Global Reinsurance - November 2010 e-edition

NOVEMBER 2010

SAVVY CEDANTS How buyers select reinsurers they can trust

DEVIL IN THE DETAIL Incautious underwriting will bump up claims disputes

FACULTATIVE REINSURANCE The pick’n’mix way to cover risks

G LOBAL RE I NSU RANCE.COM

Strike a pose How the reinsurance industry is putting its best foot forward

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Cover image: Getty Images

Does it really make sense to scrutinise the quarterly results of an industry that renews the bulk of its business on an annual basis?

Leader

It can’t be easy running a listed reinsurance company.

It seems chief executives of such firms are constantly being pulled in several directions. Not only do they need to satisfy the demands of their shareholders and clients, but they also need to ensure that pressure from either side does not cloud their underwriting judgment.

This is never clearer than during periods of soft or softening rates.

Leaders’ underwriting instincts tell them to pull back from unprofitable business or raise rates, but shareholders clamouring for growth augments clients’ demands for cheaper cover in tougher times.

While unlisted fi rms also have shareholders to satisfy, listed firms’ owners are arguably less likely to be general investors rather than reinsurance experts, and if private firms’ backers are dissatisfied, it isn’t immediately registered in glaring red on stock exchanges’ ticker data for the world to see.

As this month’s cover story shows, investors have trouble getting to grips with the (re)insurance industry, and the resulting depressed stock market valuations

can either limit M&A opportunities or make the companies look like takeover targets.

Listed companies also have to fi le regular fi nancial statements to regulators and the stock exchange. While public disclosure of performance is clearly a good thing, does it really make sense to scrutinise the quarterly results of an industry that renews the bulk of its business on an annual basis and that is routinely hit by big losses?

2010 is a case in point: some reinsurers’ fi rst-quarter and firsthalf results must have looked pretty grim to the outside world, but on an annual basis, many are likely to look much more healthy as a result of the more benign last two quarters.

Could it be time to acknowledge that a stock market listing and reinsurance underwriting are incompatible? Or does the industry simply need to get better at managing the two?

Ben Dyson Assistant editor Global Reinsurance GLOBAL REINSURANCE NOVEMBER 2010 1

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November The industry shows its best side, page 14

Habib Kattan goes for core values, page 26

G LOBAL RE I NSU RANCE.COM

The Markel team are on message, page 20

News

Cedants

1

Leader

24 Because bad cover is worse than no cover

4

News digest

8

Opportunity knocks Introducing start-up Paraline Group

The cedants’ tool kit for selecting a reinsurer they can trust

10 Catastrophe cashpoint 12 Swiss Re-structures 14 News agenda

A new source of capital

Will reorganisation work this time?

The industry needs to work on its image

People & Opinion 18 Peter Hughes

taking a closer look at how they work

20 Profile 44 Diary

The buying process has changed, says Kiln’s Habib Kattan

Claims 40 Details make the difference

The perils of a soft market

Special Report 34 Fac to the future Facultative reinsurance is bigger than ever

Don’t judge the rating agencies before

19 Up the ladder

26 Q&A

36 When the going gets soft The market’s not for turning 38 Renewable optimism

Smart reinsurers are going green

Access Re’s Enda McDonnell is nobody’s fool

The close-knit team at Markel International

Monty is fishing for the latest on Everest Re’s C-suite

Editor-in-chief Ellen Bennett Tel +44 (0)20 7618 3494 Email ellen.bennett@globalreinsurance.com

Publisher William Sanders Tel +44 (0)20 7618 3452 Email william.sanders@nqsm.com

Assistant editor Ben Dyson Tel +44 (0)20 7618 3480 Email ben.dyson@globalreinsurance.com

Sales director Jonathan Trinder Tel +44 (0)20 7618 3423 Email jonathan.trinder@globalreinsurance.com

Finance reporter Lauren Gow Tel +44 (0)20 7618 3454 Email lauren.gow@globalreinsurance.com

Account manager Donna Penfold Tel +44 (0)20 7618 3426 Email donna.penfold@globalreinsurance.com

Group production editor Áine Kelly Email aine.kelly@globalreinsurance.com

Managing director Tim Whitehouse

Deputy chief sub-editor Laura Sharp Email laura.sharp@globalreinsurance.com Art editor (group) Clayton Crabtree Email clayton.crabtree@globalreinsurance.com

Group production manager Tricia McBride Senior production controller Gareth Kime Digital content manager Michael Sharp Head of events Debbie Kidman

Lines & Risks 41 No time for auto pilot Turbulence ahead for aviation

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GLOBAL REINSURANCE MAGAZINE is published 10 times a year by Newsquest Specialist Media Ltd 30 Cannon Street, London, EC4M 6YJ, UK Tel +44 (0)20 7618 3456 Fax +44 (0)20 7618 3457 www.globalreinsurance.com © Copyright Newsquest Specialist Media Ltd. All rights reserved. No part of this publication may be used, reproduced, stored in an information retrieval system or transmitted in any manner whatsoever without the express written permission of Newsquest Specialist Media Ltd. This publication has been prepared wholly upon information supplied by the contributors and whilst the publishers trust that its content will be of interest to readers, its accuracy cannot be guaranteed. The publishers are unable to accept, and hereby expressly disclaim, any liability for

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2 NOVEMBER 2010 GLOBAL REINSURANCE

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News Digest Buffett: Berkshire Hathaway was a

LLOYD’S RAILS AGAINST FSA REPLACEMENT Lloyd’s Market Association (LMA) has argued that the proposed new UK financial services regulatory system will create costly “triple regulation” and could see Lloyd’s managing and members’ agents facing regulation from the Prudential Regulatory Authority, the Consumer Protection and Markets Authority and Lloyd’s itself, reported Insurance Times.

In its official submission to HM Treasury’s consultation, the LMA argued that the new system is geared too heavily towards banking, describing it as “overengineered” for the general insurance industry. (goo.gl/YL1Z)

Lord Young: restrict ‘no win, no fee’ ads

YOUNG BACKS CLAIMS OVERHAUL Lord Young of Graffham has backed a shake-up of the claims handling process in his wide-ranging review of UK compensation culture, reported Insurance Times. The Tory peer’s report Common Sense, Common Safety recommends, among other things, restrictions on advertising for ‘no win, no fee’ compensation claims. The government has accepted all of the recommendations put forward by Lord Young, who will continue to work across departments. (goo.gl/qgcm) A ABOUT GOO.GL: Type the goo.gl address into your web browser to access our recommended articles from globalreinsurance.com and its sister titles

People BRIT RESHUFFLES BOARD UK insurer Brit has appointed new directors to the boards of Brit Insurance Ltd and Brit Syndicates Ltd, reported Insurance Daily. The insurer has promoted within the group, including group chief operating officer Malcolm Beane; UK business unit chief executive Ray Cox; chief executive of Brit Reinsurance and active underwriter of Lloyd’s Syndicate 2987 Jonathan Turner; and chief executive of global markets Matthew Wilson. All will be joining both boards, subject to regulatory approval.

SANDLER SHUNS TOP JOB Ron Sandler has rejected a series of approaches from Lloyd’s to take over as chairman of the society when Lord Levene of Portsoken steps down next year, reported Insurance Insider. It is understood that Sandler, who was chief executive of the society during its darkest days in the mid1990s, was the preferred option to take up Levene’s mantle. But despite repeated efforts, Sandler is unwilling to return for a second spell in the top job.

AON TO CUT UP TO 1,800 STAFF Insurance broking giant Aon could shed between 1,500 and 1,800 jobs across its global business as part of plans to integrate Hewitt Associates, reported Insurance Times. The roles are mostly non-client facing and will not affect service levels, Aon said. The plans are detailed in a regulatory fi ling in the USA. (goo.gl/TtwZ) COOK TAKES BMS HELM (Re)insurance broker BMS has appointed Nick Cook, former chief executive of rival broker Glencairn, to the new position of chief executive of its London market wholesale business, reported Insurance Insider. Cook will also join the board of BMS Group, subject to FSA approval.

MAN OF OPPORTUNITY Warren Buffett has been the subject of many column inches over the past month, in part for describing his purchase of textile mill Berkshire Hathaway as a $200bn blunder, and also for taking his stake in the world’s largest reinsurer, Munich Re, above 10%. Buffett intends to buy more of the German reinsurer, but filings insist the acquisition is opportunistic rather than strategic.

HARMER HEADS UP CGU Insurance Australia Group has appointed former Aon executive Peter Harmer as chief executive of its Melbournebased Australian subsidiary CGU Insurance, reports Insurance Insider. Harmer, who was former head of Aon UK and Aon Australian operations, was recently linked to the top role at Sydney-headquartered insurance group QBE. Harmer’s CGU appointment follows the resignation of former chief executive Duncan West, who stood down for personal reasons.

