Bermuda Shakeout Continues As Storm Season Nears

For others, it was the storms alone that wrecked year-end financial statements. And once the fourth-quarter developments of storm losses and their impacts on results came to light in late February and March, two island carriers–PXRE and Quanta–saw their financial strength ratings tumble over rating cliffs, falling below the "A-range." As a result, both say their boards are currently in discussions with investment bankers looking at their options.

The outcomes of those discussions have not yet been revealed, but investors aren't shying away from Bermuda, as some look to make hay while the sun shines before the next hurricane season.

Last month, Paris Re Holdings Limited, Bermuda–a newly created consortium of international investors led by Stone Point Capital LLC–announced plans to set up a new reinsurance vehicle, Paris Re, to assume AXA Re's portfolio through a 100 percent quota share agreement. AXA Re will continue to front the business for an unspecified period, the announcement said.

More recently, New York-based Tower Group announced it is sponsoring CastlePoint Holdings Ltd., now capitalized with $265 million. In late February, Tower Group Chairman Michael Lee, who will also head up CastlePoint, said opportunities emerging to write program business nationally and from Allstate's exit from the homeowners market in New York prompted consideration of the new venture.

"We predicted that our premium volume would exceed our underwriting capacity using our own capital by approximately $200 million," he said during a recent conference call, explaining that operating companies will include a reinsurance sidecar to which Tower will cede business and one or more insurance companies that CastlePoint Holdings will acquire.

The possibility of relying on third-party reinsurers to support growth was considered, but rejected, Mr. Lee said, citing the high cost and lack of availability of quota-share reinsurance and regulatory scrutiny surrounding finite quota-share reinsurance that Tower used before 2006.

Allied World Assurance Holdings Ltd. is hoping more investors will look to Bermuda in anticipation of future growth and profit. The company filed for an initial public offering of up to $400 million in common stock in mid-March, hoping to reap the benefits of expected property price hikes.

In its filing, Allied World said it expects to be a major beneficiary of worldwide property price increases given its strong ratings and track record, noting that its 2005 hurricane property losses of $456 million were among the lowest as a percentage of June 30 book value, at 26 percent.

Distinguishing itself from other "Class of 2001″ Bermuda companies, the Mar. 17 prospectus said, "We have maintained a unique focus on the direct insurance markets, whereas most other Bermuda-based carriers predominately concentrate on reinsurance," noting that direct property and casualty insurance accounted for roughly 26.5 percent and 40.6 percent of total gross premiums in 2005, with the balance–32.9 percent–attributable to reinsurance.

Two months before the IPO filing, Oldwick, N.J.-based A.M. Best downgraded the ratings of Allied World's insurance subsidiaries, knocking the "plus" off what was the only "A-plus" in the "Class of 2001″ lineup. Best explained that prior superior ratings had hinged on strategic benefits provided by American International Group, an original sponsor.

While Allied World is developing its own independent support systems and U.S. distribution platforms–two key benefits from agreements with AIG that ended in 2005–removal of AIG support also had a notable impact on 2005 premiums.

Another "Class of 2001″ company, Olympus Reinsurance Company, suffered a more serious blow in late March at the hands of A.M. Best, which cut its rating two notches to "B-minus" from "B-plus, before withdrawing the rating at Olympus management's request. Olympus raised $156 million to continue writing business on a limited basis, without a published rating, Best said.

While ratings announcements were the major news items reported over the last few months, favorable rating actions for two of the newest Bermuda carriers were overshadowed by the cuts that pushed PXRE and Quanta to seek new paths for survival.

Omega Specialty received an "A-minus" rating from Best, and Lancashire Insurance Company had its "A-minus" affirmed just about a week after the departure of a key executive prompted the rating agency to put the rating under review.

For PXRE, a Best ratings' affirmation that came in December gave the property- catastrophe reinsurer a short-lived stay at the "A-minus" financial strength level. Best cut the rating to "B-double-plus" in mid-February, forcing PXRE to retain Lazard Freres to review strategic alternatives. The downgrade came when PXRE announced it would boost prior estimates of its 2005 hurricane losses by roughly $300 million to nearly $800 million, with the increase representing over 60 percent of shareholders' equity.

