SEPTEMBER 11: The reinsurance sure thing

Life is no longer so restful. In October Ingrey, who had spent 36 of his 62 years in the insurance industry, came out of retirement to run Arch Reinsurance, a $750 million, Bermuda-based start-up backed by two prominent private equity firms, Hellman & Friedman and Warburg Pincus.

Life is no longer so restful. In October Ingrey, who had spent 36 of his 62 years in the insurance industry, came out of retirement to run Arch Reinsurance, a $750 million, Bermuda-based start-up backed by two prominent private equity firms, Hellman & Friedman and Warburg Pincus.

“The job seemed to be a coincidence of real peak opportunities coming together,” says Ingrey, who was CEO of F&G Re, the U.S.'s seventh-largest reinsurer before it was acquired by St. Paul Cos. in 1998.

Lately, a lot of folks are dropping everything to get into the reinsurance business. Since the terrorist attacks of September 11, big insurance companies and blue-chip private equity shops have formed investment consortia and launched six new reinsurance companies: Allied World Assurance Co., Arch Re, Axis Specialty, DaVinci Reinsurance, Endurance Specialty Insurance and Montpelier Reinsurance. The backers include such well-heeled insurance companies as American International Group, Aon Corp., Chubb Insurance Co. and Marsh & McLennan Cos., and private equity investors like GS Capital Partners and Capital Z Partners.

New capital is also pouring into existing companies. In November Ace raised $1.1 billion through an equity offering, and XL Capital tapped the markets for $812 million. In early December former Bass brothers investing guru Richard Rainwater was part of a group that put $150 million into Bermuda-based PXRE Group.

None of these new reinsurers plans to focus on writing coverage for acts of terrorism, even though corporations are desperate to buy such policies. Established insurers, unwilling to take on the enormous risk, have mostly dropped this coverage from their policies since September 11. Congress adjourned for the year without passing any of several proposals to provide insurance companies with a government backstop on terrorist claims.

Before the attacks reinsurance wasn’t such a popular investment. Big, if generally obscure, operations dominate the wholesale business, buying up blocks of insurance coverage from brand-name insurers and then investing the premiums they’re paid. Essentially insurance companies to insurance companies, operating both in broad sectors like life and property/catastrophe and more specialized areas like marine and aviation, reinsurers bet that they won’t have to pay out big claims. But from time to time - as in the early 1990s, when Lloyd’s of London members were swamped with asbestos-litigation claims - they must, and havoc is wrought upon the industry.

Chronically overcapitalized, and unable to raise premiums in recent years thanks to oversupply, U.S. reinsurers have lived chiefly off their investment gains. They’ve lost money on underwriting every year since 1990, according to the Reinsurance Association of America. The net income of U.S. reinsurers fell from $4.7 billion in 1998 to $1.4 billion in 1999 and $1.3 billion in 2000, according to the RAA. “Prices have been inadequate for several years,” says Jacques Dubois, CEO of Swiss Re America Holding Corp. “Investment portfolios were doing so well that they cushioned bad underwriting.”

Reinsurance rates had begun to increase, or “harden,” slightly this year even before September 11 - reinsurers finally began holding the line on rates. But the terrorist attacks remade the business. Panicked companies and property owners have bid up the price of insurance an average of 30 percent across the board, while broadening their coverage to cope with everything from property loss to business interruption. At the same time, the World Trade Center losses could wipe out an estimated $22 billion to $25 billion of the reinsurance industry’s $104 billion in capital, according to Morgan Stanley. Reinsurers with capital bases and ratings that have been badly damaged by the losses, like Copenhagen Reinsurance Co., are expected to pull out of the market, at least temporarily.

It appears to be a good time for start-ups: Demand is up, supply is down, and the strategy has worked before. In the mid-1980s, in the face of severe shortages of liability coverage for corporate boards and environmental hazards like asbestos, Marsh and other backers formed the very successful excess-liability insurers Ace and Exel (now XL Capital) in Bermuda. And the eight Bermuda-based property/catastrophe reinsurers launched after 1992’s Hurricane Andrew produced average annual returns on equity of 25 percent, according to Standard & Poor’s.

“There’s a well-known investment thesis that says this is a good business to enter after a catastrophe,” says Edward Noonan, CEO of American Re Corp. “This money has been sitting there waiting for the next major event.”

The question is how well that money will be put to use. “In our view, there is not sufficient management talent to attract many billions of new capital to the industry and replace capital that has been lost to the World Trade Center attacks,” wrote Morgan Stanley insurance analyst Alice Schroeder on October 1, after only one start-up, Axis, had emerged. Since then five additional newcomers - and $5.8 billion in capital - have arrived.

Nevertheless, many industry observers believe that these start-ups will succeed. Endurance and Axis, for example, have the backing of insurance brokers Aon and Marsh, which guarantees them a certain flow of business. Reports of steep rate rises continue to pour in. And some industry experts predict that the increased demand for extra insurance will be long-lived; they assert that the terrorist attacks have fundamentally altered the supply-demand dynamics.

“Every risk manager at every company is reassessing his or her exposure,” says Richard Friedman, co-head of merchant banking at Goldman, Sachs & Co., which invested in the Allied start-up. “That fact drives this whole investment equation.”

But some observers wonder if an investment idea is still good when everyone seems to know about it. Creating a reinsurance business overnight is a risky proposition no matter what the environment, and some reinsurance veterans are quietly skeptical that investment history will repeat itself. They say there are subtle differences between the post-September 11 insurance landscape and the circumstances that followed previous catastrophes.

This time around, insurance companies are generally not abandoning certain types of coverage. The industry veterans point out that Ace and Exel didn’t emerge until after a full year in which extra liability insurance couldn’t be had for any price. “There was a fear of the business. People questioned whether it could be written at all,” says American Re’s Noonan. “The companies this time are not being formed to address genuine capacity needs. They’re not being formed to write terrorist coverage. All they’re doing is joining the general flow of the market.”

Some experts believe that investor expectations that pricing in reinsurance markets will either remain firm or rise for the next two to three years are overoptimistic. “A lot of people are expecting three or four stages of rate increases,” says Donald Watson, head of insurance ratings at Standard & Poor’s. “I don’t think that’s going to happen. That could spell trouble for the new capital being raised.”

Rates may soar for a time, but starting an insurance company on the fly is perilous. For one thing, even if the U.S. government agrees to provide a backstop for terrorist-related claims, no one is completely sure what uncalculated risks - such as nuclear attacks - insurance companies may face following September 11.

The timing of the terrorist attacks, near the end of the year, is forcing firms to start putting their money to work before they’re completely set up. The new companies need to start writing business almost immediately because they can’t afford to miss the renewal season around January 1, when the majority of reinsurance contracts get written. As a result, firms are already beginning to write that business, even if complete underwriting and administrative teams have not yet been put in place. Established competitors warn that these companies, most of them lower-rated, will inevitably be forced into taking greater risks. “The problem they’ll face is that they won’t be able to build a diversified book of business quickly,” says Swiss Re’s Dubois. “They’ll get the business we won’t want.”

In the end, it will take pretty clever management to safely capture the best opportunities. If the optimistic scenarios do not play out, some investors may simply choose to take their capital back before it’s put to work. “I’m surprised by the lack of differentiation of the start-ups,” says Henry Keeling, head of the XL Capital unit XL Reinsurance. “They tend to sound all the same to me. I would not be surprised if some of them don’t make it to the finish line.” Indeed, it will be a surprise if they all do.