Bermuda Carriers Work To Shake Off Probes, Legacy Issues

While two Bermuda insurers each announced attempts at an individual renaissance this year, the reinsurer bearing the name "Renaissance" fell under a cloud of scrutiny during the first half of 2005.

For RenaissanceRe, a string of events that began with accounting restatements announced in February culminated in the early-July resignation of a senior vice president, who refused to accept a Securities and Exchange Commission subpoena, and the receipt of a "Wells Notice" by the chief executive officer, James Stanard, by the end of July.

The Wells Notice recommends a civil enforcement action against Mr. Stanard for alleged violations of federal securities laws linked to the restatements, which corrected the timing of recognition of reinsurance recoverables and recognition of premium ceded on multi-year contracts.

While the restatements shifted $21 million of income into 2001 and $22 million out of 2002, the three-year impact was zero for the period from 2001 to 2003. Adjustments for three quarters of 2004 boosted income and shareholders' equity (which now stands at more than $2.8 billion) by $12.5 million at Sept. 30, 2004.

The Wells Notice, and subsequent private lawsuits and rating agency watches, like graffiti on a Botticelli, marred what otherwise would have been a good quarter for one of Bermuda's most consistent performers. RenRe's historically low combined ratios are attributable to its largely property-catastrophe focus.

While RenRe experienced the most premium growth and combined ratio improvement among Bermuda companies in the second quarter, Standard & Poor's and Fitch Ratings both reacted to the Wells Notice with ratings-watch announcements. Both noted the reinsurer's March 10-K filing, which said that its board determined that the CEO and other executives "made mistakes, and…lacked due care in connection with the Inter-Ocean transactions that led to the restatement." (See "What Are The Inter-Ocean Transactions?")

Fitch, which holds an "A-plus" financial strength rating on RenRe, said its negative watch reflects the "material possibility" that Mr. Stanard won't remain in his position, the unclear impact on the franchise, and the possibility of fines and penalties. S&P, with "double-A-minus," added that a downgrade could result not only from management instability but from failure to meet an expected 2005 combined ratio of below 90.

Hurricane Katrina wasn't even a blip on any meteorologist's Doppler radar when S&P made that statement in late July. But it is noteworthy that RenRe's 2004 combined ratio–impacted heavily by $570 million from last year's Florida hurricanes–reached 104.4 (its worst result ever), and that the reinsurer reported $30 million of adverse development from those storms in second-quarter 2005, along with an estimated $40 million exposure to Hurricane Dennis.

During a second-quarter conference call, executives said they're not concerned with rating actions. "We're among the highest-rated companies in the world when you look across the reinsurance market," Mr. Stanard said, noting that reputation, quick claims responses and a strong balance sheet would keep RenRe from "being marginalized in the market," even with a one-notch downgrade. And "that's not what we're expecting to happen. Indeed, we haven't spent time talking about it," he said.

A.M. Best seemed to support that view. Best, which affirmed RenRe's "A-plus" in May, left its stable outlook unchanged on news of the Wells Notice, citing the bench strength of the management team.

The Oldwick, N.J.-based firm also helped the largest Bermuda insurer (based on shareholders' equity of over $10 billion), ACE Ltd., to end a clouded quarter on a high note, upgrading ACE's ongoing U.S. subsidiaries to the coveted "A-plus" level.

"A.M. Best views ACE Ltd.'s announcement of its decision to restate its financials as providing considerable closure to the finite (re)insurance cloud that has hung over the company in recent months," the rating agency said, referring to ACE's July 21 announcement that it had improperly accounted for eight finite transactions–prompting it to restate its results for five years, as well as 2005′s first quarter. Best said the $1 million net effect of the restatements was "less than material."

Early this year, ACE also worked to shake off some legacy issues in its runoff entity, Brandywine, related to asbestos and environmental liabilities, with a reserve boost of nearly $300 million and the proposed sale of runoff units.

