Trends in the Bermuda ART market
By Michael J. Moody, MBA, ARM
Bermuda’s involvement in the world of insurance began in 1947, when C.V. Starr decided to form his new insurance company, American International Company, Ltd., on this small island. Further expansion of the island’s insurance roots came in 1960 when Fred Reiss began forming captive insurance companies here. Since that time, the Bermuda marketplace has flourished as a captive domicile. Many of the creative concepts in the captive arena were born in the Bermuda market. Everything from single-parent captives to large group captives found their way to Bermuda. They also pioneered the rent-a-captive concept as well as the agency captive.
Bermuda’s growing role in the insurance industry expanded further in the mid-1980s when the United States experienced significant market dislocation due in large part to liability insurance shortage. Bermuda saw the establishment of several new, innovative Marsh & McLennan lead group captives, called ACE and XL. Both were formed to provide excess liability for their owners. But as time passed, both companies have moved well beyond their original purposes. Today, they are among Bermuda’s largest insurers.
Another significant event in Bermuda’s insurance expansion came when Zurich Insurance Group formed CentreRe in 1988. CentreRe signaled a major change in direction for the Bermuda market. From here on it was clear that reinsurance was becoming a large part of the Bermuda landscape. This is a trend that continued through the 1990s as Bermuda worked to establish itself as the international reinsurance center.
Born of necessity
But it was not until Bermuda was pushed into service following several major disasters that it found its true calling. Insurance market issues following 9/11 proved to be a watershed event for Bermuda. A number of organizations were looking for cost-effective methods of deploying capital shortly after 9/11, and Bermuda soon found itself at the center of a rapidly growing insurance and reinsurance market. According to S&P, over half of the new capital that flowed into the insurance market following 9/11 went to Bermuda. In 2001, for example, 108 new insurance/reinsurance companies were formed in Bermuda. Many cite Bermuda’s flexible regulatory environment and strong infrastructure as reasons for locating there.
A similar flow of new capital occurred following Hurricanes Katrina, Rita and Wilma in 2005. In addition to more traditional insurance/reinsurance vehicles, the capital markets were looking for innovative approaches to effectively deploy their capital. As a result, Bermuda found a number of novel ways to allow hedge funds to participate in the insurance arena. In the last few years, a number of new alternative risk transfer (ART) methods have been introduced and have flourished in the Bermuda market. New capital market products such as catastrophic (CAT) bonds, industry loss warrants, sidecars, and other forms of insurance linked-securities have all become common in the Bermuda insurance market.
And for the most part, the financial results have been great. The Bermuda Monetary Authority (BMA) recently published the results for 2007. They showed increases in premiums, as well as growth in the capital base. The BMA noted, “Bermuda’s insurers had aggregate total assets of $440.4 billion,” which is a 33% increase from the prior year. Gross premiums also showed strong results, amounting to $115.8 billion for 2007, surpassing the prior year’s $110.7 billion. The BMA also indicated that a total of 71 new insurance/reinsurance companies were formed in 2007.
Soft market concerns
While it appeared quite unlikely just a couple of years ago, the lack of any meaningful catastrophic property losses over the past two years has caused the general insurance market to become soft. This softening market began in the liability area a couple of years ago and has reached the property market over the past 12 months. The January renewals for the 2008 policy period have shown meaningful, double-digit reductions across the board.
One of the most troubling problems for the insurance industry historically has been how to deal with over-capitalization. Much lip service is given to the concept of maintaining “underwriting discipline,” but when push comes to shove, few underwriters have the courage to stick to their guns. As a result, competition becomes strong. Obviously, it remains to be seen how the capital markets in general will react to the severe price competition that is a hallmark of a soft insurance market—and, more specifically, how the Bermuda market will react to this softening market.
At first blush, one would think that the capital markets would abandon the insurance industry in droves, leaving Bermuda to the tourists. But that does not appear to be the case. Obviously, there will be some retreat by the capital markets. Gone are the days when hedge funds arrive in Bermuda with sacks of money, but money is still flowing there. As noted above, 71 new insurance/reinsurance companies were formed in 2007. Some of the more exotic ART forms will probably have less involvement. For example, sidecars appear to have fallen out of favor; however, that was the beauty of ART approach anyway. Other products such as CAT bonds and other insurance-linked securities will likely stay for the short term. There are a number of reasons for the capital market’s resistance to retreat from the insurance market.
Advantages remain
One of the major draws for the capital markets to enter the insurance marketplace has always been the desire for diversification. Not just diversification, but as Alan Waring, president, Crump International, Hamilton, Bermuda points out, “non-correlated” exposures. Without question, Waring says, this is still a major draw for the capital markets. Many investors such as private equity funds and hedge funds are reassessing their positions following the sub-prime mess, and they are going out of their way to find investments that are non-correlated and unaffected by the results in the stock market. Waring says that even with falling interest rates, “Some investors are willing to take lower returns in exchange for non-correlated risk.” According to Waring, this will be one of the major reasons that the capital markets will remain interested and an active participant in the insurance industry.
There is one other issue that Waring points out about the current capital market’s involvement in the insurance marketplace. He says that private equity and hedge fund money is quite different from other forms of financing. Traditional methods of raising funds would likely involve selling stock, thus gaining shareholders. This, of course, sets the stage for the annual showdown at the stockholders meeting. Waring says this 12-month view of finance has been responsible for many decisions that may not always be in the best interest of the insurer/reinsurer.
“Hedge fund and private equity fund money is different,” Waring says. It can take a longer-term view and has a longer time to develop results. He notes, “So much of the current capacity is coming in from investors that are not associated with public stock.” He points to the case of CitiGroup that obtained funds from a sovereign debt fund that is under no pressure to resolve the Group’s financials in a one-year window. This use of capital markets in this fashion, “really represents a fundamental shift in the insurance marketplace.” And since convergence provides capital that is not tied to an annual shareholders meeting, insurance/reinsurance companies have the latitude to have a much more strategic focus.
Additionally, Waring notes, “Money is still flowing into Bermuda today. But,” he says, “it is different than before. Today it is not for insurance startups.” Today there are varieties of ways of making an adequate return on investment within the insurance industry. As a result, capital markets are finding new ways to convert investment into some form of risk-taking vehicle, frequently ones that do not tie up the investor’s funds for long periods of time. And since they are initially investment vehicles, they are much more successful at attracting more capital. One of the new ways that has been gaining traction is for reinsurers to “trade” risks with other reinsurers. For example, one underwriter will “trade” a portion of his Japanese earthquake for a portion of Florida windstorm. The major advantage of this approach is that they both gain an element of diversification.
Conclusion
It would be easy to think that the capital markets would be losing interest in the insurance industry during this downturn in rates, and while this is true to some extent, many capital market players remain. A number of factors account for this situation, including the search for non-correlated risks. As time goes on, Waring believes this will be the factor that will drive capital market participation. And certainly the Bermuda market will lead the way in this quest for innovative investment vehicles. *