RIP ANDREW BEAZLEY Co-founder of Lloyd’s insurer Beazley Group, Andrew Beazley, died on 13 October after a long battle with cancer, reported Insurance Times. Friend and mentor Robert Hiscox said: “Andrew was a man who looked for what was best for the community and society, not just Beazley. They are rare, those beasts. He was a man of integrity and total decency. It is more than a pity that he, of all the people, has to die young.” (goo.gl/IahD)

Reinsurers COURT DECISION NETS HANNOVER RE $140M Hannover Re has received €100m ($140m) windfall following a ruling by Germany’s Federal Fiscal Court, reported Global Reinsurance. A legal dispute had arisen about whether investment income generated by a German reinsurer’s Ireland-domiciled subsidiary should be taxed at the parent company level in Germany because the parent had effectively outsourced business operations to a group-owned entity in Ireland. The court has ruled the provisional fees held by Hannover Re to pay for the taxation will not be needed, so the funding will be released, boosting Hannover Re’s third quarter and its full-year 2010 net income by around €100m. (goo.gl/xayA)

PHOTOS: NBCUPHOTOBANK, REX FEATURES ILLUSTRATION: PATRICK BLOWER

Regulation

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News Digest s a ‘blunder’

View from Insurance Times: Bid for Aviva

Brokers AON BENFIELD HIRES CHINA CATASTROPE HEAD Reinsurance broker Aon Benfield appointed Helen Ye as executive director and head of catastrophe reinsurance in China, reported Global Reinsurance. The former AIR risk modeller will be responsible for developing catastrophe reinsurance business by advising clients on their exposures in China. She will also be developing a centre of excellence for catastrophe reinsurance in China and will be working with the government and (re)insurance market to promote a higher level of awareness of catastrophe exposures. (goo.gl/4NHz)

BUFFETT SET TO BOOST MUNICH RE STAKE Billionaire investor Warren Buffett and three fi rms he controls now collectively own 10.244% of the voting rights of German reinsurance group Munich Re and intend to acquire more, according to a Munich Re fi ling, reported Insurance Times.

However, the fi ling said that the investment was being made to make trading profits rather than implement strategic objectives. (goo.gl/EeVT) HARDY OPENS IN SINGAPORE Hardy Underwriting has launched a new office in Singapore to cope with the growing tendency for local markets to retain increasing amounts of insurance and reinsurance risk, reported Global Reinsurance. Underwriting will begin in December 2010 with the planned arrival of Richard Lim. Initially, Hardy Asia will concentrate on treaty business from the Asia Pacific region (excluding Japan), along with associated reinsurance protections for key clients. (goo.gl/mQ5I)

GUY CARPENTER CREATES FLORIDA UNIT Reinsurance broker Guy Carpenter has formed a dedicated Florida team addressing the increasingly complex needs of Florida-based companies and the dynamic nature of the state’s insurance and reinsurance markets, reported Global Reinsurance.

The team will be headed up by Kevin Stokes, a member of Guy Carpenter’s client strategy team. (goo.gl/7Ekz)

‘The media continues to perpetuate myths about rating agencies’ Peter Hughes, Litmus Analysis

>>> see People & Opinion, page 18 WILLIS RE UNIFIES IN EUROPE Reinsurance broker Willis Re has merged its teams handling continental European and UKbased property and casualty business into an expanded European unit, called Willis Re Europe, and is establishing a new global specialty casualty practice group, reported Global Reinsurance. London-based managing director Tony Melia has been appointed head of the unified European team.

Colin Kiddie will take on overall leadership of Willis Re’s specialty business. It has also created a specialty casualty practice group that will operate on a global basis. The group is led by David Thomas. (goo.gl/imcX)

Capacity

£22.92 bn Total Lloyd’s capacity for the 2010 underwriting year

The 94 syndicates active in Lloyds during the 2010 underwriting year put up total capacity of £22.92bn for the year, according to reinsurance broker Aon Benfi eld’s analysis of Lloyd’s results for the fi rst half of the year. The syndicate with the most 2010 capacity is Catlin’s 2003, with £1.44bn, followed by Amlin’s 2001, with £1.05bn. In equal third place are Hiscox Syndicate 33 and QBE Syndicate 2999, each with £1bn of 2010 capacity.

Aon Benfi eld’s report said that, in the absence of a market-changing event so far in 2010, the Lloyd’s franchise board is facing its fi rst real test of resolve, as newer operations look to expand their Lloyd’s businesses in a diffi cult market environment. The report added, however, that the established syndicates appear to be showing restraint. Proposed capacity changes to date indicate a 2% overall reduction in capacity for 2011, Aon Benfi eld said.

For example, Hiscox Syndicate 33’s proposed capacity for 2011 is £900m, £10m lower than in 2010.

Kiln plans to cut capacity at Syndicate 557 to £60m in 2011, from 119.6m in 2010, and ICAT Syndicate 4242 is aiming to reduce capacity to £80m from £99m. However, a number of syndicates are projecting capacity increases for 2011. Argenta is booting Syndicate 1110’s capacity to £65.2m from £52m, and Syndicate 2121’s to £200m from £174.9m.

Mergers and acquisitions are back on the agenda in the UK general insurance market following news that Allianz, Zurich and Resolution had discussed taking over and splitting Aviva with RSA, whose £5bn bid had already been reported. The companies involved are refusing to comment.

Resolution is well known for its consolidation activity within the life market, and given that RSA would not be interested in Aviva’s life business, the split bid stacks up.

Meanwhile, if the company were in play, it would make sense for insurers that have growth ambitions outside the UK to look at its foreign operations – Allianz and Zurich were reportedly interested in splitting Aviva’s European and Asian businesses between them. Allianz has been open about its acquisition plans; group chief executive Michael Diekmann told the Financial Times that the German insurer had earmarked €1bn ($1.4m) annually for acquisitions, with a focus on property and casualty.

So why target Aviva? Rivals may be hoping to pick the business up cheap after a tough couple of years – its general insurance premium fell more than £1bn in 2009, following former chief executive Igal Mayer’s controversial distribution policies and rating actions.

This, coupled with the fact that most insurance stocks are currently trading at low prices, makes it a good time to act.

The market should brace itself for further developments of this kind. Next year, insurer M&A will be the hottest topic in town as businesses prepare themselves for Solvency II, which comes into force in 2013. Under the new rules, they will need to hold more capital – and M&A is one of the simplest ways of achieving this.

For more news and views from the general insurance industry, visit:

.co.uk

GLOBAL REINSURANCE NOVEMBER 2010 5

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News Digest

It seems that some companies are questioning the value of running a captive, partly as they anticipate greater capital and time costs as a result of the pending insurance directive Solvency II, claimed an AM Best report.

Yvette Essen, report author and head of market analysis at AM Best, explained that, as an estimated one-fifth of captives are dormant, some companies may consider demands from the new regulation to be too onerous.

“The cost of complying with increased regulation, combined with the general desire to achieve greater capital efficiency in the wake of constrained capital markets, has resulted in parent companies increasingly evaluating the effectiveness of using captives. Specialist insurers are consequently developing exit models to run off captives, or to purchase some of the liabilities associated with them.”

The report said there were other factors causing companies to reconsider operating a captive, such as a need to find the best way to deploy capital in the wake of the global economic crisis.

Some businesses may be looking to release trapped capital for use elsewhere, perhaps to expand their core business, while others may be seeking certainty on historical liabilities.

AM Best’s report added that captive formation has been “sluggish” in recent years, largely reflecting a soft market for rates and a reduced need for alternative risk transfer.

“However, there is an understanding that the inherent value of captives extends far beyond merely obtaining lower premiums,” Essen said. “The use of a captive is recognised as a long-term strategy, not a short-term solution.”

For more news and views from the risk management industry, visit:

.co.uk

M&A BUFFETT REGRETS BUY-OUT Warren Buffett has described his 1964 purchase of textile mill Berkshire Hathaway, from which his company takes its name, as his dumbest ever in an interview with CNBC, reported Investment Week. Buffett, who described the purchase as a $200bn blunder, said in the interview that his investment would be worth twice as much now if he had invested in a good insurance company rather than a textiles firm.

HARDY REJECTS BEAZLEY BID Hardy has turned down a 300p per share cash offer made by rival Lloyd’s insurer Beazley, reported Insurance Times. The offer was made on 6 October 2010 for the entire issued and to-be-issued share capital of Hardy, valuing the business at around £158.3m, and to be funded from Beazley’s existing internal resources.

However, five days later, Beazley received a letter from the board of Hardy, rejecting the proposal. Beazley was reportedly “surprised and disappointed” by Hardy’s outright rejection of the bid, while Hardy said Beazley’s bid substantially undervalued the company. (goo.gl/ltfs) SAUDI ARABIA POISED FOR INSURANCE BOOM The Saudi insurance market is ripe for mergers and acquisitions, but these await a nod from the central bank, according to the chief executive of the kingdom’s biggest insurance fi rm Tawuniya, reported Reuters. The insurance sector’s potential is constrained by the Islamic view that buying an insurance policy indicates a lack of faith, which is against Islamic law. But Saudi authorities have licensed 30 new insurance fi rms and are keen to create jobs for a rapidly growing population, to cut reliance on oil receipts and limit state aid to fi rms and individuals after unpredictable events.

Capital markets ASCOT REDUCES CAPACITY Lloyd’s has approved Ascot Underwriting’s 2011 capacity of £600m. Ascot has de-empted its stamp from £700m in 2010 in response to the current market conditions, reported Insurance Times. Ascot chief executive Andrew Brooks said: “In light of the prevailing market conditions, Ascot has taken a key strategic decision in reducing its underwriting capacity from £700m to £600m. We view this as essential in managing our business through the next 12 months.” (goo.gl/orIq) 2010 CAT BONDS HIT $2.8BN Two catastrophe bonds were brought to market in the third quarter of 2010, transferring a total of $232m in risk to the capital markets, according to Aon Benfield’s latest quarterly report on the insurance-linked securities sector, reported Global Reinsurance. While the level of Q3 issuance fell behind that seen in previous quarters, Aon Benfield says it was in line with expectations. Total issuance for 2010 now stands at $2.8bn. (goo.gl/4JO4)

Hungary: Dam acc

DEVASTATED On 6 October, a massive flood was caused by a break in a dam holding a giant man-made lake of highly caustic mud from an alumina factory in Kolontar, Hungary, claiming seven lives and devastating local towns.

