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Reinsurance market ‘ripe’ for more mergers

Consolidation trend: the island's reinsurance sector could see merger activity pick up again

The pace of dealmaking has slowed this year in the Bermuda reinsurance market — but more mergers are likely in an industry “ripe for additional transactions”.

That is the view of industry analyst Brian Schneider of Fitch Ratings, the New York-based credit rating agency that has issued a report highlighting conditions of “challenged profitability” for the group.

Fitch states in its report that it expects mergers and acquisitions activity to pick up after a relatively quiet period, although not on the scale of 2015.

Mr Schneider, senior director with Fitch, told The Royal Gazette: “Reinsurance-sector mergers and acquisitions activity has slowed down due to increased valuations and reduced interest from foreign buyers as they digest recent deals.

“Nevertheless, we expect M&A activity to pick up again in the not-too-distant future as market conditions remain ripe for additional transactions — companies continue to face limited organic growth options and are looking to enhance scale and diversification.”

Some of the biggest deals agreed last year on the island included XL Group’s purchase of Catlin, Ace Ltd’s acquisition of Chubb, and the buyout of Ironshore by Chinese investment firm Fosun International, as well as the purchase of PartnerRe by Italy’s Exor.

The wave of merger activity has led to some job losses, but as Bermuda Executive Services director Bill Zuill told this newspaper last week, the hit to local employment has not been as great as many had feared.

However, the Fitch report, which describes a market struggling to maintain a healthy level of profitability amid intense competition from third-party capital, falling reinsurance rates and investment income squeezed by a prolonged period of ultra-low interest rates, suggests more M&A activity is likely.

The report describes the Bermuda market as having delivered “favourable but tempered operating results” with combined underwriting profits of $4.4 billion, a combined ratio — the proportion of premium dollars spent on claims and expenses — of 86 per cent, and a net income return on equity of 10 per cent.

Asked what it would take to improve the prospects for the group, Mr Schneider said: “It will be challenging to improve the profit outlook for reinsurers in the near term, as we expect premium prices and investment yields to continue to decline, weakening profitability.

“The next hard market will have to be driven by a sizeable reduction in industry capital that can push price increases.”

Lower than normal hurricane losses over the past decade have dampened reinsurance rates, as has the abundance of capital pouring into market via insurance-linked securities such as catastrophe bonds.

Hurricane Hermine was the first hurricane to make landfall in Florida in 11 years last Friday, but early estimates from Karen Clark & Co suggest losses in the region of $500 million — not enough to make a serious dent in the industry’s capital.

Fitch noted that the Bermuda group’s reported written premium volume decreased by 7 per cent in 2015 over the year before, while the aggregate investment yield was 2.1 per cent, marking the seventh straight year of declining yields.

The report found that some companies were allocating more of their investment portfolios to equities and alternative investments.

“While some companies have increased risky assets, it is not to a level that would cause us any rating concern at this time,” Mr Schneider said.

The US Federal Reserve has indicated its intention to raise interest rates within the coming months — with the next increase potentially coming as soon as next week. Higher rates would likely result in a fall in the value of the fixed-income securities that dominate the investment portfolios of most of the island’s property and casualty reinsurers.

But Mr Schneider believes that most of the market is well positioned to withstand such a shock.

“We would consider most reinsurers prepared for a rise in rates as they are maintaining short-duration portfolios that can be reinvested relatively quickly into higher-rate investments,” he said.