Last week I talked about what the reinsurance industry is doing as a result of the terrorist attacks in the United States. This week we will look at the implications of their actions on the commercial insurance industry in Bermuda.

Due to reduced reinsurance capacity, tightening of underwriting guidelines and increased premium rates, the commercial insurance industry is experiencing what is called a 'hard market'. Explained simply, a hard market occurs when demand exceeds supply. When demand exceeds supply, the suppliers (insurers and reinsurers), have the ability to do whatever they need to do when the client wants to purchase their service. Some examples include increasing premium rates, putting exclusionary language on policies, introducing higher retentions (deductibles) and so on.

The commercial insurance industry was slowly showing signs of entering a hard market in the year 2001 but the signs were more industry specific and risk selective than general. However, because of the events of September 11, the hard market has come fast and furious, affecting every line of business and coverage across the board.

When reinsurers tighten their underwriting guidelines, alter their premium rates or reduce in numbers, the majority of direct commercial insurers are affected by their actions. Particularly affected are those insurers domiciled in the United States who have to adhere to strict regulatory requirements including, operating with a 3 to 1 premium to surplus ratio and maintaining a net capacity (minus reinsurance ceded) of 10 percent or less of their policyholders surplus (net worth). As a result of these solvency requirements, many direct commercial insurers will not be able to offer large limits of liability (the amount of insurance an insured can purchase from an insurer).

Without the backing of several reinsurers, limits will be cut back significantly causing those insured to have to purchase a patchwork of insurance coverage from many different insurers to try to maintain the limits they had in the past. A serious disadvantage of this consequence becomes evident when clients have losses and encounter conflicting claims handling approaches among the variety of insurers they have used, which leaves them in a very vulnerable position.

Some believe the reinsurance industry sets the standards for the direct insurance industry and in effect controls the underwriting cycles. These observations have been proven true by the catastrophic events of September 11.

Some direct insurers in Bermuda have been able to quickly raise capital by selling stock to strengthen their balance sheets and due to the favourable regulatory environment in Bermuda, are able to continue to write insurance without the backing of reinsurance companies.

Therefore, they are able to still provide large limits of liability to clients, allowing clients to achieve seamless cover without having to worry about different philosophies when it comes to claims handling.

Direct insurers in Bermuda also have the ability to quickly change their rates and terms and conditions without having to file with government officials for approval.

This ability gives the Bermuda insurers a competitive advantage over insurers domiciled in other jurisdictions because they can not only make business decisions about how to continue in the very challenging market they find themselves in but can also quickly act on them as well. As a result, the Bermuda market is able to offer firm terms and conditions to their clients for their upcoming renewals making it a very attractive place for both clients and insurers to be for the 2002 underwriting year.

When the excess market was started in 1986 in Bermuda, one of the major selling points was that the insurers in Bermuda were net line underwriters (they could underwrite and accept risks 100 percent without reinsurance).

Several commercial direct insurers in Bermuda decided to purchase reinsurance because it was cheap and readily available in the 1990s so its benefit (adding a cushion to their balance sheet) far outweighed the cost of purchase.

However, now that the cost of purchasing reinsurance coverage has escalated and the process has become very cumbersome by forcing direct insurers to facultatively (individually) place Fortune 500 companies, several direct insurers in Bermuda have decided it's not worth trying to reinsure these risks.

These insurers feel their balance sheets are strong enough to write risks net of reinsurance.

Some insurers in the Bermuda Excess Casualty market are once again meeting the shortfall for the pharmaceutical industry, which started the market in 1986.

As mentioned last week, pharmaceuticals are now excluded under all treaties with the major reason being their deteriorating loss history.

Premium rates for pharmaceuticals have skyrocketed because no market other than Bermuda seems willing to underwrite them without reinsurance. And because the Bermuda insurers are willing to take on this added exposure to their balance sheets, they must charge more premium to write these risk without reinsurance. As mentioned last week, reinsurers already facing bleak results because of the latent development of past liabilities compounded by the total reduction of their capital and surplus as a result of September 11, 2001 do not want the added risk of pharmaceuticals and therefore, they have made the decision to exclude them from their treaties.

Because of the Bermuda insurance industry's ability to quickly respond to the negative cycles of the global insurance industry, it has already attracted new capital eager to take advantage of the hard market.

This is why we are seeing several new companies forming on the island. Investors are looking for ways to safely earn back capital lost as a result of the devastating effects of September 11, 2001.

These investors are anticipating a significant reduction in capacity available on January 1, 2002 and hence the race to have companies up and running prior to this date to take advantage of the shortfall in the insurance industry. Bermuda is in a very enviable position in the global insurance arena right now.

@EDITRULE:

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in The Royal Gazette every Monday. Feedback crduffyibl.bm