Bermuda Babies In Class Of 2001 Holding Their Own Despite Soft Market Challenge

Olympus Re–one of the first sidecar facilities–was set up by White Mountains Insurance Group to tap into soaring reinsurance prices after the Sept. 11, 2001 terrorist attacks, and was effectively depleted by the record U.S. hurricane season of 2005.

DaVinci Re was created by leading catastrophe reinsurer RenaissanceRe, which actively manages DaVinci's entire portfolio on behalf of its investors.

Because Olympus Re has ceased operations while DaVinci Re effectively exists to provide a source of fee revenue for RenaissanceRe and a source of additional capacity for cedents, this article focuses on the five stand-alone members of the Class of 2001.

Aided by ready access to unprecedented amounts of capital, these five companies were able to get up and running very quickly–in many cases quoting business for January 2002 renewals only weeks after raising their initial capital.

Their speed-to-market was further streamlined by a Bermuda domicile that sped the procurement of required licensing. In several cases, a focus on reinsurance reduced the need for costly infrastructure and mitigated staffing needs.

In many ways, the timing of these companies couldn't have been better.

The property-casualty insurance industry has benefited from a very favorable pricing environment that began in earnest in 2002, the effects of which persisted through the first half of 2007–although insurance rates have moved off of peak levels.

Moreover, benign catastrophe activity in 2002 and 2003 enabled the fledgling companies to quickly build their capital bases through retained earnings.

Additionally, while many established underwriters spent the initial part of the hard market cycle strengthening their loss reserves for business written in the 1990s, the Class of 2001 benefited from favorable market conditions and a lack of legacy issues.

The market's concerns about the new entrants' security were outweighed by a dire shortage of capacity in short-tailed property lines, where uncertainty about an underwriter's longevity is less critical than for longer-tailed casualty lines.

Potential reservations about placing business with the Class of 2001 may have been further alleviated by the fact these companies were in each case led by well-known industry executives and in several cases were sponsored by large insurance brokers, which have a vested interest in maintaining capacity in the marketplace.

As a result, these new players hit the ground running and were able to quickly build up their portfolios to levels that supported modest infrastructure.

To evaluate the Bermuda market's performance from 2002-2006, Fitch has compiled financial information from GAAP earnings releases (based on generally accepted accounting principles) and annual statements filed with the Securities & Exchange Commission (10-K filing data) for 11 publicly traded Bermuda-based insurers and reinsurers.

In assessing the best performers over the past five years, it is instructive to focus on the following three key operating metrics:

o Growth rate in book value per share (adjusted for common dividends paid) since year-end 2001–a reasonable proxy for an organization's ability to create economic value,

o Net returns on average equity (ROAEs) from 2002-2006, which measures a company's ability to generate returns on unlevered capital, and

o Underwriting results, as measured by average combined ratios from 2002-2006, which are the primary driver–but not the only driver–of an insurance underwriter's profitability.

Based on these key operating metrics, the accompanying table shows that the Bermuda market performed quite well during the hard market cycle, growing book value per share by an average of 89 percent from 2002 to 2006 when adjusted for common dividends paid, while posting average combined ratios of 93.8 and reporting average ROAEs of 11.4 percent over the same time frame.

Notably, the Bermuda market's overall performance was largely consistent with a larger group of 50 publicly traded property-casualty underwriters during the five-year period ending in 2006, although the Bermudian results reflected much greater volatility than the industry in aggregate.

This volatility should not be surprising, given that the Bermuda market has a heavy concentration of property business and was relatively more exposed than the industry to record insured catastrophe losses of 2005.

The Bermuda Class of 2001′s performance over this admittedly short time period was quite similar to many of its more seasoned Bermuda-based competitors. Over the last five full years, 2001′s Bermuda Babies grew book value per share at an average rate of 83 percent, with all five publicly traded members reporting gains of at least 47 percent.

From 2002 through 2006, the class of 2001 reported average ROAEs of 11.5 percent and average combined ratios of 91.5.

By way of comparison, a group of eight more established Bermuda insurers and reinsurers grew book value per share at an average rate of 93 percent and reported average ROAEs of 11.2 percent and average combined ratios of 95.2 over the same time period.

The results of these two groups of underwriters were similarly volatile during this time frame, as both subgroups were hit hard by the 2005 U.S. hurricane season.

Three of the five members of the Class of 2001 posted a net loss in 2005, with Arch and AXIS as the lone exceptions.

Perhaps not by coincidence, these two companies have also been the strongest performers among the Class of 2001 over the past five years, having demonstrated the greatest growth in book value per share, highest average ROAEs and best underwriting results among the Class of 2001.

Moreover, the results of both Arch and AXIS were among the least volatile of the Class of 2001 and more established Bermuda insurers. This positive result may be attributed, in large part, to the fact that both Arch and AXIS have developed more diversified portfolios with a heavier casualty component than many of their more property-focused peers.

The members of the Class of 2001 have firmly established themselves in the marketplace, having developed strong franchises backed by sizable capital bases and large books of business.

The 2001 Bermuda Babies' financial performance since inception has been remarkably similar to that of their more seasoned Bermuda-market peers at comparable volatility levels.

Additionally, while the Class of 2001 faces fresh competition from start-up companies established following 2005′s record hurricane season, these 2005 Bermuda Babies are facing more difficult market conditions than the Class of 2001 faced at comparable times in their history.

While it has yet to be challenged by extended soft market conditions, the Class of 2001 appears to be here to stay.