While ACE's A&E charge, announced in February, actually hit 2004 rather than 2005 results, XL Capital Ltd. continued the trend of reserving for past issues in second-quarter 2005, with a $191 million pre-tax reserve charge–mainly for U.S. casualty and workers' compensation business written from 1997 through 2001. (The announcement predated a second-quarter earnings report, which included a $63 million charge, mostly for boosting life reinsurance policy benefit reserves.)

XL CEO Brian O'Hara–a vocal critic of the high costs of Sarbanes-Oxley disclosure requirements–chalked part of the charge up to the needs of cedents to "recognize losses on their books with greater transparency and timeliness," noting that an uptick in cedent claims reports fueled the charge.

A.M. Best said the charge fell within an anticipated range of adverse development for XL, leaving XL's "A-plus" unchanged with a negative outlook. But Best cautioned that the charge was "indicative that more material charges may be on the horizon for other reinsurers that have not been as proactive…in addressing legacy issues."

Fitch, on the other hand, noted that adverse development at XL totaled $267.6 million in 2004, $937.3 million in 2003 and $400 million in 2002, with the latest charge creating "further uncertainty" about long-term adequacy and adding downward pressure to the "double-A" ratings of its insurance subsidiaries (other than financial guaranty subs, which at "triple-A").

(XL's ratings were originally placed on Watch Negative by Fitch in February, following XL's announcement that it was entering into a yet-to-be completed independent valuation process with Winterthur Swiss Insurance Company regarding settlement of a reserve seasoning agreement related to XL's July 2001 purchase of Winterthur International.)

Not Quite Business As Usual

Rating agencies weren't the only ones sending out mixed signals in the quarter. While executives of Bermuda insurers and reinsurers offered negative comments about market conditions, more than half of the 15 reviewed by NU reported premium growth in excess of 20 percent. And good results on the combined ratio front–with an overall ratio below 90 for the group–masked some mechanics behind the numbers.

Reserve movements, more often than not, explained differences in second-quarter 2005 and 2004 combined ratios, with only six companies showing better 2005 ratios.

Property reinsurer IPC Re, with the lowest combined ratio, also showed the largest deterioration–reporting $24.4 million in losses compared to $4.9 million in last year's second quarter. Included in the quarter's loss total was $15.3 million of developments related to last year's hurricanes, explaining most of the 20-point change in the combined ratio.

At Montpelier, where the second-quarter combined ratio was 13.6 points worse in 2005 than in 2004, executives explained that the key driver was a lower level of favorable prior-period reserve development–$9 million compared to $34 million last year–a common theme among Bermuda companies with lower underwriting profits in 2005.

The largest improvement–5.2 points at RenRe–came largely from a $108 million release of reserves generated as a result of a review and enhancement of the company's catastrophe reinsurance reserving processes.

Responding to questions from analysts, RenRe executives described changes in its reserving methodology (and an ongoing look at reserving in other units) as "process changes." Mr. Stanard said, "The philosophy is the same. We try to be prudent in the approach that we take, recognizing that it's a difficult thing to get right."

Max Re reported more than five points of improvement in its second-quarter combined ratio and the biggest jump in net income (76.5 percent) among older Bermudians.

"The complexion of earnings has changed. Our underwriting results are really driving profitability," said Max Re CEO Robert Cooney, adding that the company was disappointed by hedge fund returns in its investment portfolio, which came in lower than planned and historic levels.

Comments about weak returns from hedge fund investments were common in the quarter, with PXRE and RenRe executives among those that offered them. Montpelier, however, announced a new venture with a hedge fund manager, West End Capital Management (Bermuda) Ltd.–the co-founding of Rockridge Reinsurance Ltd., a new Cayman Islands reinsurer capitalized with $91 million in equity, including a $10 million investment from Montpelier.

Rockridge will assume high-layer, short-tail risks from Montpelier, and the two companies will share equally in fees earned for services on the ceded business and investment fees. The deal's specifics raised the eyebrows of at least one analyst. "The fact that you're their exclusive client…, you're an investor, and the guy running the company is the son of your former chairman [Jack Byrne]–those are the sorts of things that raise flags," he said.