Results EVEREST EXPECTS $75M CAT LOSSES IN Q3 Bermuda-based reinsurer Everest Re is expecting its thirdquarter results to be affected by $75m of catastrophe losses, net of reinstatement premiums and taxes. Everest said events affecting its results included the New Zealand earthquake and the hailstorm in Calgary, reported Global Reinsurance.

Everest produced early earnings estimates to assuage concerns following the announcement that chief executive-elect Ralph Jones had resigned from the fi rm, forcing current chief executive Joseph Taranto to delay his retirement plans. Taranto will now continue in the role until the end of 2012. (goo.gl/EP2x)

PHOTO: ACTION PRESS/REX FEATURES

View from Strategic Risk: Captives

BRIT/APOLLO DEAL DEADLINE EXTENDED The deadline for private equity firms Apollo and CBC Capital Partners to make a formal offer to buy Lloyd’s insurer Brit has been extended to 25 October from the original deadline of 15 October, reported Insurance Times.

In a statement, Brit said that significant progress had been made in satisfying a number of the pre-conditions to the offer including the completion in all commercial due diligence by the Apollo/CVC consortium. The firm added, however, that a number of regulatory matters and legal documentation still needed to be finalised. At the time of writing, Brit was due to release its interim management statement on 26 October. (goo.gl/3K2u)

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News Digest ccident creates toxic flood

TOXIC SLUDGE HAS LIMITED IMPACT ON INSURERS The international property and casualty market will likely sidestep clean-up and liability costs in the Hungarian chemical disaster, reported Insurance Insider. While Allianz is the insurer for the owner of the alumina plant responsible for the environmental disaster after toxic sludge burst the banks of a reservoir, it is understood the insured has little cover in place.

ABI SLAMS UK FLOOD DEFENCE CUTS The UK government’s spending review is threatening the future of flood insurance, reported Insurance Times. The government has cut funding from £2.15bn in the previous three years to £2bn for the next three years.

Both the Association of British Insurers and Aviva have labelled it “disappointing” that funding will not be maintained to previous levels. (goo.gl/x6ej)

View from the market: GCC

Claims TYPHOON MEGI CREATES $150M LOSSES Cat modelling firm AIR has estimated the insured losses to onshore properties in the Philippines from Typhoon Megi will be $150m, reported Insurance Journal. AIR noted that, although the insured losses are minimised, the storm caused considerable damage. The AIR report stated: “Flooding has been reported in the coastal provinces of Cagayan and Isabela, where rain fell at a rate of 50mm-60mm per hour.

Sections of northern Luzon accumulated more than a foot of precipitation. Landslides have been reported in mountainous areas, while coastal areas have been hit by swells, storm surges and large waves.”

CLASS ACTION HITS LLOYD’S A US district judge has quashed a move by Lloyd’s reinsurers to dismiss a Florida property damage coverage dispute that has wide-ranging implications for surplus lines in the state, reported Insurance Insider.

The class action names almost every managing agent at Lloyd’s as a defendant, including all syndicates that provided property and casualty insurance for policies issued in Florida during the 2005/2006 period.

‘Investors look at reinsurers’ net tangible assets, they don’t look at profits’ David Haggie, Haggie Financial

In terms of raw numbers, the insurance and reinsurance industries in the Gulf Cooperation Council (GCC) are hardly the most impressive. In 2008, the total GCC insurance market was worth $11bn, while the reinsurance industry was a mere $5bn. Yet behind these top-line figures, there are a number of trends that indicate a huge potential.

Insurance penetration rates in the GCC are low (at 0.94% in 2008, up from 0.73% in 2000). This is at a level of a developing country – a conundrum given the high GDP per capita of the region (Qatar has the highest GDP per capita in the world, with Kuwait 14th and UAE 16th).

The sector is growing rapidly, however. In 2005-08, the insurance market in the GCC grew by an annual compound rate of 30%, with Qatar the star performer growing at 37%, the fastest growth rate in the world.

As demand for insurance soars, so does the need for reinsurance.

Yet at present, GCC insurance markets rely heavily on reinsurance, with average cession rates coming close to 50% and for certain ‘mega risks’ even approaching 100%. This dynamic is set to change, however, as regulators worldwide impose higher capital requirements and shareholders apply pressure for better capital management.

In terms of the wider picture, demand and industry development is likely to be driven by the combined forces of the region’s rapid economic growth (4.8% GDP growth forecast per annum between 2009 and 2013, with Qatar registering the greatest growth per annum of 11%); government commitments to use the revenues from vast natural resources reserves to diversify economies; increasing education and awareness; pick-up in growth of life insurance due to new products such as takaful; and regulation and tax, both locally in the GCC and globally.

Financial centres in the GCC are looking to capitalise on the unique proposition of the region. For example, the Qatar Financial Centre has identified reinsurance and captive insurance as two core parts of a three hub strategy (along with asset management). Qatar faces competition from rivals in the area, but has certain advantages: it allows foreign insurers and reinsurers full access to the domestic market rather than just an offshore location, while its legal framework is based on English common law.

Importantly, structural impediments to insurance take-up are being removed and markets developed. The introduction of compulsory lines (including liability insurance for certain professions), developments in motor third-party liability and health protection, not to mention the increasing availability of Shari’ah-compliant products are expected to drive demand and deepen insurance markets. Meanwhile, corporates are fuelling demand for more sophisticated products.

Huge spending on infrastructure across the GCC and the developing trend for public-private partnerships in project finance are likely to be powerful drivers for insurance products and consequently spur demand for reinsurance. Despite (re)insurance still being in its infancy and facing numerous challenges, the combined trends for growth are compelling.

Akshay Randeva is director, strategic development at Qatar Financial Centre Authority

>>> see News Agenda, page 14 GLOBAL REINSURANCE NOVEMBER 2010 7

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News Analysis Start-up

Opportunity knocks ‘Surge capital’ is the key to success for new company Paraline, chief executive Jack Graham tells Ben Dyson. The Bermuda-based reinsurer says that Lloyd’s structure is perfect for a counter-cyclical company looking to scale up or down according to market conditions

“We have started a new business at what is arguably the worst are good and withdraw it when they are less favourable. One of the possible time,” admitted Jack Graham, chief executive of new reasons for this ability is Elliott’s attitude to investment. Graham said Bermuda-based (re)insurance holding company Paraline Group, at the $17bn hedge fund specialises in the insurance and reinsurance a press conference marking his company’s official launch in markets and has a particular appetite for investing in highly cyclical, late October. volatile markets. It understands the need to deploy capital in good It is difficult to argue with Graham: most (re)insurance start-ups times and preserve it when the market is soft, so it can then be used in are formed when the market hardens suddenly after a large loss or better times. series of events. Paraline is setting out when, globally, rates in almost He also argues that the unique annual venture structure of all commercial insurance and reinsurance lines are softening, Lloyd’s, where syndicates are closed at the end of each underwriting indicating that there are already too many competitors in the market. year and then recapitalised and rejuvenated for the next year, is However, Graham added that, while the timing may look bad, the ideal framework for a venture such as Paraline. “The Lloyd’s Paraline’s approach, capital backing and cycle management system is the best system in the world for capital management – if will allow it to thrive. “We are committed to being a disciplined you choose to use it in the way it is intended to work,” he says. “Each underwriter in a softening year we can scale up or scale market,” he said. “We are down our business based on in a very competitive soft market conditions and the Paraline looking for more acquisitions marketplace today. It is a opportunities that are being dangerous marketplace. presented to us. In the context Paraline was formed in August by the management of ICAT Holdings, Knowing how to operate in this of our desire as Paraline marketplace is critical.”

Group to be counter-cyclical, a US-based property insurer that underwrites through Syndicate While Paraline is seeking opportunistic underwriters 4242 at Lloyd’s. In addition to backing from ICAT management, opportunities to expand and disciplined in soft markets, the operation is also funded with capital from private equity fi rm now and is looking to be a the Lloyd’s structure is the Wand Partners and private equity/hedge fund Elliott Management “meaningful participant in perfect environment in which Corporation. the insurance and reinsurance to operate. That is why we The new company’s founding action was to buy ICAT from previous marketplace”, Graham adds founded ICAT Syndicate 4242 owner, Vulcan, a private investor. Paraline will now seek to build its that the expansion “will be back in 2006.” operation geographically and by product line into a global, Bermudadone at the right time, under based (re)insurer by acquiring further businesses and teams of the proper market conditions Alarm bells people. As with ICAT, Paraline’s underwriting will be done at Lloyd’s.

Underpinning Paraline’s and with the right people”. opportunistic strategy is He is adamant that the ICAT’s core small commercial company will not be flooding property business. ICAT has the market with fresh capacity two main divisions: small commercial property and mid-sized while rates are already soft. “We are not going to add fuel to a commercial property. The mid-sized book has suffered the effects of burning market,” he said. “We are building capabilities. We are not the soft market but Graham says that small risks rates, although they going to be jumping into the marketplace to capture market share. flattened out during soft markets, have never dropped to unprofitable Lloyd’s doesn’t need us doing that. Nobody needs more capital in the levels. “Those businesses are few and far between. We have one today marketplace right now.” and will work hard at fi nding more,” says Graham.

