A safe bet: hardened by tough market conditions, insurers are seen as a solid investment.

Insurers are getting fairly good access to capital markets as a somewhat safe bet among financial services segments, despite signs of pricing pressure in property/casualty underwriting.

That access is coming in handy. In the wake of Hurricanes Katrina and Rita, insurers and reinsurers--particularly those based in Bermuda--are plunging into the capital markets with equity and debt offerings, raising funds to shore up battered balance sheets as they head into the January reinsurance renewal season.

The safety investors perceive in insurers is partly due to the stronger capital position of property/casualty insurers after three years of strong pricing and underwriting discipline ingrained, ironically, by the inability of insurers themselves to earn high investment incomes on their own portfolios. The enforced accountability that is supporting insurers' stocks in the equity markets also may shore up their debt offerings, as Europe's approaching adoption of the Solvency II capital adequacy standard prompts closer examination of bond offerings.

Gary Ransom, property/casualty equity analyst with Fox-Pitt, Kelton, said property/casualty insurers "are looking at some headwinds" as pricing declines in time with the softening of the market cycle. "Investors are aware of that, and they know that's one of the negatives built into all P/C stocks"

That bit of bad news is partly offset by several factors, said Ransom. For one, premium rates at present are mostly set at profitable levels. Also, combined ratios have been below 100 for many insurers over the past few years, meaning that the once-elusive underwriting profit is alive and well.

"They're still turning in earnings and growing book values, but the trajectory of that as you look forward is probably toward less growth and even some decline," said Ransom.

The Katrina Factor

Nearly all property/casualty companies affected by Hurricane Katrina, not to mention Hurricane Rita, are unsure exactly how much they will lose in storm-related claims. The latest overall industry estimate is $40 billion to $55 billion, from Towers-Perrin's Tillinghast affiliate.

For reinsurers, the storms will likely prop up premium rates going into the January renewal season. In the meantime, they find themselves in a capital crunch, between having to reserve for large expected third-quarter losses and putting together funds to underwrite in a more favorable market in 2006.

Kenneth LeStrange, chairman, president and chief executive officer of Endurance Specialty Holdings Ltd., said the rush of Bermuda reinsurers to the capital markets after Katrina, followed by Rita and other catastrophes around the world, is prompted by three factors. First, there has been an absolute reduction in the market's capital because of Katrina and the other catastrophes.

"Katrina alone has been deemed to be a $40 billion to $50 billion loss, and a greater proportion of that loss will be hitting the reinsurance markets than the four hurricanes last year," he said.

Still, that factor alone probably wouldn't have sparked the rush to capital markets that has occurred, said LeStrange. A second factor is pressure on the reinsurers' financial strength ratings. Ratings reviews in the wake of Katrina have "called into question the efficacy of some of the vendor risk models to be able to manage portfolios," he said.

The third factor driving the race for capital is that some reinsurers want to make sure they have sufficient capital to trade in what will be a hardening market for property coverage, said LeStrange.

Investors in general are showing a good appetite for the stocks and bonds reinsurers are floating in the market, and they aren't showing signs of being spooked by large loss figures and ratings pressure, said LeStrange. "From what I hear on Wall Street, there's a whole line of people getting in queue to do their own capital raising," he said.

Oliver Peterken, chief risk officer of Aspen Insurance Holdings Ltd., said there's a lot more capital insurers can access today, following major catastrophes, than in the past. The question for the reinsurance market isn't so much whether reinsurers can get more capital, but where they are going to deploy it. "It remains to be seen if some reinsurers are going to want to deploy that capital in the U.S. Gulf Coast region, or take it somewhere else where they think they can put it to better use," he said.

Aspen was among the hardest-hit Bermuda companies in terms of its stock price in the wake of Katrina and Rita. When Aspen's estimate of gross losses from the storms went from an initial $590 million to as high as $925 million, Aspen's stock plunged 23% from Oct. 3, the day it revised its loss estimate, to Oct. 5.

"That was a reaction to our revised loss estimates and a function of the market trying to find its new steady state," said Peterken. "You can talk to people about catastrophe exposure and show them the models, but until a catastrophe actually hits, they don't always understand what it can mean."

Better Than Banks

From an investor's point of view, the performance of insurers themselves isn't the only factor to consider, said Ransom. Insurance stocks fit into the portfolios of, say, mutual fund managers or pension funds in relation to other types of stocks. "Investors want financials in their portfolio, but they generally don't like the banks," he said.

