the year. Inter-Ocean Reinsurance Co. also recorded a dramatic shift in regional focus, with Europe constituting 88% of 2000 premium (92% including London).

Reduced catastrophe exposure, increased underwriting losses
In the past decade, Bermuda's underwriting losses paralleled the frequency and severity of property catastrophes. The winds of change have brought a range of causes for underwriting losses. Rather than blaming Mother Nature, the twin threats of underpriced premium and loosened contractual terms and conditions squeezed profit margins and contributed to higher aggregate underwriting losses. Diversification before establishing in-house expertise has been another negative impetus.

Realised gains from investments have contributed significantly to investment earnings and net income over the past four years. During this time, equity investments constituted an average of one-fifth of period-ending invested assets (higher if synthetic portfolios were allocated appropriately), but declined to 13% of the aggregate invested assets of Bermuda survey participants in 2000. With the 10.1% decline in the S&P 500 index in 2000 (amplified by the 12.9% decline through March 16, 2001), market participants are experiencing the cost of volatility. Though no one admits to trying to time markets, the reduction in equity exposure is hardly accidental and is particularly evident in some of the larger investment portfolios. The reductions in equity exposure might also signal a reduced willingness to accept volatility on excess capital, particularly as those excess amounts have been reduced by poor underwriting results.

Bermuda's property catastrophe sector
Trenwick International and PXRe are evolving franchises, with the merger of acquired companies (Trenwick merged with LaSalle Re and Chartwell Re Corp.) and with the development of new lines of business at PXRe contributing to challenges as well as increased opportunities. PXRe, Trenwick and IPCRe each offset low catastrophe losses with strengthened property catastrophe reserves. Partner Re's performance was hampered by reserve additions in the fourth quarter and its top-line growth was depressed by the disposition of its US life franchise in mid 2000. Notwithstanding, operating performance was strong at Partner Re and significantly improved from 1999, which was heavily affected by catastrophes. PXRe has elected a more radical restructuring over the past two years, which included diversification into casualty lines, the Lloyd's Market, diversified international reinsurance lines of business and finite risk. Despite Standard & Poor's negative outlooks, each of these organisations expects improved performance from strengthening rates.

LaSalle Re is now part of the Trenwick franchise, but its core property catstrophe business has performed similarly to IPCRe's over the past few years. LaSalle's earnings deterioration in 1999 and 2000 reflected both catastrophe losses and reserve increases on diversified lines. When faced with deteriorating operating performance, strategic alliances beyond those in place became attractive compared to going it alone. As part of a larger entity, the merger provides LaSalle Re with the opportunity to focus on property catastrophe risk selection on a larger capital base. IPCRe historically returned higher dividends, rather than diversify or otherwise deploy capital and, while dividends were withheld in 2000, its share price has improved at year-end, with market value approaching book value, up from just 77% of book value at year-end 1999.

Partner Re established a prominent market position in its specialty lines of business through acquisition but paid a price in terms of operating returns. Performance in 1999 and 2000 has been lower than historical levels because Partner Re added to reserves for 1999 and was also one of the few to report large losses for the fourth quarter in its surety, aviation and property businesses. Moreover, Partner Re consciously decided to diversify into more traditional reinsurance business and away from property catastrophe. As with traditional companies, Partner Re's margins have been under pressure from expanding terms and conditions and soft pricing.

Compared with its peer group of specialty property catastrophe writers, IPCRe and Renaissance Re are the two players left to go it alone, with largely monoline franchises. For IPCRe, the strategy proved successful through 1998, with a historical return on equity (ROE) of 18% for the period from 1995 to 1998, but returns have fallen to 4.5% over the past two years because of the high levels of 1999 accident year catastrophes. IPCRe's five-year weighted average loss ratio of 55.3%, with an average expense ratio of 21%, makes for strong average operating performance. Key factors for IPCRe are whether the trend toward higher catastrophe rates persists in the absence of large natural catastrophe losses and whether its clients consider its narrow focus a benefit or a limitation.