"We've dealt with this by disclosing the information," responded CEO Anthony Taylor. Describing the venture more generally, Mr. Taylor said, "We're not expecting Rockridge to be a significant earner in 2005, but we trust it will build in later years" to provide a new income source.

Other Bermuda companies have been actively building future income sources this year, with XL announcing that it purchased the renewal rights for a large chunk of the risk management book of San Antonio-based Argonaut in late August, and Endurance revealing, in July, that it would soon acquire a non-admitted shell company.

Still A Growth Story

Outside of acquisitions, there is still a growth story coming out of Bermuda. Yet unlike recent years, it's not just a story of fast-growing new players but one in which those with property reinsurance books in Florida sprinted faster.

Executives describing "last-minute tightening" and "pleasant surprises" in Florida consistently reported finding opportunities in the catastrophe market (and even property pro-rata and per-risk opportunities) and rate hikes of 15-to-20 percent on loss-impacted contracts.

"I was clearly wrong," said Mr. Taylor, noting his prior predictions that Montpelier's overall gross premiums would fall 10 percent this year are no longer valid with premiums exceeding last year's totals at the same point in time. "That demands explanation," he added, pointing to stronger-than-expected Florida renewals as one factor.

The good news, however, came with a warning. "The real message is that the pricing of [hurricane and Japan typhoon-impacted contracts] is obscuring what is actually happening in the market. Conditions are no better than I described them at the beginning of this year," he said, pointing to declining measures of rate movements without these contracts. "We continue to exercise underwriting discipline as a result, and…have continued to trim and refine the book where appropriate."

Still, only two Bermuda companies–AWAC and PartnerRe–actually reported premium declines, and executives at those firms delivered similar messages about softening and discipline. At ACE, where net premiums grew just 1.5 percent in the quarter, CEO Evan Greenberg also said that analysts rightly detected a change in his tone in describing a more competitive market.

"There are a number of incumbent companies trying to hold what they have and maintain discipline… There also are a number of competitors trying to grow in an…irresponsible fashion," he said, expressing the greatest surprise of the speed at which competition has become evident in the London market.

Bermuda executives generally saw their greatest competition coming from the United Kingdom, but at AXIS, CEO John Charman, a former Lloyd's executive, used stronger language. Describing London underwriters as "bandits," he said they "continue to defy the laws of gravity by consuming everything they are offered."

More generally, he commented, "This is an unstable global marketplace, with conditions varying by situation, by class and by region."

Still Axis and Aspen reported two of the highest premium growth rates in the quarter–26 percent and 34 percent, respectively–attributing the jumps to diversified insurance and reinsurance platforms with broadening specialty businesses (including a start-up U.S. professional liability unit at Axis, and new marine and aviation teams at Aspen).

Sidebar: (In sidebar text)

Flag: Recap

Head: What Are RenRe's

Inter-Ocean Transactions?

Central to Renaissance Re's accounting restatements earlier this year are deals referred to as "the Inter-Ocean transactions."

According to the company's 10-K filing, Renaissance–which has an ownership stake in Inter-Ocean–recorded a three-year excess-of-loss ceded reinsurance contract and a sale of reinsurance recoverables (referred to as an "Assignment Agreement" in the 10-K), as two transactions.

"These contracts…should have been treated as a single transaction and, when so treated, lacked the necessary risk transfer to be accounted for as transactions involving ceded reinsurance and a sale of reinsurance recoverables," the filing said.

The filing notes that the excess-of-loss contract initially provided for $45 million of maximum limit over a three-year period in exchange for annual premium of $7.3 million, and was later amended to provide for $30 million of maximum limit at the same premium.

Under the "Assignment Agreement," Renaissance sold $50 million of recoverables for $30 million.

Head: Worth Noting!

There were several restatements coming from Bermuda this year, but perhaps the most unusual–and the smallest–came from Quanta Capital Holdings in May.

Quanta restated first-quarter net income of $1.4 million to a loss of $0.6 million when it discovered that $20.4 million of acquisition expenses had previously been misstated by $2.0 million.

CEO Tobey Russ chalked up the calculation error to the pains of "a young company" transitioning from a manual spreadsheet environment to a fully automated system.