With a second straight year of benign loss activity contributingto a second year of record earnings, Bermuda insurers andreinsurers ranging from established old-timers to relative toddlersface an enviable problem--an embarrassment of riches.

Alan Murray, senior credit officer of Moody's Investors Servicein New York, described the situation that way as he highlighted"robust balance sheets and strong operating profits" among factorsleading the rating agency to put a stable outlook on the Bermudainsurance market.

"These companies have better capitalization than they've everhad, and their profitability is fantastic with no [major]catastrophes this year," he said. "With the stars seemingly allaligned, one might very reasonably ask: 'Doesn't this translate togood news for the industry?'"

"The answer is absolutely yes," he said, explaining the outlook,which reflects the view that the number of rating actions will bemoderate over the next 12-to-18 months.

The embarrassment of riches, he noted, accumulated in the wakeof huge catastrophe losses for 2005 and 2004, as companiesrecapitalized, prices hardened dramatically in catastrophe-exposedbusiness lines, and Bermuda market participants tightened theirrisk management practices.

"It's a happy conundrum to have--to be very profitable,well-capitalized and heading into a downcycle where you'reprobably, in general, starting to pare back your writings," Mr.Murray said.

Moody's published its report on the Bermuda market outlook backin September, and since then, most publicly traded Bermuda insurershave reported third-quarter financial results with record returnson equity, solid underwriting results and even stronger capitalpositions.

In total, 17 companies tracked by National Underwriter reportedoverall net income jumps of nearly 6 percent in third-quarter 2007,and 21 percent for the first nine months, while total shareholdersequity for the group rose more than 14 percent over the levelreported at year-end 2006.

Only four of the 17 companies reported third-quarter incomedeclines, with the biggest drops--for XL Capital andRenaissanceRe--coming from investment losses and markdownsattributed to turmoil in the credit markets.

On the underwriting side, with favorable loss developmentsbenefiting results for many of the selected companies, the averagecombined ratio for the group was near 82 for the quarter and thenine-month period--roughly unchanged from the comparable 2006periods.

The Bermuda firms now face the challenges of a softening market,and executives who say they'll reject underpriced business havealready started reporting shrinking top lines.

While overall gross premiums fell only 1 percent in the quarter,reports of declines in their reinsurance books of 20 percent ormore were not uncommon, and neither were discussions of a varietyof challenging primary insurance markets.

With more capital than they can use in the businesses they'realready engaged in, insurers and reinsurers said they stepped upefforts to expand into new lines and geographies during thequarter, and talked about plans to give back capital they can'tdeploy to their shareholders.

"Any companies at this point in the cycle [that] are notshowing...discipline, are not frankly admitting that rates aredeclining rapidly--and perhaps more rapidly than hoped--and are nottaking capital management steps, should have to explain why they'renot," said Richard Brindle, chief executive officer of Lancashire,during a third-quarter earnings conference call.

Lancashire, one of the youngest companies and the one with thebiggest jumps in income among the 17 companies reviewed--100percent for the third quarter and 200 percent for the year sofar--plans to give the majority of 2007 profits back toshareholders through the combination of share buybacks and a"strategic dividend."

"We're matching the capital to the underwriting opportunities,"said Chief Financial Officer Neil McConachie.

Speaking for one of the oldest Bermuda companies, PartnerRe CFOAlbert Benchimol also said his firm is giving back capital.Reporting year-to-date share buybacks totaling $152 million, henoted that from its inception, the reinsurer has now returned $1.6billion through dividends and share repurchases to commonshareholders. "This exceeds all common equity ever raised by thiscompany," he said, describing the company milestone during aconference call.

Articulating the second strategy at Montpelier Re, which hadbeen among the least diversified members of the class of 2001 witha property-cat reinsurance focus, CEO Anthony Taylor described atrio of diversification actions--in London, the United States andSwitzerland.

During Montpelier's third-quarter conference call, Mr. Taylorsaid that "we are first reacting to the change in the environment"after 2004 and 2005, in which "capital required to support givenpeak-zone exposures more than doubled. This encourageddiversification...geographically and by class."