RenaissanceRe Holdings (RenRe) posted above-average operating results without the drain from prior-year events and it is emerging as a clear industry leader in the underwriting of property catastrophe risk. RenRe posted an impressive ROE that averaged 18.3% through the cycle. ACE Tempest Reinsurance also avoided reserve deficiencies, contributing positively to reported results at ACE. ACE is diversifying its reinsurance operations at Tempest from property catastrophe and is expected to grow with increased underwriting of related and third-party multi-line reinsurance. RenRe has leveraged its underwriting strength and developed a fee business, which should support ongoing growth and superior profitability during a hardening market.

XL had a transition year in 2000. Management undertook a strategic expansion in the financial sector to establish financial guarantors (XL Capital Assurance and XL Financial Assurance) and its weather derivative company, Element Reinsurance. XL also increased its ownership of Latin American Reinsurance Co. to 100% as part of a strategy to exit its interest in Risk Capital Re. XL has diversified by sector, with just less than half of its business generated from insurance operations and more than half from reinsurance operations. XL posted fourth-quarter charges for the restructuring and integration of its US, London Market and Lloyd's operations, but not of a magnitude sufficient to affect its financial strength. The ratings on XL continue to benefit from extremely strong capital adequacy, broad business diversification and low financial leverage.

ACE has gained a significant financial guarantor following its acquisition of Capital Re, but the big story in 2000 on ACE has been its strong operating performance throughout the global enterprise. Neither the market nor Standard & Poor's expected the former CIGNA property and casualty operations to generate consistent underwriting profitability so soon after their acquisition. Fundamentals throughout the ACE organisation are strong, even in the absence of the large capital gains that had bolstered results over the past three years, with very strong operating performance across all business lines.

Underwriting income of $205m (£139m) is at a historical high for the company and, except for OPL, for surveyed companies over the five-year period. Renaissance Re is a strong second in 2000, with underwriting income of $83m (£56.3m) on a much smaller revenue base. Credit derivative losses in ACE Financial Services and management changes in the international arena might present new challenges for management to overcome in 2001. Both ACE and XL are performing well, compared with their peer group on the global market, with very strong ROEs and underwriting margins on increasingly diversified franchises.

Troubled times for some companies
Standard & Poor's downgraded Mutual Risk Management (MRM) following the company's reserve strengthening because of lower operating earnings. The stable outlook on MRM is based on Standard & Poor's expectations of improved profitability. MRM's difficulties stem from its high reliance on third-party reinsurers and the poor performance of business reinsured. It is an old problem, heightened by the magnitude of industry-wide underpricing as well as the reinsurance leverage at MRM's US operating companies. It spotlights the cost of giving the pen to third parties and also signals a much wider and emerging issue of slow payments on the part of highly rated reinsurers.

OPL's transformation began in October 1999 with the cancellation of its shipper's risk business, which had been core to the franchise since its founding in 1983. OPL's net loss of $558m (£378.5) plus treasury stock purchases reduced its capital by 30% to $1.78bn (£1.21bn). Premium volume fell even more dramatically (39%) to $500.7m (£339.7m). The company formed a joint venture with RenRe to assume property catastrophe risk and organised a finite underwriter in 2000. The acquisition of Reliance Reinsurance Co. and the acquisition of a team of finite underwriters from Stockton Reinsurance (Stockton) is giving the company a credible finite underwriting ability.

The new strategy reflects a desire to create a credible, independent reinsurance company. OPL has also benefited from what has been a stable shareholder base.

Stockton generated significant top-line growth in fiscal 2000 (ending in March), because of its 1999 purchase of the Crowe Insurance Group. Premiums from Lloyd's of $378m (£256.4m) exceeded total premiums for 1999, with a year-to-year increase in gross premiums written of 146% to $569.4m (£386.3m). This growth offset a modest decline in finite writings and has changed the franchise from one dominated by reinsurance to one split almost evenly between direct and reinsurance premium. Stockton's use of reinsurance protection is high, so net premiums written grew by 111% to $331.7m (£225m). Underwriting losses, coupled with lower investment earnings, contributed to a net loss of $33.8m (£22.9m) for the year. Stockton's invested asset risk remains high, with equities and other investments constituting 56% of invested assets compared with 62% in 1999 and even with the level held in 1996.

