Ratings Rebound For Bermudian Carriers

With at least five upgrades for Bermuda property-casualty companies since October 2007, it may appear that a variety of strategies to diversify books of business are prompting A.M. Best analysts to take a more positive view of the market.

Even though all of the Bermuda insurance and reinsurance executives interviewed by NU recently outlined strategies to broaden their horizons globally and by product line, analysts at the Oldwick, N.J.-based Best rating agency say diversification schemes in and of themselves will not translate into top ratings.

"I'm going to use the word 'restore,' rather than 'upgrade,'" said Robert DeRose, an A.M. Best assistant vice president, going on to explain that three factors allowed the ratings of Bermuda insurers such as Endurance Specialty and RenaissanceRe to be lifted in 2007 back up to pre-2005 levels.

"Earnings have been very strong for these organizations," and as a result, "their capitalization is enhanced," he said--noting that earnings drove a balance-sheet rebound for Endurance, while RenRe has always had a strong balance sheet, which became even stronger as a result of earnings.

"Probably the most important thing for both is our restored confidence in their overall risk management capabilities," according to Mr. DeRose.

"In the case of Endurance, we were a little concerned following [Hurricanes] Katrina, Rita and Wilma, with the size of losses they had," he said. "With RenRe, there were regulatory issues that surfaced that pointed to some weaknesses in internal controls, which we now believe have been resolved."

A.M. Best raised Endurance's financial strength rating to "A" in November 2007, and RenRe to "A-plus" in December.

Mr. DeRose did not comment on three other upgrades--those of Peleus Re, Amlin Bermuda and Aspen--noting that the last two are rated by counterparts in Best's London office, and that the Peleus change resulted from a restructuring late in 2007.

What about the notion that rating agencies are pushing some Bermuda insurers to diversify by assigning monoline companies comparatively lower ratings?

"It's not A.M. Best," said Mr. DeRose, reacting to suggestions that Bermuda executives often bemoan the fact that rating agencies take a dim view of companies that aren't diversified by product line.

Analyst Peter Dickey agreed. "It's more likely that the equity analysts saying that."

Two reinsurers that have historically been monoline property-catastrophe writers--IPC Re and Montpelier Re--both saw their ratings affirmed in 2007. But IPC--the older of the two, which carries a higher "A" rating--had a negative outlook assigned to its ratings on Dec. 19, 2007.

"We don't mention a lack of diversification, because I don't think that's a primary concern of ours," Mr. DeRose said, referring to the IPC rating announcement. "They are a property-cat company, but when you look at their portfolio, it is fairly well diversified," he added, referring to IPC's wide geographic spread around the world.

"I think our issue there is that the returns--long-term returns--really are not commensurate with the risk, which leads us to question their [enterprise risk management] capabilities," he said.

Ultimately, it was a lack of ERM that prompted A.M. Best to downgrade XL Capital's financial strength rating to "A" from "A-plus" late last month, a day after XL revealed that it expected to take fourth-quarter charges in the range of $1.5-to-$1.7 billion related to credit market exposures.

The exposures arose principally from a 46 percent stake that XL has in Security Capital Assurance, a financial guaranty insurer and reinsurer. (See the NU Online News Service stories on Jan. 24 and 25 for more details.)

"The rating downgrade is based on A.M. Best's opinion that XL Capital's risk management controls are below expectations as the company takes an unanticipated charge...continuing the trend established by the litany" of prior charges, Best's Jan. 25 statement said, citing previous-year charges related to XL's acquisitions of NAC Re and Winterthur, and higher-than-anticipated losses from 2005 catastrophes.

The statement also said Best believes XL has further subprime exposure through its directors and officers and errors and omissions insurance and reinsurance portfolios. "Adverse development charges relating to these lines...beyond A.M. Best's expectations will result in further rating actions," the announcement warned, later noting the fact that the subprime debacle has had minimal impact on insurers so far might indicate a future D&O and E&O claims surge.

Mr. DeRose, responding to an overall market question about such exposures and reserve adequacy during an interview prior to the XL action, said, "I think there are a few companies that have potential D&O/E&O exposures, but I think generally there is still some [reserve] cushion in the hard market years--2004 and 2005."

He added that "we expect to continue to see reserve releases in 2008 for those years to help offset deterioration in underlying business fundamentals."

Like XL, RenRe and PartnerRe announced fourth-quarter charges related to holdings in a financial guaranty reinsurer (Channel Re), and Everest Re warned of a $311 million pre-tax asbestos charge.

In response, Best issued statements noting that these charges were anticipated, and that ratings would not be altered.

The rating agency was less forgiving of XL, first assigning a negative outlook to the prior "A-plus" rating last December, citing troubles at SCA, and subsequently taking the rating down a notch.

A.M. Best said that even though XL's charges had not caused any immediate concern about capital adequacy, XL's "earnings inconsistency and ERM are not indicative of a superior-rated company."

"Following [a] May 2007 ratings review, it was A.M. Best's expectation that the likelihood of unanticipated large loss events would be curtailed given management's previous representations concerning enhancements to risk controls and processes," the downgrade statement said.

On the same day, less than two hours before releasing its statement about XL's downgrade, A.M. Best also officially issued a document outlining how risk management is incorporated in the overall rating process. ERM encompasses three key areas--culture, identification and management--as well as measurement, Best said.

Does all this mean that diversification really is not a big concern of A.M. Best analysts? "We always look for diversification within a portfolio. Ultimately, that should lead to a level of earnings stability," Mr. DeRose responded.

Montpelier's "A-minus" rating, which is among the lower ratings for Bermuda insurers, has not been upgraded even though the company embarked on a trio of diversification actions last year--setting up a Lloyd's syndicate, moving into the U.S. excess and surplus lines market, and putting a marketing office in Switzerland.

"It's too early," said Mr. Dickey, noting that time is needed to gain confidence with the company's risk management and controls. "They're expanding into a soft market here, into lines of business they're not really familiar with. So we decided to be conservative on that rating."

As for the differing types of diversification strategies being touted by executives--ranging from forays in the U.S. E&S market, to expansions into Asia, Latin America and the Middle East--Best sees none as necessarily pleasing or worrisome.

"The proof is in the pudding. We have to see how they perform," said Mr. DeRose.

"They're all making a pitch to us that it is a good move," whichever strategy they choose, he said. "I can assure that those pitches show profits and not losses, otherwise they wouldn't be going into those particular segments."

Still, he added, "only time will tell for sure" if they can cover the cost of capital and achieve acceptable returns over the long term.