The Bermuda re/insurance market is coming under increasing pressure from low insurance rates and the market cycle has yet to reach its trough, according to a special report on the Island’s insurers by credit ratings agency AM Best Co.

The report, entitled “Favourable Results Conceal Looming Concerns for Bermuda’s Re/insurers”, found that profits have been substantially bolstered by loss-reserve releases, capital retrieved after claims for loss events were less than what was set aside to pay them.

“Broadly speaking, pricing pressures persist, investment portfolios lack sufficient yield, and loss-reserve releases which are masking the symptoms are likely drying up,” AM Best reported. “On top of that, insurers face potentially industry-changing financial regulation and taxation.”

With Bermuda company valuations depressed and companies flush with capital, conditions are “ripe for mergers and acquisition activity”, the report stated.

Shareholders’ equity of the 18 publicly traded companies monitored by AM Best in the Bermuda market was close to $90 billion at September 30 this year. And the aggregate reported combined ratio the percentage of premium dollars spent on claims and expenses was a healthy 93.5 percent through the first nine months of the year. However, Best noted: “The market’s annualised return on equity is approximately 11.6 percent. The real story, however, is revealed by adding back the 7.1 percentage points of favourable loss-reserve development, increasing the combined ratio to 100.6 and cutting the ROE to the mid-single-digit range.”

Bermuda re/insurers were “not burned too harshly” by the frequency of catastrophes this year, AM Best added. This year’s major catastrophes, in terms of insured losses were the Chile earthquake, the Deepwater Horizon oil rig disaster, the New Zealand earthquake and European windstorm Xynthia.

The Bermuda companies remained “flush with capital and companies are bracing themselves for continued downward rate pressure at the January 1 renewals”.

There had been no turn in the market, Best said, and 2010 had made companies aware that they will “need to dig in for a war that is far from over”.

“Broadly speaking, the Bermuda market’s reported results through September 30, 2010 have varied little among companies, but AM Best believes the next 12 to 18 months will show disparities in performance and put management teams to the test,” the rating agency said.

The report, put together by AM Best vice-president Robert DeRose and senior financial analyst Greg Reisner, argued that the Bermuda market could stand up well to much-discussed proposed changes to the US tax code that would seek to levy more tax on non-US reinsurers.

And it suggested that those companies that had redomiciled were not doing so just for tax reasons.

“Bermuda carries the stigma of a ‘tax haven’ because it has been among the world’s most competitive tax environments for businesses,” the report stated. “In the United States, the Neal Bill is proposed legislation that would close certain tax loopholes.

“This is the type of well-worn topic that doesn’t matter, until it does. Several companies already have redomiciled for destinations such as Ireland and Switzerland that not only offer competitive tax environments, but also ample office space, a perceived level of more security due to tax treaties with the United States, and a more open labour market, among other advantages.

“Nonetheless, AM Best expects the Bermuda market to stay relevant even if US legislation is passed. The Bermuda market will continue to be innovative and, depending on the severity of the Neal Bill, may even attract more companies.”

Another challenge on the way for the market is Solvency II, the new set of European Union rules for insurers, due to take effect in 2013, which will raise the level of capital companies are required to hold and raise standards of transparency and corporate governance. “While Solvency II will impact many jurisdictions, it is particularly important for Bermuda to gain equivalency,” Best commented.

“Bermuda has devoted much time, effort and resources to be recognised as equivalent in its solvency regime, and the initial determination could be made by July 2011.”

On likely mergers, Best said: “Merger and acquisition (M&A) rumours always circulate in the Bermuda market, but recently it seems to be a lot of talk and little action. Few deals get done.

But as companies are more flush with capital than they have been in quite a while, and valuations are depressed, conditions are ripe for M&A activity.”