worst disaster -- but diversification into other types of insurance underwriting has a ratings agency worried.

Standard & Poor's (S&P) Bermuda Catastrophe Reinsurance Market Report released this month is not completely favourable to the sector.

The good news is that primary insurers are told that the Bermuda "cat'' market is well capitalised and should be able to meet its obligations, even under severe catastrophe conditions.

S&P believes the so-called "soft market'', in which premiums are falling, will lead to increased exposures at very high layers and accelerate the efforts of Bermuda reinsurers to diversify into other lines of business.

The rating agency said diversification will absorb capital and may moderate operating results, but should ultimately lead to more stable earnings as the companies mature into multi-line providers of capacity.

It said the price of "cat'' cover will continue to fall in 1997, by about ten percent. A major cause of softer pricing has been the superior results of the Bermuda "cats'' since their inception.

With the reinsurers starting to use financial leverage via bank lines of credit to enhance capital and liquidity, S&P analysts believe it is likely that there will be public offerings of non-equity securities in the near future.

The report accepted as appropriate that Bermuda reinsurers which have genuine excess capital should return it to shareholders, but warned: "The magnitude of some recent decapitalisation plans may have a significant impact on the capital adequacy of these reinsurers.'' The bad news, according to the report, includes the belief that "not all clients of companies on the Island, and certainly not all potential clients, fully trust and accept Bermuda companies.

"In many cases, Bermuda companies are used as a last resort, and because the client cannot obtain enough (in some cases any) insurance from more conventional markets.'' The report said Bermuda continues to suffer a stigma in the world's regulatory community, "partially due to inaccurate perceptions of lax supervision'' and because of historic rules of secrecy.

The 1995 revisions to the Insurance Act, said S&P, partially address some of these issues by allowing the Registrar of Companies in Bermuda to intervene in a more timely fashion and by modifying the degree of supervision to be commensurate with the level of risk of the company being regulated.

But the rating agency said, "Unfortunately, the bankruptcy filing of the newly domesticated Electric Mutual Liability Insurance Co. once again raised concerns about the level of regulatory supervision accorded Bermuda-registered insurers.'' S&P does note that Bermuda has become integral to the world's insurance and reinsurance markets, commenting that it is one of the few places in the world where large and unusual risks can be underwritten.

And it says that the Island is home to some of the more creative minds in the industry and through continued innovation Bermuda should retain its competitive advantage. It accepts that more creative and innovative insurance mechanisms will be tried first in Bermuda and then exported globally.

But the hope was expressed that Bermuda would not make the same mistakes that "naive capacity'' in global markets made in the 1970s and early 1980s.

S&P is concerned about property catastrophe reinsurers' expansion into other lines "in which they may not have as much expertise''.

And it claimed, "In some cases Standard & Poor's' prediction has already come true, as several of these companies have started creating casualty, as well as property, books of business.

"...ACE has diversified into satellite business, while XL has started a property book.

"While such diversification may ultimately prove to be successful, and Standard & Poor's clearly favours risk diversification in most situations, we remain sceptical at this point that the expertise is in place to successfully implement such diversification.

"Further, Standard & Poor's has warned that the long term intentions of the owners of these companies will significantly affect their ultimate success. To a large extent, many of the investors are insurance-savvy and can be expected to be patient capital, nevertheless, it still remains to be seen if and how all the equity holders will behave over the longer term, especially if and when significant losses are reported.

"Thus, while the companies in Bermuda have a wonderful opportunity, the realisation of that opportunity remains subject to the ultimate defining factor -- follow through. Regardless of how innovative a strategy is and how well designed it may be, in Standard & Poor's' experience, it is the implementation process where success is separated from mediocrity. Thus, management in Bermuda, as any place else, will have to accurately implement strategy, day in and day out for some time, before victory can be declared.'' S&P said Bermuda had emerged as perhaps the world's leading market on the cutting edge of insurance risk financing and risk-management techniques.

And with the innovation Bermuda is known for, together with the establishment by government of a Class system for insurers (and reinsurers), a market has been created here "that can realistically aspire to gain world-class status.'' Copies of the report can be obtained by contacting Dorothy Hemingway at 212-208-1759 or faxing requests to 212-412-0352.

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