In addition, he said, "the London market has rebuilt itself post9/11...Business today, particularly in the large commercial andspecialty arenas, is no longer automatically flowing to Bermuda asit did in 2002-2005 but instead is being retained and written inthe London market."

"We felt we needed to get closer to our clients and the sourcesof access to their business," he said, explaining that to do this,Montpelier first set up a Lloyd's syndicate to locally accessLondon market business, and next opened a marketing office in Zug,Switzerland, to access regional European business.

Finally, through a newly formed U.S. managing general agency,Montpelier seeks to access U.S. business with limited peak-zoneexposure via binding authorities to the Lloyd's syndicate.

"This is an important change of tactics for Montpelier and setsthe company on a broader path for the future," Mr. Taylor said in astatement. "We have concluded that now is the appropriate time toexpand our platform beyond the shores of Bermuda," he noted, addingthat the syndicate would write a small amount of specialty casualtybusiness in addition to nonmarine property and engineering.

Back in the summer, Montpelier said the MGA would acquire someproperty reinsurance business for the syndicate. More recently, inNovember, Montpelier announced it would buy a U.S. excess andsurplus lines company from GAINSCO to develop its U.S platformfurther.

STRATEGIES SCRUTINIZED

Strategic shifts in business mix and announcements of officesbeing positioned outside Bermuda--in places like Dubai and LatinAmerica--were a common theme of announcements during the quarter.(See related story, page 19.)

At Moody's, Mr. Murray told NU that as the market softens,attempts to break away from narrowly defined business strategies"are worthy of monitoring."

Mr. Murray said he's particularly watchful of companies pursuingthe U.S. E&S market. "Those of us that watched the evolution ofthe market in the late 1990s remember how the E&S market becamea target growth business for companies heading into that downcycle.A number of those either are no longer in the market or they foundthat it was a slippery slope," he said.

"A common denominator to look out for is companies that haven'tbeen in the E&S market that choose the onset of a downcycle astheir opportunity to enter for the first time," he added.

While Mr. Murray said he hasn't seen anything terriblyconcerning about the forays of Bermudians into the E&S marketthis time around, the next two or three years will be telling."After all, these companies may be big in Bermuda, but the E&Smarketplace here is established and there are other big names thathave their own strategies," he said.

"What happens in a market downcycle isn't entirely determined bywhat's in a particular company's control. There are a lot of forcesat work--and a lot of that may have to do with the fact thatstandard market companies are looking to defend their share ofbusiness in the marketplace," prompting them to also shift theiractivity to E&S.

Marty Becker, CEO of Max Capital--the first Bermuda insurer toenter the U.S. E&S market in 2007--said his company's E&Ssubsidiary, Max Specialty, has already seen market competition heatup on all sides.

"These aren't unusual facts," Mr. Becker told NU. "This seems tohappen every cycle. The standard lines companies become moreaggressive in what they're willing to write in their search forpremiums. So they will write some risks that traditionally havebeen in the E&S market. And likewise, existing E&S playerswill take a greater share of accounts. In the hard market theymight have written a $25 million line; in this market they mightwrite $75 million," he said.

For Max's age as an organization, "we actually probably were oneof the last ones" in Bermuda to enter the U.S. E&S market, hesaid, noting that Max has tended not to go into any segment whereit didn't have someone with a proven track record and afollowing.

Although industry veteran John Vaccaro is now leading theeffort, timing has been an issue for Max Specialty this year, Mr.Becker disclosed during Max Capital's third-quarter earningsconference.

"Year-to-date [E&S] gross written premiums will be less thanoriginally projected," he said, noting that Max Specialty, which isoperational in 46 states, is not up and running in the largeststate for E&S business--California--where a regulatoryseasoning requirement will delay startup until second-quarter2008.

In addition, he said electronic interfaces for real-time qualitycontrol of 43 MGAs are only two-thirds complete.

Despite these issues, "we would still likely have less premiumthan initially forecast," he said, noting that softer pricing andincreased appetites of some larger E&S players have made MaxSpecialty cautious about growing its E&S platform tooquickly.

