How Bermuda rigs insurance rates in Florida

Oct 25, 2010

This article was published in the Herald Tribune on October 25, 2010:

In early 2006, Florida was on the verge of a financial disaster.

After two deadly hurricane seasons, major insurance carriers were leaving, smaller companies struggled to raise capital and Florida families scrambled to find coverage and pay escalating premiums.

As they strove to recover from the eight hurricanes of 2004 and 2005, Floridians took another hit — from Bermuda reinsurance companies that seized on the crisis to double or triple their rates.

These reinsurance companies, which insure the insurance companies, are the lifeblood for scores of under-capitalized, highly leveraged start-up insurers. Most carriers could not remain in business without costly reinsurance policies geared to cover their losses.

But in 2006, many reinsurers reduced the storm coverage they were willing to give Florida. Some purposefully refused to write policies for months, convinced they could extract an even higher price from insurers that neared collapse.

First-hand accounts, brokerage reports and copies of reinsurance contracts written that year show Florida insurers were still cobbling together hurricane protection in August and September, during the peak of danger, and paying three times the January rate.

The cost was paid by Florida property owners, some of whom suddenly faced premiums as high as their house payments. Real estate agents complained they were losing home sales as buyers no longer qualified for mortgages, and Florida bank leaders trouped to Tallahassee begging relief.

The squeeze was legal, and opportunistic.

“That’s what we saw after hurricane Andrew and that’s what will happen again, in my opinion, the next time we have a major hurricane,” said Steve Alexander, actuary for the office of the Florida Insurance Consumer Advocate.

REINSURANCE OPERATES ON a global scale, regulated to some extent in Europe and hardly at all elsewhere, especially in Bermuda, a tax haven.

The tiny volcanic rock 600 miles east of North Carolina is home to nearly half the reinsurance sold to Florida, a $470 billion powerhouse crammed in a few blocks between the rum bars and T-shirt shops.

There are more than 1,200 foreign insurers incorporated in this oceanic frontier town, including 59 reinsurers that provide billions of dollars of hurricane protection for nearly every home in Florida, from swamp trailer to coastal high-rise.

They crowd and color every aspect of Bermuda. With no place to build, newcomers worth hundreds of millions settle for whatever they can lease. Two cram offices next to a hair salon, heralded by wooden signs of equal size.

With no place to park, wealthy executives buzz around on motor scooters, ties flapping and knees peeking beneath colorful Bermuda shorts, one of the persisting oddities cultivated by the island’s financial expats.

An industry broker once dubbed them the “almost-pirates of the almost-Caribbean.”

Bermuda’s regulations are famously light, exposing consumers to business practices designed to reduce competition and encourage price-fixing.

Solvency requirements exist, but they are dramatically light compared with what private financial rating firms consider reasonable. Only the island’s 37 largest reinsurers must file audited annual reports. Only 29 of those agree to make the document public.

The only other records Bermuda allows the public to view are kept in a drab office building two blocks from the harbor. Hidden on the third floor, behind a wobbling counter propped against the wall, a government clerk will fetch all that Bermuda cares to make public about the financial giants who shoulder Florida’s tremendous hurricane risk.

The manila files are virtually empty.

What they do contain is unhelpful — mostly lists of island lawyers who serve on boards of convenience that hide the real owners and decisionmakers.

THE STREETS OF New Orleans were still flooded in 2005 when reinsurers started raising money to pay for Hurricane Katrina and take advantage of the market boom expected to follow.

By December, Bermuda’s reinsurers had raised $17 billion from eager investors, primarily hedge funds, private equity firms and U.S. investment banks such as Merrill Lynch, Goldman Sachs and Lehman Brothers.

But the flood of new money was not used to make more hurricane coverage available to Florida.

Reinsurance contracts and comments by executives show that even when they had money in the bank and board approval to use it, Bermuda reinsurers cut the capital they were willing to allot to Florida.

The layoff in part was driven by the belief global warming had increased hurricane risk, a view backed by some scientists hired by the insurance industry.

But it also was driven by a hunger to maximize profit — to, as ACE Ltd. Chief Executive Officer Evan Greenberg told investors in a 2006 earnings call, “ruthlessly take the elevator up at the right times.”

Rather than just ride Katrina-driven price increases, the Herald-Tribune found, reinsurers worked to make them bigger. They sat on business they normally would have signed. They turned away Florida insurers they normally would have backed.

“It’s a good tactic to do this,” Aspen Reinsurance CEO Chris O’Kane told stock analysts in early 2006. When he spoke, Aspen had written only half its normal Florida contracts.

“We’re confident that we will be able to replace a significant part of this lost exposure by the middle of this year at much better prices.”

O’Kane expected reinsurance prices to double because Aspen was not the only reinsurer refusing to write. Other reinsurers also were holding out.

Axis Capital chairman John Charman started the Florida writing season predicting severe shortages, and ended it by confirming in an earnings call, “We held back capacity.”

Other reinsurers were willing to write policies but seized on the opportunity to boost profits in other ways.

Montpelier Reinsurance, for example, stopped selling a broad form of coverage on which many Florida reinsurers relied and offered a more expensive substitute.

CEO Anthony Taylor urged analysts to be patient as the Bermuda reinsurer turned away early business. He would make it up later, he promised, earning 30 percent more while writing half the risk.

“This is an unprecedented market disruption,” Taylor said in the conference call, “providing opportunities for those who have available capacity.”

By July, Florida’s cost to reinsure against the biggest hurricanes had tripled.

Aspen’s O’Kane told analysts he still was withholding capacity, confident Florida insurers would return in a few months as “distressed buyers.”

