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Carriers look to capital management amid thinning opportunities

Capital management remained firmly on the agenda for Bermudian and short-tail carriers during the second quarter as market headwinds continued to erode profitable growth opportunities.

Along with (re)insurers repatriating more capital, the recent M&A consolidation spree also continued with one major acquisition - XL's of Catlin - moving to completion as Tokio Marine's $7.5bn purchase of HCC was announced.

Total capital returned by The Insurance Insider's Bermuda peer group climbed by just over a third year-on-year to $678mn in Q2 2015, representing 1.04x the composite's Q2 operating income.

This was largely fuelled by a 43.1 percent increase in Q2 share repurchases to $551mn as (re)insurers struggled to put surplus capital to use.

This mostly offset a slump in buybacks in Q1 2015, meaning that year-to-date repurchases are now roughly in line with prior-year levels.

Allied World significantly increased its appetite for share repurchases during the second quarter with $194mn of buybacks - more than double the $71mn it repatriated in Q2 2014.

This included the repurchase of over 4 million shares directly from PartnerRe acquirer Exor at $40.55 per share in a negotiated transaction, which CFO Tom Bradley labelled "a unique opportunity" to buy back a significant block of shares at a discount.

This brought year-to-date buybacks to $245mn - comfortably above the $175mn of repurchases in both full-year 2013 and 2014 respectively - with $173mn remaining under its authorisation as at 30 June 2015.

As such, Bradley said that the (re)insurer would probably suspend buybacks for "most of 2015", adding that there was a possibility of restarting them later in the year.

"I certainly don't expect anything in the third quarter and we'll look at it again in the fourth quarter as we get towards year-end," he said.

Combined with $21.5mn of dividends paid and the fact that cat and non-cat losses bludgeoned Allied World's bottom line last quarter, the carrier repatriated the equivalent of 8.35x its Q2 operating profits.

Buybacks vs special dividends

Arch also ramped up its buyback activity in Q2 2015 after the (re)insurer bought back $199mn of shares - up from nil repurchases in the prior-year period and equal to 1.36x the firm's Q2 operating income.

With the carrier now trading at a 48 percent premium to trailing book value, Arch CEO Dinos Iordanou said it would consider repatriating excess capital through special dividends, although it preferred the share buyback mechanism.

He explained that when the firm repurchased shares at a premium to book value, its objective was to earn back that premium for remaining shareholders over a reasonable period based on expected returns on equity - something dependent on how quickly the company generates earnings.

However, he warned that the current market environment had created uncertainty surrounding future earnings, adding that competitive conditions made profitable growth in traditional (re)insurance lines "difficult to achieve".

Meanwhile, Iordanou said that acquisitions were last on his list of preferred uses for excess capital, with investment in recruiting people and teams coming first, followed by renewal rights transactions.

The Bermudian has been at the centre of M&A speculation in recent months after The Insurance Insider reported in May that it was considering a fresh approach for Axis, having registered its interest at a number of points over the last few years.

However, in August this publication revealed that Arch will not make a bid after Axis failed to close its agreed acquisition of PartnerRe.

It is believed that the work undertaken by Arch on the potential deal led it to reconsider, with concerns about the size of Axis's reinsurance business and the extent to which a takeover would create true strategic value.

Meanwhile, Axis handed back just $29.1mn of capital to shareholders last quarter, solely through dividends, after the company was forced to pause its buyback programme as a result of its pending M&A deal with PartnerRe.

The agreement was subsequently terminated in August after PartnerRe opted for a $6.9bn sale to rival bidder Exor instead.

Axis will now hold a review of its business. It will receive a $315mn termination fee from PartnerRe, including a $280mn break-up fee and $35mn to offset merger-related expenses.

This is set to be largely returned to shareholders in H2 2015 after the company announced that it had reinstated its buyback programme and would complete $300mn of accelerated share repurchases by no later than the end of 2015.

Like Axis, Endurance bought back no shares last quarter, as has been the case since the May 2013 arrival of CEO John Charman. His ethos has been to create shareholder value by using excess capital to transform the business.

This was recently illustrated through Endurance's $1.94bn cash and stock acquisition of Montpelier Re, which closed on 31 July.

While Charman told investors that the deal is expected to free up $300mn to $500mn of capital by the end of 2016, he reaffirmed the company's stance "first and foremost" of deploying capital to profitably expand and grow the business.

