The balance sheets of Bermuda's insurance companies are "in the best shape in years", according to a special report by credit rating agency AM Best.

A lack of catastrophes and solid investment returns over the past two years have allowed companies to build up their capital base.

The positive results has meant the evolution of the Island's insurance industry has accelerated over the past two years to the point where "Bermuda is clearly as prominent as any market in the world", Best said.

But the report added that with growing competition in a softening market, the industry fundamentals are set to deteriorate.

In past soft phases of the insurance cycle, companies under pressure to deploy their capital have been tempted to go after underpriced business.

But Best senior financial analyst Devin Inskeep, who wrote the report, "Bermuda — 2007 Financial Review", believed Bermuda companies were determined not to repeat the lack of underwriting discipline that exacerbated soft markets in the past.

"As the July renewal season looms, insurers in Bermuda seem to sense they're on thin ice, and none wants to be the one to break it," Mr. Inskeep wrote.

In an interview with The Royal Gazette,Mr. Inskeep added: "We are hearing from a lot of companies that they have learned the lessons of past markets."

Trends noted in the report include active share repurchase programmes and widespread increases in dividend payments. And Best also expects some vigorous mergers and acquisitions activity in the coming months.

"CEOs should expect to filed calls from investment bankers pitching opportunities as routinely as drinking the morning cup of coffee", the report states.

Mr. Inskeep said: "We didn't see the megadeal people expected in 2007. What we did see were acquisitions that expanded distribution."

The report spells out this trend in more detail. "The Island's interest in US excess and surplus lines specialty markets continues unabated, as carriers such as Max Re, Montpelier Re and Endurance have set up domestic [US] operations. Another major trend is Bermuda companies entering Lloyd's markets through the formation of a Lloyd's syndicate, such as Aspen or Montpelier Re, or through transactions such as Ariel Holdings and Validus Holdings acquiring Atrium and Talbot, respectively.

"A common theme of these trends is admittance to essential distribution networks to access certain classes of business."

This was partly fuelled by a desire to diversify away from catastrophe business or to put capital to work by expanding business opportunities.

The report stated that the sub-prime mortgage crisis had caused some Bermuda carriers to make write-downs, but had not so far impacted their operating results.

"The sub-prime questions going through 2008 include: Is the worst over and what will the impact be on the carriers with directors and officers or errors and omissions exposure?" Mr. Inskeep wrote.

The Bermuda achieved a healthy combined ratio of 83.6 percent in 2006 and 82.9 percent last year. Anything under 100 percent indicates an underwriting profit.

Best found that Ace was by far the largest operator on the Island, having written non-life net premiums of $11.6 billion. XL Capital is the second biggest player, with $6.3 billion of non-life net premiums, followed by Everest Re and PartnerRe with $3.9 billion and $3.2 billion of net premiums respectively.

The capacity of the Bermuda market, expressed as shareholders' equity has increased by 46 percent since 2005, boosted by the "Class of 2005" companies which came here in the wake of Hurricae Katrina, bringing $10 billion in capital.