Paraline’s operations focus around an existing business, ICAT, While Paraline’s decision to launch now may be explained by its which is reducing its capacity. Graham said that Syndicate 4242 strategy, its use of private equity backing could ring alarm bells for is one of three syndicates so far that have announced their some observers. Private equity fi rms typically have a specific exit intention to reduce underwriting capacity at Lloyd’s for the 2011 time, typically three to seven years. However, Paraline chairman underwriting year.

Bruce Schnitzer, also the founder of Wand Partners, insists that there Highly cyclical, volatile markets are no such restrictions on Paraline. “We are fortunate that all of the funding is not tied to a specific fund,” he says. “It is not connected to However, when opportunities do arise, Graham says that Paraline a timeline so we really can say, with not just intention but structure, will be able to jump into the market at a time when the rest of the that we don’t need a specific exit strategy timeline.” market is cash-strapped and pulling back. He argues that the backing Graham adds that the company could happily continue with its from ICAT management, Wand Partners and Elliott Management current backers and private structure, and has no fi rm plans to go Corporation gives Paraline access to “surge capital” – the ability public, although it is always a possibility. GR to put a large amount of capital to work when market conditions 8 NOVEMBER 2010 GLOBAL REINSURANCE

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22/09/2010 11:32

News Analysis Contingent capital

Catastrophe cashpoint An alternative capital facility from Société Générale offers reinsurers a banking solution they can turn to in a crisis, writes Ben Dyson

Capital relief benefit The main advantage it has over traditional capital raising, says du Boislouveau, is that it provides capital relief without diluting existing shareholder stakes in the fi rm. In a traditional equity capital raising, a company would issue shares in return for cash, increasing the number of shares in the market, thus reducing the value of existing shareholders’ stakes – assuming they do not participate in the capital raising. But with Edge, users get capital relief for having guaranteed buyers for their shares without having to issue any shares. For

regulators and rating agencies, the capital is as good as there. Shares are only issued if the pre-defi ned trigger event hits, which, according to du Boislouveau, is unlikely.

“The event we envisage is remote,” he says. “The beauty of the structure is that you have the effective benefit of a capital increase and the flexibility of a banking facility without any of the disadvantages, such as dilution.”

Catastrophic consequences If an event big enough to trigger a share issue hit, argues du Boislouveau, the company would be in such need of capital that dilution of stakes would be the least of shareholders’ worries. In addition, a company badly affected by a catastrophe may struggle to raise fresh capital. Investors such as private equity fi rms are turning their backs on the insurance industry in search of better returns and may not feel inclined to bail out the industry if trouble strikes.

Traditional capital raising is also unattractive given the current low valuations of insurance and reinsurance stocks relative to book value. Rating agency Moody’s expressed concern in a June report that the industry may struggle to recapitalise after a major catastrophe because of the low share price to book value ratios of listed reinsurers. Edge, however, guarantees fresh capital when it is needed most.

The facility also offers price benefits, says du Boislouveau – although he declined to give its price. “Because of the price, some clients would be interested in replacing some of their existing agreements with Edge.”

Having an investment bank as a counterparty, rather than a reinsurer or capital markets investor, also allows users of Edge to diversify their sources of capital. A bank, by its very nature, is unlikely to be heavily exposed to the catastrophic events that trouble reinsurers, potentially making it a more stable counterparty.

While catastrophe bonds, in theory at least, offer diversity of counterparties, they tend only to cover specific risks. The focus has been on natural catastrophes in specific territories because it is easy for investors to quantify a loss quickly. However, du Boislouveau says Edge could apply more generally. “There is a price for everything and we believe we can structure a large range of trigger events,” he says.

“This means we can complement the classical kinds of events covered by cat bonds with the Edge contracts.” GR

ILLUSTRATION: BRETT RYDER

A contingent capital facility launched by Société Générale Corporate & Investment Banking (SG CIB) could replace some of the existing reinsurance and retrocession agreements, according to Thierry du Boislouveau, head of equity corporate fi nance at the bank.

SG CIB launched its event-driven guaranteed equity facility – or Edge – in September, describing it as a multi-year alternative source of risk mitigation for listed insurers and reinsurers. Under the initiative, the bank will buy new shares in the protected company if a trigger event hits, thus providing it with fresh capital.

Du Boislouveau says that each mid- to large-cap insurer could easily consider implementing solutions such as Edge for 5% of their total share capital.

The launch of Edge closely followed the news that French reinsurer SCOR had taken out a contingent capital facility with Swiss bank UBS. The timing was no coincidence – SG CIB had advised SCOR on the deal.

It could be argued that now is a bad time to set up an alternative source of capital for insurers and reinsurers.

While the retrocession market remains tight, supply of traditional reinsurance capacity is outstripping demand and the industry is overcapitalised – as reinsurers’ efforts to return capital to shareholders through buy-backs or increased dividends proves.

There are also a number of alternative sources of capital already in existence, in particular catastrophe bonds and industry loss warranties, which insurers and reinsurers can tap to protect themselves against events.

However, du Boislouveau believes Edge has several features that set it apart from other options, including traditional reinsurance or raising capital by issuing equity or debt.

10 NOVEMBER 2010 GLOBAL REINSURANCE

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News Analysis Strategy

Swiss Re-structures On the crest of a wave of positive developments – solid profits, success in court and a positive rating outlook – Swiss Re has decided to reorganise its business structure and management heads. But, writes Helen Yates, some aspects have been tried before, with mixed results

downgrades, subsequent losses, a quota share with Berkshire Swiss Re chief executive Stefan Lippe unveiled a new leadership Hathaway (when legendary Sage of Omaha Warren Buffett rode to structure at the beginning of October and a reorganisation of the rescue in return for 20% of the reinsurer’s P&C business), senior the company’s business into three units: reinsurance, corporate management changes (including the decision in February 2009 solutions, and admin reinsurance (known as Admin Re). He to replace then chief executive Jacques Aigrain with Lippe), and a also announced a replacement for Raj Singh, the company’s chief corporate restructuring. risk officer.

“The run-off of the legacy David Cole was named as operations has been remarkably Singh’s successor as well as unproblematic – market a member of the executive Swiss Re’s personnel changes conditions have helped – committee. He will join Swiss but anyone watching a year Re on 1 November 2010 to spend As well as installing David Cole as Raj Singh’s successor as chief risk and a half ago will be surprised time with Singh before his quite how well it’s worked departure in March. Cole officer, Swiss Re has made some other management changes: out,” Dawson says. “The joins the reinsurer from back-to-basics approach – ABN AMRO, where he spent 11 • Life and health (L&H) division head Christian Mumenthaler has and frankly there was no other years, most recently as head of been appointed to the role of chief marketing officer of reinsurance option – does seem to have group risk management for ABN and a member of the executive committee. The new head of L&H worked quite well. One thing you AMRO Bank. has yet to be announced. have to say is that all during the Given Cole’s background crisis period the underwriting in the banking sector, Tim • Chief operating officer Agostino Galvagni has become chief and risk management sides Dawson, an analyst with executive of the corporate solutions unit, and remains a member of of the business performed Swiss-based Helvea, thinks the executive committee. extremely well.” he will need to adjust to the different set of risks presented • David Blumer’s responsibilities as the company’s chief investment The future’s bright by a reinsurance company, officer has been extended to include Admin Re. particularly the liability side Most observers feel that Swiss of the balance sheet. Singh Re has done well so far under • Thomas Wellauer has been named new chief operating officer and will be a hard act to follow, Lippe, and the future certainly member of the executive committee, joining from Novartis, where but his departure does not seems to be looking brighter he was head of corporate affairs. Other previous roles include chief ring alarm bells. “Inevitably, after a profitable year in 2009: executive of Credit Suisse Financial Services and member of the if someone like a CFO or CRO net income was CHF506m supervisory board at Munich Re. leaves everyone thinks: ‘What ($525m). Despite some have they just found?’” he says. catastrophe losses in the fi rst • Michel Liès, currently chief marketing officer and member of the “But the fact Singh is staying on half of this year, the Atlantic executive committee, will assume a newly created position as until March next year is a pretty hurricane season has so far chairman of global partnerships. He takes up the role in January, strong indication that there are failed to bring major losses stepping down from the executive committee at the end of the year. no skeletons in the closet.” and, while rates are softening, 2010 is shaping up well for the Good call, bad call company: profit for the fi rst half The restructuring of the of the year was CHF970m. company into three main units could raise some eyebrows, Dawson In early October, a US judge dismissed an investor lawsuit against believes. The decision to ring-fence large corporate insurance business Swiss Re for losses relating to the CDSs. This was soon followed by a into a dedicated corporate solutions entity is a familiar tactic for Swiss positive rating outlook from Standard & Poor’s, suggesting the fi rm is Re and one that has not had much success in the past. “They were close to regaining its coveted AA rating. doing the same thing in the 2000/01 period and got into some sticky “The outlook revision reflects our view that Swiss Re’s fi nancial situations,” Dawson says. “They lost quite a lot of money – particularly strength has recovered considerably because of the speed and in the pharmaceutical areas in that business. But I think the chance of effectiveness of its de-risking process and the resilience of its them repeating the errors of 10 years ago are pretty small.” franchise,” says S&P, adding that “the potential for the discontinued In fact, Dawson praises the fi rm’s performance since the fi nancial operations to produce further substantial losses appears to be crisis. As a result of the crisis, Swiss Re suffered a $1bn writedown reducing, which should facilitate strong and more stable earnings because of two credit default swaps (CDSs), which sparked over the rating horizon.” GR 12 NOVEMBER 2010 GLOBAL REINSURANCE

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02/08/2010 12:48

News Agenda Is the reinsurance sector a victim of an inevitable industry cycle or does it have a more fundamental image problem? Tim Evershed investigates

Image

is crucial

14 NOVEMBER 2010 GLOBAL REINSURANCE

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News Agenda downward earnings pressure, both now and in the longer term.