Nonetheless, Endurance paid $15.8mn of dividends in Q2 2015 - roughly a fifth of its Q2 operating profits.

XL restarts

Having suspended its share buyback programme in January in connection with its $4.2bn acquisition of Catlin, XL Group repurchased $110mn of shares during the second quarter - representing 44.8 percent of the carrier's Q2 operating earnings. It came after the deal closed on 1 May.

As of 6 August, the company had completed a further $60mn of buybacks since the end of Q2.

Speaking on the firm's Q2 earnings call, chief executive Mike McGavick told analysts that the company plans to sustain capital to meet the highest capital level required by rating agencies, along with a buffer equivalent to the firm's "largest most likely source of loss".

He said that the company would then assess how best to use any surplus capital, with one of the options being to return it to shareholders.

"Since restarting share buybacks following 1 May, we have followed the rate previously shared with you of a bit more than $50mn per month," remarked McGavick on the company's second quarter earnings call.

As such, XL unveiled a fresh $1bn share repurchase authorisation and raised its quarterly dividend by 25 percent to $0.20 per share.

Following an integration update at the beginning of June, analysts predicted that XL will complete $400mn of buybacks in 2015 with the potential for $200mn of dividends.

Similar to Allied World, Aspen returned nearly all (97 percent) of its Q2 operating earnings to investors in a quarter when its profits took a hit from mid-sized losses, primarily in energy.

This included $47mn of share repurchases - compared to zero a year ago - along with $13mn of dividend payments.

Hires and opportunities

Meanwhile, The Insurance Insider's composite of short-tail specialists - which is now down to three members following Montpelier Re's sale to Endurance - gave back $138mn of capital to shareholders in Q2 2015, up from $113mn a year ago.

This came as aggregate Q2 buybacks moved up from $64mn to $94mn, primarily driven by increased activity at Validus, where repurchases totalled $85.1mn.

This compares to nil buybacks in Q2 2014, when Validus paused its programme on account of its acquisition of US specialty insurer Western World.

Including $28.2mn of dividends paid, the carrier returned approximately 1.18x its Q2 2015 operating profits.

"Absent business opportunities to deploy our capital, we expect earnings for the year to be a good proxy for the amount of capital we intend to manage through the share repurchases and dividends," remarked CFO Jeff Sangster.

Sangster said that despite market headwinds, opportunities to deploy capital had "recently improved" with new hires already made and others in the pipeline.

This included the appointment of Arch Re executive Jim Franson in July as president of a new US domestic reinsurance operation that will write on behalf of its Swiss platform, in a bid to expand into the casualty treaty market.

Nonetheless, Validus CEO Ed Noonan stressed that management sees casualty treaty as complementary in rounding out its product offering rather than a major focus in its own right.

"Don't expect to see us jumping all over casualty. This isn't some bold move into the class and you're not going to see us become a casualty company," he told The Insurance Insider.

"In our DNA we're a short-tail company, but if the market gets better we'd be fools not to be able to take advantage of that."

In contrast, rival RenaissanceRe completed a modest $8.4mn of buybacks during the second quarter - down from $37.4mn in the prior-year period - marking the first repurchase since it announced its $1.9bn acquisition of Platinum in November 2014.

CFO Jeff Kelly said that the company took a "conservative but reasoned" approach to rebuilding its capital, adding that the firm was now in a "solid position" and had "several hundred million dollars" of capital in excess of its requirements.

Kelly said the firm would probably be in the market for share repurchases in future, probably to a more significant extent in the fourth quarter than the third quarter.

Furthermore, CEO Kevin O'Donnell said that the company's decision to not renew the large Florida retro programme that it bought in 2014 - which allowed it to repurchase shares in the third quarter last year despite it being the height of the hurricane season - would not influence its decisions on buybacks going into the wind season.

London-listed peer Lancashire returned no capital to shareholders in the second quarter.

The firm reaffirmed that it would look to pay out substantially all of its earnings absent a market-changing event if it could not find the right opportunities to deploy capital.

Meanwhile, Keefe, Bruyette & Woods analyst Paris Hadjiantonis said that while Lancashire's management had played down the possibility of a takeover by a larger company, he believed it is a likely acquisition target.

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