Centre Reinsurance continues to demonstrate a robust growth in revenues, with gross and net premium written up 16% and 55%, respectively, but profitability continues on the downtrend, with a 112% weighted average loss ratio over the past five years and 114% in 2000. Standard & Poor's believes traditional measures of profitability are less relevant when assessing Centre's operations, given the company's sensitivity to contract structure. Notwithstanding, return on equity is down considerably for 2000 to 3% from an average of 22% over the prior three years because of lower earnings.

Commercial Risk Reinsurance Co. provides non-traditional and alternative-risk products worldwide and has a high concentration of premium volume in workers' compensation, largely written through its US arm. The company is a key alternative risk transfer operation of SCOR, the largest reinsurance group in France and the tenth-largest reinsurance group globally. In Bermuda, the company writes weather derivatives and other capital markets-oriented products. Commercial Risk has reported a steadily increasing loss ratio over the past five years and a higher combined ratio (108.5% in 2000) despite higher volumes reducing the expense ratio. Investment earnings continue to bolster earnings, with a high 10% investment return, up from 4% in 1999. Enterprise Re is reporting good results for 2000, its third full year of operation, with a modest underwriting loss reflecting a high expense load.

Standard & Poor's Sovereign Ratings
Publication date: February 24, 1999
Analysts: Morgan Harting, New York (1) 212-208-5784;
Marie Cavanaugh, New York (1) 212-208-1579
Credit Rating AA/Stable/A-1+

The ratings reflect Bermuda's:

  • ongoing achievements in attracting and retaining offshore financial services companies (largely insurance and increasingly investment management) that in turn support upscale tourism and a growing business services sector and underpin solid economic performance and high income per capita
  • strong fiscal position, as evidenced by modest deficits and a general government debt burden of less than 10% of GDP, although fiscal flexibility is limited by competitive pressures compelling low tax and fee burdens, the government's preference for offshore funding and medium-term expenditure pressures in education and pensions
  • net external creditor position, which mitigates the territory's high import dependency and narrow, albeit rapidly growing, export base
  • stable monetary management through the Bermuda dollar being held at par with the US dollar since 1972. This arrangement limits flexibility, but has fomented little pressure because of the importance of the US in Bermuda's offshore financial services and tourism industries.

    The ratings are constrained by Bermuda's narrowly-based, highly open economy, which leaves it vulnerable to external shocks, such as tax, regulatory and other cost developments in competing jurisdictions. The diversification of Bermuda's offshore business from captive insurers to a broader range of insurance and financial management products has been impressive, but both offshore business and tourism face continued challenges in maintaining and building shares in these competitive markets. The domestic banking sector has been profitable, but reported non-performing loans have increased to 6.2% of lending at mid-1998 and significant related lending suggests that asset quality may be weaker than reported.

    The stable outlook reflects the expectation that the key economic and export sectors of offshore business and, to a lesser extent, tourism, will continue to grow, supported by a favourable policy climate, and that the linkages to the domestic economy will strengthen. The Progressive Labour Party (PLP), which recently formed a government for the first time, has become more centrist in recent years, articulating its commitment to maintain a regulatory and tax environment conducive to attracting international business. The PLP government's February 1999 budget continues to emphasise cautious management of public finances, albeit with more emphasis on education. Changes in immigration practices also may be in the offing. As long as the competitive advantages of conducting business in Bermuda are preserved and the government does not stray from its track record of fiscal prudence, downward revision of the ratings is unlikely. Upward revision of the rating is constrained by the fact that the island's small economy is relatively undiversified, compared with more highly rated sovereigns, leaving it more vulnerable to shocks.

    This article was previously published on Standard & Poor's RatingsDirect on May 29, 2001. Prior to this a version had been published by Bermudian Business and is reproduced here with Bermudian Business's permission. All rights reserved.

    Bermuda insurance analyst contact:
    Karole Dill-Barkley New York (001) 212 438 7167

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