For carriers exposed to particularly soft prices, top-line premium growth could slow or decrease.”

He adds: “Worse, if companies are too aggressive in a softening market, adverse reserve development – that great destroyer of reinsurance capital – may soon rear its ugly head. Investors remember the events of the last soft cycle: significant reserve strengthening, particularly on longer tail lines. This has caused them to be nervous about owning reinsurers’ shares.”

The industry analyst agrees.

“Reinsurance companies post loss reserves against future claims and there’s a feeling that companies are too optimistic about the levels required.

So they will have to strengthen them at some point. But I do not think we are at a point where liabilities are understated.”

Dealing with losses

It all comes down to perception.

Valuations of reinsurance companies appear to be trapping trading in the sector at historic lows. Investors are hesitant to commit capital to reinsurers while analysts issue relatively few ‘buy’ recommendations.

Admittedly, the industry is sailing into some pretty strong headwinds as investment returns and underwriting profits come under significant pressure.

But beyond these factors, does the industry have an image problem and how can investors be made to see its inherent charms? Perhaps it could do a better job of making itself understood and overcoming the fallout from catastrophes that have wiped out its capital by promoting itself more actively. Or is this just a product of participating in a cyclical industry during the soft market?

“Historically there have been a few reasons why valuations have lagged,” says one industry analyst.

In today’s market, however, the tough

‘Because they are reinsurance companies, investors look at the NTA, they don’t look at profits’ David Haggie, Haggie Financial

economic climate is thought by many to be partly responsible for the depressed share prices, particularly as there remains uncertainty as to exactly where on the cycle the industry is.

Guy Carpenter global head of business intelligence David Flandro writes in a report: “There is a belief that softening reinsurance pricing will become softer. Lower pricing of varying degrees has been seen in the most recent reinsurance renewals. This creates several areas of

Reinsurers have suffered a year of heavy losses. The Chilean earthquake and European storms have triggered industry-wide losses of $22bn.

However, dealing with such losses is part and parcel of the industry – capital is plentiful at reinsurers despite them. So without a major catastrophe, sector valuations look set to remain at multi-year lows. Fitch Ratings estimates that total excess industry capital is $330bn.

Numis Securities analyst Nick Johnson says: “We have reduced debt leverage. Anticipation of Solvency II has meant capital has been retained rather than returned to shareholders through special dividends or share buy-backs.

“One area where there would be an element of investor frustration is Solvency II and the lack of information and understanding around that.

Investors do not really understand how capital requirements relate to reinsurers because it is not very prescriptive.”

Flandro asks: “Why are these companies’ forward returns on equities (ROE) so low? Is it fear of overly aggressive growth followed by reserve strengthening? Is it heavy exposure to low-yielding assets? Is it unusually high catastrophe exposure?”

He adds: “Why, in a softening market, do the favoured few trade at such a premium? Is it their unique underwriting acumen, superior risk protection, or careful and well-advised capital allocation?”

The problem is that high levels of industry capital depress prices. So while the likes of Everest Re are reallocating capital from property to more profitable > GLOBAL REINSURANCE NOVEMBER 2010 15

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News Agenda healthcare lines, others, such as Munich Re and PartnerRe, have returned cash to shareholders this year, but in buy-backs of less than $1.5bn.

“It is because their business models are not very clear and they show a lack of growth,” the analyst comments. “If you are not a growth prospect at the moment you need to become a value play, but reinsurers are a bit hit and miss. Munich Re has done a superb job of returning capital but once the current plan ends nobody knows what is going to happen next.”.

According to Fitch: “As long as uncertainty over capital requirements under upcoming Solvency II regulation remains, most reinsurers will maintain high capital buffers. That makes them reliant on a catastrophe with losses exceeding $30bn-$50bn – in the same league as 2008’s Hurricane Ike – to stem declines in premium rates.

Until then, a persistent discount to book value for listed players remains the dismal forecast.”

The valuations are such that, technically, many fi rms would be worth more if they discontinued underwriting today and went into run-off, which would also relieve pressure on management to provide growth in a soft market.

The industry analyst says: “If you think about the cost of capital, it is around 10%. Investors and analysts are focused on the marginal returns and coming to the conclusion that returns will not exceed the cost of capital.

“If you were to stop writing business today, the company would be worth more because of the loss reserves and the time value of money.”

Two-pronged pressure Underpinning this truth is the pressure on both investment income and underwriting profits. It is such that, according to research by Credit Suisse, most lines of business will be unprofitable by the end of next year if premium pricing rates and fi xed income yields do not improve.

“Investment returns are as low as they have ever been,” Johnson says.

According to Flandro, a key factor is the low value of investment-grade bond yields, which reinsurers now rely on for returns.

“In many regions, these bonds trade at or near 40- to 50-year lows. With the heavy focus on underwriting in the reinsurance sector comes the danger of forgetting that well over half of carriers’ earnings are supplied by investment income over the cycle,” he says. “When fi xed income securities yields are low, this crucial income stream diminishes.

‘If companies are too aggressive in a softening market, adverse reserve development may rear its ugly head’ David Flandro, Guy Carpenter

“This scenario has existed in varying degrees since the depths of the fi nancial crisis and shows few signs of abating.”

Even if the investment picture were rosier, some reinsurers may still have a problem, believes one reinsurance broker. “The investment community does not have any confidence in the assets of reinsurance companies. That may have been fair enough before the credit crisis, when some fi rms held credit default swaps and mortgagebacked securities, but now assets are pretty stable,” he says.

Underwriting priorities While the wider investment environment is beyond reinsurers’ control, in theory at least underwriters do have a greater say over rates and pricing for the business they write.

However, despite fi rst-half losses this year, rates remain flat or continue to slide in most geographies and classes. It appears that client retention is more important to reinsurers than underwriting discipline as most will not jeopardise relationships with major cedants by raising prices.

Market share is once again trumping underwriting profit.

“Reinsurers in general are competing with their clients, the primary insurers, which have an advantage over them in that they require less capital,” the analyst says.

But the market is cyclical and it was not that long ago that rates were hard and reinsurers were reporting healthy profits every quarter.

“What matters more than simply looking at results is returns on net tangible assets [NTA], and by and large that return is mid-teens at the moment,

whereas historically it has been up to 25%-30%,” Johnson says.

Haggie Financial senior partner David Haggie agrees. “Because they are reinsurance companies, investors look at the NTA; they don’t look at profits.

If they were engineering companies making these profits, people would be dying to back them.”

So could the reinsurance sector do a better job of attracting and retaining investors?

“The reinsurance industry overall does quite a good job of investor relations,” Haggie says. “Investor relations is about talking to investors and making sure they are in the loop about what and how you are doing. That takes resources, and chief executives do not always have the time to do as much of it as they would like. Hence the role of the investor relations officer.”

He continues: “There are some very good investor relations people out there, but investors do want to talk to the chief executive or the chief fi nancial officer as well. Your major shareholders need to be spoken to on a one-to-one basis. You need to give investors a clear message explaining what your business is all about. Then they will back you.”

Johnson agrees. “Reinsurers put a lot of effort into investor relations but it is the industry itself that is the problem.

It is more down to the fundamentals of the industry we are in, and I’m not sure investor relations can get round that.

He concludes: “Investors do not like risk and uncertainty.”

Yet that is always going to be an occupational hazard for reinsurers operating in the business of risk. The challenge is to ensure investors focus on their “best” side. GR

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People & Opinion For exclusive opinion and insight from Global Reinsurance and its sister publications, visit

globalreinsurance.com

EU OUTLINES VISION FOR TAXING THE FINANCIAL SECTOR Banks should contribute to cost of rebuilding Europe’s economy, says Commission strategicrisk.co.uk

FITCH: UK NON-LIFE SECTOR REMAINS STABLE But rating agency warns insurers to expect rocky road to maintaining profits insurancetimes.co.uk

In my view Ratings: your flexible friends Rating agencies have been battered by the media, but Peter Hughes says this is because people don’t understand how they work. Instead, he says, they need to look more closely at the agencies’ rating methodology and why they are trusted by banks, brokers and investment houses It concerns me that the media continues to perpetuate market myths and misconceptions about ratings of fi nancial strength and the rating agencies. Perhaps it is time to redress the balance.

One myth touched upon in September’s Global Reinsurance is the lack of oversight of such ratings and the companies that provide them. However, rating agencies have been regulated for many years by the US Securities and Exchange Commission, and this is being taken to a higher level by the tightening of that oversight and the introduction of regulation from the EU. In addition, many major banks and investment houses, as well as the larger insurance brokers, employ analysts who use ratings day in, day out. In doing so, they provide their own check on the output of the agencies: if they didn’t think the agencies were doing something right, they wouldn’t use them.

While rating agencies have come in for heavy criticism from various quarters, I would suggest that much of this talk is from people who don’t understand what a rating is. Indeed, in a way, a key role of ratings is taking the blame when things go wrong.

