More Capital Washes Up In Bermuda

o What are you going to do with all that capital, they asked leaders of these companies during earnings conferences and investor road shows.

o If you're not going to allocate funds to support new business, then will you return capital through stock buybacks that will increase returns on equity?

The questions came before the earthquake in Chile late last month, where the impact on Bermuda insurers who write insurance and reinsurance coverage in Latin America was yet to be determined.

Evan Greenberg, chief executive officer of ACE Ltd., insisted he sees organic growth opportunities ahead and also opportunities to make acquisitions over a medium-term time horizon in order to grow both ROE and book value. He suggested that many investors and analysts miss global acquisition prospects because of their U.S.-centric viewpoints.

"Some shareholders judge…that the best way to increase earnings-per-share and book value-per-share is by buying back stock…We recognize the validity of that option, but it's not applicable for all companies at all times," he said.

For ACE, he said that "a more strategic way" to increase EPS is "by growing the company, not shrinking it, which is essentially what share buybacks do."

"We are a global diversified company with a long-term strategic plan, [and] there is plenty of opportunity around the world to grow our company over time. Even if you don't see it at the moment, it doesn't mean it doesn't or won't exist," he said, going on to add that if the company were to build up excess capital that could not be put to work productively over a reasonable period, then ACE would consider repurchasing shares.

The leader of the largest insurer in the group stood in contrast to most other publicly traded companies operating in Bermuda, which are in varying stages of buyback programs. At the other extreme, executives at one of the smallest Bermuda companies–Lancashire Insurance, which had registered shareholders' equity of $1.4 billion at year-end 2010–said they'll give back more capital than they make in 2010.

"This industry has a great deal too much capital and not enough ways to give it back," said Richard Brindle, CEO of Lancashire, a proponent of issuing special dividends as an "ideal way to right-size a balance sheet."

Other companies, which instead retain excess capital on their balance sheets, "all too often fall into the classic trap of expanding headcount and product lines into a softening market," Mr. Brindle said.

Neil McConachie, president and chief financial officer of Lancashire, said: "We have returned 81 percent of what we made in 2009, but that's still not enough. It's impossible to say with 100 percent certainty, but if the insurance cycle doesn't improve in 2010, we are likely to return more capital than we earn. Putting it in simple terms, he said this means "our balance sheet on Dec. 31, 2010 would be smaller than our balance sheet at Dec. 31, 2009."

Falling just below the middle of the pack of publicly traded Bermuda companies in terms of capital size is Endurance Specialty, with just under $3 billion of shareholders' equity as of Dec. 31, 2009. Endurance CEO David Cash, speaking at the Bank of America Merrill Lynch Insurance conference late last month, shared his prospective views on long-term capital management, noting that the company also has a history of giving capital back.

"We've walked that walk," he said.

"Generally, the way we've generated the capital to buy back stock is we've reduced some of our risk profile," he said. "As an underwriter, what that means is you literally draw your underwriters back from the market, [and] I'm very willing to do that," added Mr. Cash, who rose from the position of chief underwriting officer to CEO to take over from retiring former CEO Kenneth LeStrange on March 1.

Mr. Cash, who described Endurance as a balanced company with a book that's evenly split (50-50) between insurance and reinsurance and across the property, casualty and specialty sectors (with one-third each), also talked about opportunities for organic growth–highlighting areas such as international reinsurance and middle-market U.S. casualty insurance sitting within the broader sectors.

Just days after Endurance announced its succession plan, however, its largest shareholder put forth a contrary view of the best way to increase shareholder value–suggesting the company should move to capitalize on a consolidation trend he believes will accelerate in the Bermuda market in the near term, and expressing concern that Mr. Cash was not the man to lead that charge.

In a filing with the Securities & Exchange Commission, Richard Perry of New York-based Perry Corp., who owns more than 12 percent of the company, said Endurance "should undertake an evaluation of its strategic alternatives and pursue a possible merger or other strategic transaction in order to create a stronger company with a defined growth strategy and best-in-class lines of business."

"Many market participants are trading below book value per share and are heavily concentrated on similar lines of business," Mr. Perry's 13D filing said. "These factors, together with recovery in the financial markets, are likely to support a trend of industry consolidation or a return of excess capital," the filing said.

Mr. Cash declined to give a direct response to Mr. Perry's filing when he spoke at the Merrill Lynch conference, but he did respond to a question about what his near-term priorities will be, putting acquisitions last on his to-do list.

With the market softer today than it had been under Mr. LeStrange's leadership, he said Endurance executives "will collectively be tightening some of our internal underwriting controls" going forward, setting out his first goal.

"We'll be more careful as to where we put premium on our books. We will be spending more time making sure we have a clear read on casualty business," he said.

"I would say you'll see us grow there, but it's the one area that is under the most pressure now. I think our organic growth strategy will work [for casualty], but [not] unless we have a great deal of transparency around that area," he said, explaining that while the focus of enterprise risk management activities in the Bermuda market generally has been on property risk concentrations in the recent past, the same attention and analysis hasn't been applied to the casualty side.

Mr. Cash also said he'll focus on internal coordination issues–like finding ways to cross-sell business and to make sure internal resources are being used efficiently throughout the company of 700 employees working in 20 offices in five countries.

"Both those things are about alignment. They're not necessarily about strategic direction, but they're a lot about communication," he said, noting that he will personally be communicating more directly with 30-to-50 managers throughout the company that sit below the senior management executive team.

Continuing to list priorities, Mr. Cash said: "I expect us to grow organically. We are at the point where we have a sufficiently developed infrastructure [so that] we can add an underwriter and not much add much if anything in the way of back office [to] grow [a] book of business."

"Going beyond that, we'll certainly consider acquisitions," he added.

Earlier, during his prepared remarks, he said Endurance would not be looking for "transformative acquisitions," giving the example of a 2007 deal to acquire ARMtech, an MGA specializing in agricultural risks, as the more likely type of deal target.

"We do think there are some businesses that we will not grow ourselves organically but which add value to investors over time that we should own and we can make more valuable," he said.

See related article: Is U.S. Casualty Next For Validus?