REINSURANCE DOWN

While executives say specialty insurance price competition isworrisome, reinsurance businesses had the most pronouncedthird-quarter gross premium declines for the 17 Bermuda companiesreviewed by NU.

"Insurance and reinsurance both are having price declines, butwhat you also see on the reinsurance side is the insurancecompanies--your customers--buying less [reinsurance] because they,too, are having difficulty growing," Mr. Becker said. "If they buyless reinsurance, it helps them show more net premiums."

"This is classic cycle behavior," said Mr. Murray at Moody's."Especially after a relatively benign and very profitable twoyears, there may be a sense that there's less risk out there. Andbecause of shareholder expectations, managements do want to protecttop lines. The absolutely easiest way to do that is to changeattachment points of reinsurance programs."

At PartnerRe, CEO Patrick Thiele said that for the past twosuccessive Jan. 1 renewal periods, his company "started out 10percent in the hole" because clients had raised attachment pointson their reinsurance contracts. During an earnings conference call,he said these clients, with improved financial positions, sought tokeep more business rather than pay high reinsurance costs.

Looking ahead to Jan. 1, he said that actual proposed programsPartner has seen so far suggest this trend is abating, basing hisassessment on early discussions that recently took place at aconference in Baden Baden. Ceding company attachment points are nowat levels where any increases in loss frequency or severity hitthem first instead of getting into reinsurance programs, he said,referring in particular to the impact of second-quarter andthird-quarter U.S. storms that didn't impact reinsurers.

"That, combined with the idea that there is somemoderation--slow and gradual as it may be [in reinsurancepricing]--should lead to a slowing in the increase of attachmentpoints" in the United States and Europe, he predicted.

Mr. Thiele and others also reported "some beginnings of attemptsto have differential pricing" and terms for each reinsurer on asingle reinsurance program. "It's probably a little bit moreadvanced in Europe than in the United States," where a brokermarket predominates and brokers shy away from the administrativecomplexity that differential treatment introduces.

"The impact on the industry, I think, would generally be abeneficial, because at the moment...the lowest-rated reinsurer canhelp set the price--usually downward," Mr. Thiele said. "If asystem allowed high-quality reinsurers to charge a fair price forincreased assurance that would meet their financial obligations, Ithink that would actually be a good thing," he added, noting thatestablished companies would benefit.

MOST STRESSED CLASS?

However, even a CEO for one of the newest Bermudacompanies--Edward Noonan of Validus Re--said his company had beenthe recipient of differential pricing and preferential signings,attributing the favored treatment to the value clients put in thereinsurer's use of proprietary risk analytics.

While rating agencies such as Moody's and S&P both identifythe initially narrowly focused "Class of 2005"--on short-tailedbusiness lines--as the most stressed class of Bermuda companies,executives at Validus said the company is fully utilizing itscapital.

Asked if Validus will repurchase stock or pay a dividend thisyear, Mr. Noonan said, "we're not there today," during athird-quarter conference call. "We're not going to reach and try tofind a way to deploy [or] hold onto capital we don't need," hesaid, adding, however, that capital returns aren't likely untilnext late year.

At Lancashire--where Mr. Brindle said his company's good resultsare "a vindication of [a] centralized underwriting structure" thathas executives "convene daily" to review every risk put on thebooks--Mr. McConachie described a continuous process of capitalmanagement.

Noting that a $100 million share repurchase scheme has been putin place this year, the CFO also said that if results play out asexpected this year, Lancashire will pay out at least half of 2007profits in "a strategic dividend."

"We chose the phrase 'strategic dividend' because we felt [themore commonly used term] 'special dividend' implies a one-offevent--and I think that large dividends are something we will userelatively often through cycles in years to come," he said. "Theycould become a recurring part of capital management that you seehappening every year to match the capital to underwritingopportunities."

Mr. Murray said Moody's looks more favorably on sharerepurchases than dividends, because the latter tend to createshareholder expectations of capital returns, while buybacks aresomething companies can do more opportunistically.

"The bottom line is now companies are headed into the downmarket in both property and casualty lines, and they're looking tobalance their growth trajectories with their capital needs,consistent with their risk management guidelines. It's a balancingact," Mr. Murray said.