Starting with the rating of banks, there are two important factors for people to bear in mind.

The fi rst is that a bank’s rating starts with a standalone credit profi le, indicating the core strength of the bank.

To this are added implicit ratings for systemic support; this is the belief that banks are essential to the economic system and that there will come a time when a government has to step in to prop up a

bank. This is what we saw with so many institutions in the UK. The second factor is that agencies talk about the transition profile of ratings, and make every effort to highlight the likelihood of rapid transition of a rating for institutions where this might be an issue. The transition profile – the speed with which the rating may change in a stressed scenario – has been gentle for most major motor manufacturers but steeper for companies in confidence-sensitive industries. This is something those of us from the reinsurance industry understand well.

Some critics complain about the accuracy of ratings, but there is an equal number who grumble about their stability.

As medium-term indicators, they are aiming for stability. My favourite analogy for describing how ratings tackle this issue is Hooke’s Law, which describes the elasticity of a substance.

Put simply, if you extend a spring it will return to its original shape, except when extended beyond a point of no return.

Similarly, ratings need to be stable over the medium term, but rated entities

Start with the understanding that agencies are trying to predict the future

18 NOVEMBER 2010 GLOBAL REINSURANCE

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People & Opinion FIVE LESSONS FROM CHILEAN MINE DISASTER There are Important ethical lessons for businesses to learn, says blogger strategicrisk.co.uk

change their fi nancial characteristics by the day, or even the minute, so they are always “pulling on the spring” – challenging the elasticity of the rating.

Rating agencies start by looking at the underlying fundamentals of an entity, such as its fi nancial position and the nature of its market, and then consider how the entity will cope with normal market stresses and whether the rating will survive such a situation.

Sometimes the markets move dramatically away from the fundamentals, for instance when there are big changes to share prices, credit default swap spreads or other indicators, which appear to suggest that an entity needs a different rating.

This has happened dramatically in some cases when, before a collapse, the short-term indicators suggest a rating much higher than the agencies’ current ratings. In other cases, the ratings remain high even though the markets have lost confidence and the spreads suggest much lower ratings.

The key is that in most instances the shortterm indicators return to the fundamentals, but sometimes they stay out for so long that they shift the fundamentals: this is the point at which the spring of Hooke’s Law cannot return to its original shape and the rating needs to change.

It is all an issue of timing, and determining the point when a downgrade is necessary is taken seriously by the agencies.

Ultimately, understanding the approach that rating agencies take starts with the appreciation that these organisations are trying to predict the future. This can only involve degrees of probability – not the absolute certainty that some marketwatchers seem to think they’re indicating.

Finally, it is easy – and important – to view the performance of the rating agencies by looking at their default and impairment statistics. These show that there is a high correlation between ratings and default, and that this applies even through the recent fi nancial crisis. GR Peter Hughes is founder of ratings consultancy Litmus Analysis

Weblog Traffic to the Global Reinsurance website hit new peaks as breaking news came thick and fast. Online readers piled in to the site on the back of the Monte Carlo RendezVous in September, and they continued to visit frequently to pick up the news as it happened over the past month.

The most popular story on the site over the last few weeks gave details of Aon’s plans to cut global jobs as it integrates recently acquired consultancy Hewitt Associates. Up to 1,800 jobs are in the fi ring line, according to an 8-K regulatory fi ling at the US Securities and Exchange Commission.

The company estimates that the restructuring, between now and 2013, will cost $325m. This figure includes $180m for workforce reduction and property rationalisation. Global Reinsurance’s online readers will no doubt be eagerly

anticipating updates as this develops.

Also in the top five of most-read stories is the news that Allied World Assurance Company Holdings (AWAC) plans to redomicile from Bermuda to Switzerland.

The company is awaiting a shareholder vote on the decision at a special meeting later this year, but it expects the move to be complete before 2011.

Further stories from Switzerland caught readers’ attention. These included Swiss Re buying a stake in UBF Seguros, a Brazilian surety and agriculture insurer, and Lloyd’s insurer Amlin completing the redomestication of its Bermuda reinsurance subsidiary to the place that is famous for, among other things, chocolate and cheese.

To contribute to the website, email Ben Dyson at ben.dyson@globalreinsurance.com

Online top five 1. AON TO SHED UP TO 1,800 GLOBAL JOBS Mainly non-client-facing roles to go in restructure 2. AWAC TO TRADE BERMUDA FOR SWITZERLAND (Re)insurer plans to shift domicile by end of this year 3. SWISS RE TAKES CONTROLLING STAKE IN BRAZILIAN INSURER Reinsurer will take a stake in UBF Seguros 4. RGA RESTRUCTURES Life reinsurer creates three global businesses 5. AMLIN COMPLETES SWISS MOVE Lloyd’s insurer ‘remains committed to Bermuda’

Up the ladder How did you make it to where you are today?

Through education, hard work, creative thinking, a sense of humour, willingness to take a calculated risk and an ability to listen.

How has the industry changed?

There is more use of analytics and technology, but the importance of personal relationships and understanding clients’ needs is the same.

What are the key challenges for you and the industry?

The risk of politicians interfering with commonsense business solutions; global warming; the world recession and manipulation of currencies.

And what are the biggest opportunities?

Global warming, which will result in a greater need for catastrophe reinsurance.

What advice would you give to someone starting in (re)insurance broking?

Educate yourself by earning professional

qualifications. Also, you have two ears and one mouth: use them proportionately.

What is the biggest mistake you’ve made?

Trusting that people will do what they say they will do. My philosophy is: “Fool me once, shame on you; fool me twice, shame on me!”

What comes to mind when you think of friends and contemporaries in the market?

Reinsurance is a unique industry where business competitors can also be your personal friends.

What do you do to relax?

I like a lively conversation with friends and family over a nice bottle of wine and good food; a competitive game of golf; and I’m encouraging people to shave their heads for the Californian charity stbaldricks.org, which fights childhood cancer.

Enda McDonnell is president and chief executive of reinsurance broker Access Re

GLOBAL REINSURANCE NOVEMBER 2010 19

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Profile

L-R: Jeremy Brazil, William Stovin, Nick Line, Andy Davies 20 NOVEMBER 2010 GLOBAL REINSURANCE

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Profile Markel International, the (re)insurer created from the muddle of Terra Nova, is bursting with ambition. Ben Dyson talks to its leaders about where next for the firm that has embraced US-style management and has its eye on major growth

The Markel makeover

PHOTOS: GREG FUNNELL

The senior management team at Markel International, the (re)insurer that was formed following US insurer Markel Corporation’s purchase of Terra Nova 10 years ago, has clearly spent a lot of time together. Team members are not shy of interrupting each other to make additional points or flesh out an idea, and they often fi nish one another’s sentences or trains of thought.

Although there are four people in the room – chief operating officer William Stovin, insurance company president and syndicate active underwriter Jeremy Brazil, fi nance director Andy Davies and chief actuary Nick Line – it is clear they all have the same message, even if they occasionally stumble over one another to deliver it.

In some ways, this is hardly surprising: Stovin, Davies and Line are all members of the Terra Nova old guard. This united front is, according to the four executives, a world away from the situation at the company that Markel Corporation bought at the turn of the millennium.

Made of many fragments Terra Nova had eight Lloyd’s syndicates operating under the Octavian Syndicate Management banner, as well as a London market operation Terra Nova

‘If you had asked a Lloyd’s syndicate back then: ‘What’s your corporate culture?’ they would have looked at you like you were an alien’ William Stovin, Markel International

Insurance Company, French reinsurer Corifrance, Bermudan insurer Terra Nova (Bermuda) Insurance Company and a Bermudan holding company. There were also offices in Belgium, Australia, Hong Kong and a branch in Canada.

To hear the executives describe it, Terra Nova was a company in the loosest sense of the word. “It was a fragmented organisation – we had six fi nance departments, for example,” says Davies. “Each divisional syndicate had its own ecosystem.”

“They were very separate businesses,” Stovin chips in. “They had their own accounting, recruitment and reinsurance arrangements.”

As well as being inefficient, this structure was clearly doing nothing for the company’s structural integrity. “As you can imagine with eight syndicates, two companies and other bits around the edge, there was massive infighting, nobody feeling like they were part of anything in particular, and the medieval Lloyd’s fiefdoms that were the old-fashioned syndicates,” says Stovin.

Line adds: “Almost all of them wrote personal accident business. Most of them wrote property business. They were all fighting over the same stuff.”

The company was also in poor shape fi nancially. Stovin says Terra Nova would have gone bust if a buyer had not been found.

Gut-wrenching changes It was clear that nothing short of a drastic and speedy overhaul would fi x the problems at Terra Nova. Over nine months, the fi rm’s sprawling operations were whittled down to two core units: Syndicate 3000 and Markel International Insurance Company Ltd, the London market insurer.

The Bermuda operation was closed.

Corifrance was placed into run-off and sold. The Hong Kong operation was sold and the Brussels operation and the Australian unit, which Stovin describes as a “total disaster”, were shut.

“You can imagine that, in buying something like that, you had to make some gut-wrenching, radical changes,” says Davies. “For the fi rst nine months, the real focus was developing a structure that we were comfortable with. Rather than doing it piecemeal, which ultimately is a more painful exercise, we did it in one swoop.”

As well as bringing together the underwriting, they also consolidated the company’s back-office functions, such as reinsurance and claims handling. > GLOBAL REINSURANCE NOVEMBER 2010 21

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Profile The new two-piece Markel International was organised around six divisions: marine, aviation, reinsurance and specialty, professional and fi nancial risks, retail and property. The company’s book was pared back from $900m annual gross premium to around $650m.