Banks are out of favor because they are being caught in a flattening of the interest-rate yield curve.

While banks are a larger portion of the financial services sector, if investors want to steer clear of them, they will take a look at property/casualty companies, because they have profitability, at least for now. "Even though we're entering a soft market, property/casualty is probably still one of the more attractive segments in the financials," said Ransom.

Investors will look carefully at the market positions of individual companies, given the uneven softening trend from line to line. Ransom pointed out that, in the great softening cycle of the late 1980s and 1990s, much of the softening was on the casualty side. Insurers like American International Group Inc. and Chubb Corp. performed well, and saw steadily increasing stock prices, as they offset low casualty premiums with deft work in property lines.

Because of the cyclical nature of the property/casualty industry, it's often hard for investors to look at property/casualty stocks as a long-term buy-and-hold investment, said Ransom, although with certain insurers such a position would have paid off over the past 10 or 15 years. On the other hand, in the current softening market another factor is in play that hadn't been in past cycles--low interest rates.

"The last time there was a big softening cycle, in the 1990s, the bond markets were booming, giving insurers as investors a means to make up for underwriting losses with investments," said Ransom. "Now, interest rates are as low as they have been in 30 years. No one knows how much or bow fast they'll go up, but for insurers, the pressure is still on to keep up that underwriting discipline."

Ransom is skeptical of some theories that point to the world's leading reinsurers and some leading European primary insurers and their efforts to balance the ups and downs of property/casualty earnings with a smoother earnings pattern of life insurance business as the wave of the future. "That reminds me of the trend a few years ago where you had banks or even retailers buying insurers on the theory that it diversifies," he said.

If anything, pure-play property/casualty companies are a more attractive investment, because in theory, they know their business, he added.

Throughout the hard market that began in the months before the Sept. 11 terrorist catastrophe, insurers have had to figure out what to do with their excess capital. Many had resorted to stock buybacks and increased dividends, "just giving it back to the shareholder," said Ransom.

Floating Debt

Insurers also have been tapping the bond markets to raise capital, more for "opportunistic" reasons than out of necessity, said Ransom. "Some have been floating debt to keep their financial strength ratings up," he said.

Some insurers may be floating debt offerings because interest rates are low. They have an opportunity to shift capital from high-cost stock to lowcost debt. "It's cheap capital" said Ransom.

A number of insurers, particularly those based in Bermuda who have to post letters of credit for reinsurance transactions, also have been arranging multi-year credit facilities that would allow them to tap into available credit as needed, said Ransom.

Debt issues by insurers can be taken by investors as a fairly reliable indication of the issuer's risk sensitivity, according to researchers at Milano-Bicocca University in Italy. A recent paper published by economics professors Francesco Natale and Emma Zavarone found that the kinds of debt issued by insurers, along with the yield at issuance, carry signals of the insurer's risk profile. The authors found that higher yield spreads signal greater risk inherent in the issuing company, as do debt issues with callable options.

Such signals will become increasingly important for investors as European countries prepare to adopt the so-called "Solvency II" capital adequacy standards for insurers, tentatively in 2007, the study said. "Insurance companies have recently raised their funds for regulatory purposes by increasing the issues of uninsured subordinated debt," Natale and Zavarone wrote.

While the risk/reward trade-offs for equity investments have been well-documented, the authors call for more study on debt issues related to insurers, as they believe debt offerings will become more important as a tool for insurers to meet capital standards of both regulators and rating agencies.

Key Points

* Since Hurricane Katrina, many Bermuda reinsurers have plunged into the capital markets with equity and debt offerings.

* The enforced accountability that is supporting insurers' stocks in the equity markets also may shore up their debt offerings.

* Debt issues by insurers can be taken by investors as a fairly reliable indication of the issuer's risk sensitivity.

Learn More

Endurance Specialty Holdings Ltd.

A.M. Best Company # 84835 (Endurance Specialty Insurance Ltd.)

Distribution: Reinsurance brokers

Aspen Insurance Holdings Ltd.

A.M. Best Company # 83210 (Aspen Insurance Ltd.)

Distribution: Reinsurance brokers

For ratings and other financial strength information about these companies, visit www.ambest.com.