The Bermuda-London connection

As insurance years go, 2006 has to rate among the best, particularly for the Bermuda reinsurers, who experienced record profits on the back of an unexpectedly benign hurricane season.

With additional capital now lining their pockets, speculation is quickly mounting over where that capital is likely to be deployed.

Rating agencies appear content with the idea of feeding bumper profits back to shareholders.

But more favourable odds are on the classes of 2001 and 2005 exploring the route of acquisition, with Lloyd's the most hotly tipped destination. The news last week that Bermuda companies were casting their eyes over managing agency Talbot adds weight to this.

As one insurance commentator puts it: "This two-way street is really making the London to Bermuda flight a very crowded place."

With the debate over London versus Bermuda developing into no more than an "artificial headline grabber", according to Hiscox chief executive Bronek Masojada, the case for natural consolidation between the two markets is plainly clear.

Bermuda may have the benefit of 0% corporation tax, but Lloyd's has capital advantage. According to figures from investment bank Fox-Pitt, Kelton, capital required in the Lloyd's market, in comparison to Bermuda, is 40% less.

But the value of capital flexibility is not the only commercial advantage to placing a foot in both camps.

Deploy capital
Marcus Rivaldi, credit analyst with rating agency Standard & Poor's, says: "In order to put the capital they have raised effectively to work, Bermuda businesses have to substantially deploy this capital off the island, usually onshore in the US and/or in the London market. Both offer access to attractive, diverse, and typically more labour-intensive business unavailable or unserviceable in Bermuda."

By tapping into the Lloyd's market, Bermuda reinsurers are immediately offered the licence to underwrite business in more than 60 territories, accessing a greater spread of business that may not otherwise make its way to Bermuda.

Lis Gibson, a partner, who leads the general insurance actuarial practice at Deloitte, points out: "The London market is a wonderfully diverse market and, as the insurer of last resort, it has a mix and diverse book of business, which makes entities at Lloyd's quite attractive to Bermudans."

The need to achieve diversification is regarded by many as the main driver for Bermuda start-ups looking to set up in the Lloyd's market, explains Gibson.

Volatile results
She says: "The most obvious issue for the Bermudans is that they are very concentrated in terms of weather catastrophe business, which means they are subject to really volatile results. When the wind blows they make losses and if it doesn't they make huge profits."

Another factor is the decision by the Florida State Government to acquire more hurricane risk, totalling some $14bn.

"That has obviously taken business away from Bermuda and also some from the London market," says Gibson. "Companies now have capital that won't be being used and that in itself may make Bermuda hungrier to diversify into the Lloyd's market and accelerate thoughts of other investments."

Rating agencies warn against destroying shareholder value by "de-worsification" – diversify for the sake of diversifying, especially into lines of business where they have a lack of understanding and insufficient underwriting competency.

But the acquisition of a Lloyd's entity, with expertise in certain lines of business and an established presence as a franchisee, is regarded as a more appealing and safer way of strengthening a business.

It is also, says Hiscox's Masojada, a quicker way to build a diversified business fast.

There can be no doubt of the market's strategic fit, and consolidation between the two is nothing new.

With the 2007 hurricane season set to begin on 1 June, when all Bermudan eyes will be on the Atlantic as opposed to potential acquisition targets, the desire to diversify is likely to happen sooner rather than later. IT