Pointing to PXRE's year-end level of shareholders' equity–at $465.3 million–Chief Executive Officer Jeffrey Radke said, "Despite the recent rating agency actions, we remain financially sound," during a conference call, explaining the impact of the cuts by Best and other rating agencies. He also said a potential outcome of the strategic review would be a situation that would allow "PXRE's franchise to be inside an 'A-minus'-rated vehicle" so that it could "fully capitalize on market opportunities."

But hopes grew dimmer when Best dropped the rating to "B-plus" a week later and finally to "B" in mid-April, before withdrawing the ratings at the request of PXRE management. Soon after, PXRE said Chief Operating Officer Guy Hengesbaugh would leave his post in July.

At the time of the initial February downgrade, Mr. Radke said 75 percent of clients (as measured by the premium volume) had the right to cancel reinsurance contracts as a result of the downgrade or PXRE's reduced capital level, but only 7.5 percent had said they would. Weeks later, a 10-K annual filing with the Securities and Exchange Commission said one-third of PXRE's clients had cut ties with the company as of Mar. 13 and that the cancellation percentage was expected to rise.

Like PXRE, which received its initial downgrade when it reported increased hurricane loss estimates, Quanta Capital Holdings had its Best rating cut to "B-double-plus" following Quanta's report of what Best termed "unexpected loss reserve development" for Hurricanes Katrina and Rita, as well as other actuarial reserve adjustments and reported charges.

James Ritchie, Quanta's chairman and interim CEO, said the steps taken in the wake of the downgrade included the board's hire of Friedman Billings Ramsey as financial advisor to help evaluate "strategic alternatives, including the potential sale" of some or all of Quanta's businesses.

Willis Re Bermuda-based Executive Vice President James Kent said the downgrades will have "some impact" on U.S. catastrophe business. "PXRE's downgrade is probably more material in the property retrocessional market, where they offered significant capacity, especially for Lloyd's syndicates," he said.

He also commented that the speed of the downgrades demonstrates a new efficiency and "is likely to have had 'A-minus' companies watching A.M. Best's reaction carefully."

Official reports on how the market is shaping up for midyear renewals will emerge over the next few weeks as Bermuda companies announce first-quarter earnings. In the interim, assorted tea leaf readers offer varying perspectives.

In a quarterly Bermuda market report issued last month by London-based Benfield Group, Leon Janeke predicted capacity will tighten by the July 1 renewal season, even though the January season was something of a disappointment.

"The recalibration of catastrophe models, a shrinking risk appetite for peak exposures, restructuring of coverage on a more restricted basis and the increased cost of capital are generally expected to exert further sustained upward pressure on pricing," he wrote.

The wide variance of the 2005 combined ratios of Bermuda companies with 187 points separating the highest figure for property specialist PXRE's (282.4) and the lowest (95.8) for diversified Arch Capital drive home the need for some companies to reduce peak exposures and diversify into noncatastrophe lines.

But there may be a downside, according to Banc of America securities analyst Brian Meredith, who said he expects something of a "rating agency soft market" as carriers seek to escape higher capital charges in less capital-driven casualty lines.

S&P said capital charges to be announced in May could lead to some downgrades, which will be partly driven by revisions of catastrophe models.

Willis Re's Mr. Kent said most reinsurers built assumed 40-to-50 percent increases into their pricing models for Jan. 1 business, ahead of vendor model revisions. "The fact that reinsurers made this pricing adjustment instead of waiting for the official model calibration means the major pricing dislocation between January business and midyear business is not as great as it potentially could have been."

And some companies with excellent catastrophe risk management programs and financial flexibility may actually enjoy some capital requirements leeway from Best as a result of recently announced modifications to its catastrophe stress test.

Best financial analyst John Laubach said the agency is in the process of analyzing companies to see how the modifications will affect them individually but was not prepared to comment how it might affect any class of insurers.

He added that he does not foresee any softening of the property-cat market in the coming months, since carriers are still in the process of reevaluating their catastrophe exposures, which could result in tightening as more risks come on the market.

Mr. Kent said that even as the Class of 2005 comes into its own for the upcoming renewal periods, he does not see any concomitant price softening impact, asserting that newcomers have shown discipline so far. "Part of this stems from the increased capital charges and overall scrutiny of the rating agencies. But another factor is that these companies are managed by experienced and well-respected insurance professionals," he said.

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