If that was not painful enough, the company had to adapt to Markel’s reserving philosophy, which Davies says errs on the side of redundancy. This meant a round of reserve strengthening.

“For the fi rst two years, that put quite a bit of pressure on the balance sheet,” Davies recalls. “Our company was downgraded in 2002 to BBB, but was upgraded to A in 2003 once the rating agencies were comfortable with our restructuring and strategy.”

With the reserves taken care of, the company set about putting focus on underwriting profitability, as measured using a US GAAP combined ratio rather than a loss ratio, as was more typical within Lloyd’s. Coupled with this change, the company put its underwriters on bonuses tied to underwriting profitability.

As well as the changes to structure and approach, Markel International also introduced a new corporate culture to try to unify the firm. One element of this is that, in a departure from the Terra Nova days, underwriters work across both the syndicate and the insurance company.

The shift also involved a healthy dose of US-style corporate culture.

Line recalls that Tony Markel, the fi rm’s formidable co-vice-chairman, was walking around the Markel International building a day after the acquisition giving speeches on how things would be different.

Shaping up well Markel International clearly bears some of the hallmarks of the American vision of corporate culture. The four men’s suits are adorned with gold Markel lapel pins, reminiscent of the blue-and-gold flag-shaped badges that Joe Plumeri introduced at Willis when he stormed over from the USA to run the broker in October 2000.

Just as Willis now has The Willis Way, Markel has The Markel Style: a five-line summary of the company’s ethos. It is clear, however, that the London and Lloyd’s market fi nds these US-style tactics difficult to stomach. Some Willis brokers reportedly rejected Plumeri’s flag pins, and Tony Markel’s approach was clearly as much of a jolt to some Terra Nova underwriters as combined ratios and the new bonus scheme.

“If you had asked a Lloyd’s syndicate back then: ‘What’s your corporate culture?’ they would have looked at you

and has offices in Madrid, Stockholm and Singapore. The Singapore office writes business on behalf of Syndicate 3000 via the Lloyd’s trading platform in Singapore.

Time to grow

Stovin: you don’t succeed by flipping a coin

like you were an alien. It just didn’t exist as a concept.”

Stovin says. “You took your money from a capital provider each year and you either gave them a return or you didn’t. There was nothing more to it than that.

This was a huge transition for every employee and some made it, some didn’t make it; some didn’t want to make it and preferred to stay in the old system.”

While it is possible to debate at length whether such techniques are genuinely valuable or mere gimmickry, it seems to have ensured that the right people stayed with Markel International. “Without putting names to anybody, there are people still in this market who fi rmly believe that what they had done prior to the acquisition was successful,” says Stovin. “It was anything but.”

It is also difficult to argue with the turnaround in the results. Markel International’s combined ratio was 91% in 2009, on the back of $52m in underwriting profits.

The company has made underwriting profits in two of the past three years, only missing 2008 because of hurricanes Ike and Gustav hitting the USA. Markel Corporation’s 2009 report reads: “Approaching the 10-year anniversary of its addition to the group, Markel International stands as one of the crown jewels of Markel.”

Thanks to the heavy losses in the fi rst half of 2010, Markel International has made an underwriting loss for the fi rst six months, posting a combined ratio of 112%. However, Stovin says the losses from the Chilean earthquakes and the Deepwater Horizon oil rig explosion, at $15m each, were within the company’s expectations given its size.

If there are no further major losses, the company is hoping to make an underwriting profit for the full year. “If you look historically at our performance over the year, we tend to be conservative in the fi rst two quarters and the second half of the year tends to be stronger,” says Davies.

Stovin adds: “Our view is that there are no prizes given out in the fi rst two legs of a 400-metre race: it’s who crosses the line.”

While market conditions are challenging, with rates softening in both commercial insurance and reinsurance lines of business, Markel International is looking to grow. Since stripping back Terra Nova’s office network, it has begun to expand internationally,

The company has made a series of acquisitions and additions over the past year. In October 2009, it closed the acquisition of Canadian managing general agency Elliot Special Risks. More recently, in July this year, it expanded its equine business by acquiring French broker and coverholder Le Centaure.

The fi rm also launched a trade credit division in April after hiring a team of underwriters from ACE. Markel International continues to expand its capabilities by hiring individual underwriters. For example, it appointed Daniel McCarthy as a hull and war underwriter in March and hired Mike Bridgeman to develop accident and health business in April.

“Having cut our teeth on small overseas offices and doing it slowly and steadily, we are now looking to ramp that up. We are in the middle of significant research as to where to go next,” says Stovin.

Markel hired Simon Wilson, previously general representative of the Lloyd’s Singapore platform and managing director of Lloyd’s Asia, in January 2010 as director of international development. “[Wilson] is doing a lot of research into distilling our thoughts on where and what next,” says Stovin. “That is close to the implementation phase.

At the same time we are looking for acquisitions both in the UK and abroad.”

Expansion in the Asia Pacific region is part of the plan. “We will shortly be opening an office in Hong Kong, which will be the fi rst spoke from the Singapore hub,” says Brazil. “You are not going to get fat writing Singapore business, but Singapore is a good hub for that part of the world.”

While the company is looking to grow, Stovin is adamant that, whether it comes organically or through acquisition, it will be profitable.

“Significant pieces of our bonus structure are based on five-year aggregate growth in the book value of the company,” he says. “You don’t succeed at that by fl ipping a coin, holding your nose, shutting your eyes and hoping it doesn’t happen.” GR FIND OUT MORE ONLINE: MARKEL WELCOMES AM BEST CREDIT RATING UPGRADE To read this article, and for more on Markel International, see globalreinsurance.com or goo.gl/Q73o

22 NOVEMBER 2010 GLOBAL REINSURANCE

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25/10/2010 16:12

Underwriting

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Cedants

Because

bad cover

When it comes to selecting a reinsurer, cedants must choose carefully if they want to ensure reliable coverage. Sometimes the soft information is as important as the cold hard financial facts.

Lauren Gow presents the savvy shopper’s guide

24 NOVEMBER 2010 GLOBAL REINSURANCE

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Although much-maligned, fi nancial strength ratings from the four main rating agencies remain the single most important indicator for cedants. “On the quantitative numbers side, we must look at the fi nancial strength. Whether it’s an S&P or an AM Best or a Fitch rating, it obviously has an impact,” Tolle says. “But we tend to use S&P more than anything else.”

Lloyd’s insurer Canopius’s reinsurance manager Chris Swan says his company also uses fi nancial strength ratings from S&P and AM Best as a key indicator of security. “They need money in the bank to pay out so the fi nancial strength rating goes without saying.”

Although buyers use more than just ratings to make their choice of reinsurer, doing business with a poorly rated counterparty simply isn’t an option.

“We wouldn’t entertain having our reinsurance placed with someone who wasn’t fi nancially secure,” Lloyd’s insurer Barbican’s commercial deputy underwriter Conor Finn says. “Financial strength is the top priority in our eyes. It has to be.”

1 3

is worse than …

While the number of reinsurers has dwindled through mergers and acquisitions in recent years, reinsurance buyers still have a wide array of counterparties to choose from when putting together their programmes. Buyers can cede risks to large, global powerhouses or specialists that write only one or a handful of business lines in select geographies, depending on their needs.

Making the wrong choice, however, can be disastrous. As buyers frequently point out, having a reinsurance policy that does not pay out is worse than not having coverage at all. As a result, cedants have to pay close attention to the companies they entrust their business to.

Insurer fi nancial strength ratings from the main four rating agencies – Standard & Poor’s (S&P), AM Best, Moody’s and Fitch – have long played a central role in helping buyers and the brokers advising them to determine which reinsurers to use for which types of risks. For example, cedants tend to

Financial strength ratings

prefer higher rated carriers for long-tail risks, but are slightly less fussy when it comes to shorter tail business.

Howevewr, as the agencies themselves admit, fi nancial ratings are only a guide, and need to be used in conjunction with other information sources to enable security committees at cedants and brokers to make informed choices. Some of the qualities buyers look for in a reinsurer can be easily measured with hard data, while determining other characteristics requires a reliance on more subjective information, such as a company’s track record.

There is no single tool that can effectively do the job. “I am not sure there is a system out there to deal with that,” Lloyd’s insurer Beazley’s reinsurance manager Christian Tolle says. “That is why we use the tools we have to get as good a picture as we can.”

Here, Global Reinsurance highlights cedants’ top indicators and information sources for evaluating the quality of their reinsurance counterparties.

25/10/2010 16:30

Cedants

2 4 Other financial indicators

While ratings can provide an indication of reinsurer fi nancial strength, some cedants prefer to back them up with data from counterparties’ fi nancial statements.

“We have a broker that acts as a security adviser to us and it runs all the company reports through its models. This gives us various key ratios, on single-year and historic-year data,” Tolle says.

Credit default swap spreads are also used sparingly by some cedants to help spot potential problems at listed reinsurers. “We use credit default swaps but I must admit we use them for information more than anything else,” Tolle says. “The problem with credit default swaps is that they tend to be more reactionary. Unfortunately, it comes a bit late in the process.”