Florida home insurers complained prices rose so fast they were “written in pencil.” Security First president Locke Burt, seeking rate increases of his own, told regulators he would secure a quote only to discover “a month later our price was two times, then three times” the quoted amount.

Florida regulators began a watchlist of insurers without full coverage at the start of hurricane season. Industry sources said five insurers were put under temporary supervision. Records obtained by the Herald-Tribune show at least one, United Property and Casualty, was still short in mid-September and operating under a regulatory consent order, even as it sought a state loan to expand.

The average cost of reinsurance coverage in Florida climbed from $9.90 per $100 in exposure to $20, the highest in the nation.

The average home premium increased 80 percent. Residents near the coast saw increases of 300 percent. More than 300,000 Florida families lost their private coverage, forced to find a new company or join Citizens, the state-run insurer of last resort.

A few industry leaders were troubled. Bill Riker, president at the time of Renaissance Reinsurance, said the Bermuda reinsurers overreached, hurting their own market. “The reinsurers didn’t do themselves well at all,” he told the Herald-Tribune. They “lost track of what they’re all about.”

Most reinsurers simply rejoiced. Aspen Re ended the year with a $378 million profit, more than double what it lost to Katrina.

THANKS TO ANOTHER industry practice, every reinsurer enjoyed a piece of the profit, even if they had sat out the squeeze play.

A Florida insurer typically needs to buy reinsurance from a dozen or more reinsurers who each agree to pay a portion of the losses.

But the prices on those contracts are set by consensus, not competition. And only a handful of the largest reinsurers participate in the negotiation phase.

A reinsurer who has the largest share of the contract, or takes the last essential piece of it, can drive up the price everyone charges, even if there are others willing to take less.

The widespread use of “best terms” clauses ensures that every competitor on a contract gets the highest rate paid.

It robs consumers of the benefit of competition.

Industry leaders contend the process stabilizes prices and protects consumers from reinsurers that might bid too low and go broke when disaster strikes.

Some downplay the impact and argue the alternative could create more problems.

“I don’t think it restricts competition at all,” said Ken LeStrange, CEO of Endurance Specialty Insurance Ltd., one of the largest Bermuda reinsurers of Florida property insurers. Open competition on price, he said, “would be quite chaotic. I don’t see it happening.”

Florida is particularly vulnerable to the lack of competition.

The state represents the largest catastrophe risk in the insured world. It also has more small, thinly capitalized insurance companies than any other state.

Thus, Florida demand for reinsurance almost always outstrips supply, most of which comes from a few dominant reinsurers.

“It’s an oligopoly, I don’t know what else to call it,” said St. Johns Insurance president Reese Bowen.

Oligopolies can artificially drive prices higher without explicitly trying, a practice economists call “tacit collusion.” Such actions are difficult to control and frustrate antitrust authorities, international law expert Sigrid Stroux told the Herald-Tribune.

What’s more, the insurance industry as a whole is largely exempted from antitrust laws.

“It’s not a free market when people conspire to set rates,” said U.S. Rep. Bill Posey, a Republican from South Florida who for years chaired the state Senate’s insurance committee.

American regulators have raised no challenge to consensus pricing. But controversy surrounding its use overseas prompted the European Union to investigate in 20007.

Examiners concluded such practices distort market prices, “to the benefit of the reinsurers imposing it and to the detriment of the reinsured.”

Brokerage reports show state residents suffer even when a big storm like Katrina is not distorting the market.

A glut of capital and soft markets drove U.S. reinsurance prices down 15 percent in 2009. But in Florida, according to insurance broker Guy Carpenter & Co., they fell only 5 percent.

MOST OF THE MONEY behind Bermuda reinsurers comes from the U.S., as does most of the business. But the profits Bermuda reinsurers make are, under Bermuda law, tax-free.

Regulation of Bermuda’s 1,240 insurers is left to the Bermuda Monetary Authority, which is not an arm of government. The independent organization is run with oversight from a board that includes executives of the very companies it oversees.

The system is structured to allow multimillion-dollar ventures to spring to life in weeks. New executives and their business plans are reviewed by a panel of executives from other firms, not by regulators.

By comparison, it takes months of regulatory review to launch a Florida insurance company. State officials require criminal background checks and must examine the capital sources behind a new company.

Solvency requirements, though changing, remain light. In 2008, Bermuda for the first time determined how much money a reinsurer needed by how much risk it assumed. But the level was set so low it provided little protection.

Renaissance Re, the largest carrier of Florida hurricane risk in the world, needs $316 million to meet Bermuda’s requirements. To keep an A grade from financial rating firm A.M. Best, it carries more than $1.5 billion.

In places, the lines between regulator and regulated are blurred.

Paula Cox is the Bermuda prime minister of finance, as was her father before her. She also is a lawyer for ACE Ltd., the island’s largest reinsurer. Her brother, Jeremy Cox, is the supervisor of insurance, responsible for setting the standards Bermuda reinsurers must meet.

Supporters argue such intimacy is why Bermuda succeeds.

“There are few secrets here,” trade representative Brad Kading noted in an essay on Bermuda reinsurance. “That serves a self-policing role in meeting the business ethics tests.”

Bermuda officials and their supporters insist the island is making strides in matching European countries.

“You could use ‘light touch’ as a pejorative, or you could use it as the way to go,” said David Ezekial, president of International Advisory Services, a Bermuda firm that specializes in launching new reinsurers.

They also point out billions of dollars from Bermuda helped rebuild after Katrina.

“We are good for America,” said Axis Re chairman Michael Butt. “In 20 years’ time, this is going to be Florida’s survival.



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