One of the biggest drawbacks of using a variety of fi nancial indicators is that it is quite complicated to get approval to use a particular reinsurer. “We’re probably too careful sometimes. That means we have a very short list of reinsurers for our long-term business that are deemed acceptable,” Tolle says.

no cover Long-term secure relationships Ratings and fi nancial indicators reveal much about a reinsurer’s ability to pay. But willingness to pay is equally, if not more, important to cedants. “For us, security is the most important thing when we pick our reinsurers. There is no point whatsoever in having a reinsurer who can’t pay the day there is a loss,” Tolle says. “For that reason, we are comfortable with being as conservative as we are about choosing reinsurers. It works well for us and, historically, we have had very few issues with counterparty risk.”

Canopius’s Swan agrees: “We also look at the willingness to pay. It’s no good someone having pots of cash if you can’t get your hands on it. Of course, that is a little bit subjective so it’s hard to use a formula to measure that.”

Given the difficulty of measuring willingness to pay, cedants tend to prefer reinsurers they have dealt with for many years. “Willingness to pay is based on experience,” Swedish insurer Länsförsäkringar’s general manager of reinsurance Tor Mellbye says. “You can’t

really risk that. Our choices are based on experiences with companies.”

“Our trading history with the reinsurers is important,” Tolle agrees. “If historically we have had problems with someone, we are obviously far more reluctant to deal with them going forward.”

Long-term corporate partnerships are paramount to Finn. He says: “We are only interested in people willing to commit large capacity to Barbican on one line or, ideally, across a couple of lines.”

Just as cedants need to understand their reinsurers when making choices, they also have to be confident that their reinsurers will understand them. For US insurer Argo’s senior vice-president of business development, Barbara Bufkin, a key feature is “having a senior relationship manager in the reinsurer, where there is a clear understanding of our company’s needs. And the ability, with a lot of transparency, to present our reinsurance needs and engage with those from a senior management perspective.”

External opinions

Cedants often support their own opinions of reinsurers’ ability and willingness to pay with views from the outside, such as from trusted brokers. “We speak to brokers and get their feedback and opinions on companies sometimes,” Swan says.

Another source is rating agencies, which, as part of the rating process, offer opinions on the strategy and management of reinsurance companies.

Swan says Canopius uses such soft indicators from S&P. “It’s not just looking at the financials and applying formula to it,” he says. “S&P looks at calibre of the individual strategy of the organisation. Have they got a dominant position in their marketplace?”

He adds: “These days, we have access to massive amounts of fi nancial data but sometimes it’s more soft information that matters.

Someone might be under review or in a big change of management or ownership, or having problems in a certain class of business.”

In addition to its own security committee, which pools knowledge from staff about reinsurers and measures each counterparty risk, Beazley also uses an outside perspective, according to Tolle. “We have a second security consultant who gives us a more subjective view on life at the reinsurers,” he says.

GLOBAL REINSURANCE NOVEMBER 2010 25

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25/10/2010 16:30

Cedants

Q&A with

Habib Kattan A good working relationship is based on trust and understanding each other’s core values. So says the group head of ceded reinsurance at Kiln, part of Tokio Marine

Habib Kattan started buying reinsurance 10 years ago when his friend Chris O’Kane, then Wellington Underwriting’s chief underwriting officer, asked him to assist with buying reinsurance for Syndicate 2020.

When O’Kane founded Bermudan (re)insurer Aspen Insurance Holdings in 2002, Kattan became the reinsurance manager of Aspen Insurance UK. He joined Kiln in a similar role in 2004 and has been there ever since.

Kattan’s insurance career spans 33 years. Like many of his peers, he was previously a broker. He started at Willis, where he handled Arab market accounts, and his later move to a smaller fi rm allowed him to gain greater international experience.

Q: PHOTO: CARL COURT

What do you look for most in your reinsurers?

A: Kiln is incredibly lucky in that we have traded with our reinsurers for a very long time. For them and for us, the relationship is more about underwriting the culture of the business rather than

26 NOVEMBER 2010 GLOBAL REINSURANCE

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Cedants the subject matter of the business. It is a question of trust and understanding each other’s core values, which is important.

The security of our reinsurers is important to us. Counterparty credit risk is a big driver. We keep an eye on our partners’ balance sheets, fi nancial performance and market share of catastrophe losses.

Q:

Do you think we have entered – or re-entered – a soft cycle of the market?

A: The primary insurance market is certainly under pressure. The reinsurance market for non-correlating classes – those classes of business that are not susceptible to US natural catastrophes – is softening and is less challenging than the retro market. In 2011 we are expecting to see prices fall in proportion with the fall in prices we are seeing on the original inwards business. The retro market, however, will always be challenging purely because of supply, demand and capital adequacy ratios. The cost of capital for writing a retro account makes that market very difficult.

Q:

How does Kiln structure its reinsurance programme?

A: There is a collegiate approach to buying reinsurance at Kiln. The outwards reinsurance team is invited to attend the business planning sessions of all group syndicates. Underwriters make decisions about their reinsurance requirements and we, the outwards reinsurance team, challenge those decisions both qualitatively and quantitatively.

We do quite a lot of analytical work with our colleagues from underwriting, the catastrophe risk and the capital modelling teams.

For the non-marine classes, catastrophe risk modelling is a key driver in the management of our portfolios and the assessment of how much reinsurance we need to buy. The models, as a catastrophe risk management tool, are extremely helpful.

Q:

Will you be making any changes to your reinsurance programme this year?

A: In terms of reinsurer panel? No. In terms of coverage? Probably. A little bit of tweaking here and there, but nothing radical. If, for example, we cannot get

a reduction in cost, we will aim at a risk-adjusted improvement: either by lowering of the level of attachment or by some other form where coverage is expanded a bit to give us that little extra value.

Q: In general, how has the practice of buying reinsurance changed?

A: The broker’s role has changed. As a result of current disciplines, such as good corporate governance and enterprise risk management, buyers now have to validate and sign off their data before it is packaged and sent to reinsurers.

In the past, we would say to a broker: ‘This is what we are looking for. Can you please structure something and place it for us?’ These days we cannot do that.

Buyers take a much more active role, and the broker’s role has evolved from being service-oriented in terms of packaging reinsurance information and placing a programme, to being a blend of adviser, risk manager as well as placement broker.

Brokers have an additional big role to play in analysing a buyer’s output from the capital and catastrophe risk models.

Another expert opinion from brokers is always welcome. They have huge intellectual and technological resources at their disposal, which are very helpful to buyers.

Q:

How has the current market environment affected your reinsurance buying?

Q: How does Kiln structure its reinsurance programme?

A: Underwriters make their decisions and we challenge those decisions both qualitatively and quantitatively Q:

Describe your average day in the office.

A: My team’s role is gathering data, collating it, analysing it, packaging it, marketing it, processing it and reporting it, following the completion of placement. My personal role in addition to managing my team is about managing relationships internally and externally. In placing Kiln’s outwards programmes, my colleagues and I go on roadshows with our brokers to visit our reinsurers and essentially market the various Kiln businesses.

Another role of the team is reinsurance claims recoveries. Keeping on top of reinsurance debt is very important to us. We have taken that function out of the fi nance department because we like to keep a close eye on that process and make sure that recoveries are made speedily.

A: Not much. As I said earlier, we tend to favour long-term relationships with our reinsurers. We are therefore not pure opportunistic buyers. We do not mind ceding away premium in a hard market. We recognise that, like us, our reinsurers are in business to make a profit.

However, when a loss happens and we need to recover from our reinsurers, we hope that the long-term relationships we have worked hard to establish over the decades with many of our trading partners will serve us well.

A: Our performance is measured on an annual basis, as well as in the long term. In the short term, reinsurance may be viewed as a cost because premium is paid every year, but recoveries are not made with the same frequency. However, over the long term, reinsurance does the job it is designed to do.

Q:

A: I have a passion for motor-racing and cooking. GR

How will Solvency II change the way you buy reinsurance?

A: Solvency II will affect all of us, but until it is implemented it is too early to assess exactly what effect it will have.

The ideal scenario for Kiln would be for our internal capital model to be accepted as submitted to Lloyd’s.

Q:

How is your performance measured?

Q:

How do you relax?

FIND OUT MORE ONLINE: KILN AUTOMATES ITS LLOYD’S REPORTING To read this article and for more news on Kiln and Tokio Marine, see globalreinsurance.com, or goo.gl/2B2I

GLOBAL REINSURANCE NOVEMBER 2010 27

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20/08/2010 11:54

Claims A soft reinsurance market is looming, and with it come fears of a rise in claims disputes as underwriters take bigger risks to drum up new business. Muireann Bolger warns of the need to stay focused under pressure

While the spotlight has traditionally shone brighter on the claims sector during a hard market, history has shown that a soft market can present opportunities – and challenges – to reinsurers when it comes to avoiding problematic claims and contract disputes. As the sector is faced with a pending soft market, the big question is: what can reinsurers do to avoid the common pitfalls of past cycles?

This need for sharper focus on claims was highlighted in October

by Lloyd’s performance management director Tom Bolt, who announced that, having tackled underwriting discipline with its franchise performance board, Lloyd’s will now be paying similar attention to claims as market conditions get tougher.

The aim is to “build a claims reputation that is as strong as our underwriting reputation”, Bolt said recently.

“A homogenised or ‘one size fits all’ approach to handling claims, regardless of simplicity or value, is no longer appropriate,” he added.

Undoubtedly, the arrival of a soft market brings a number of challenges for claims departments. In the past, soft markets have triggered a rise in contract disputes because of looser wordings in those periods. Barlow Lyde & Gilbert partner Clive O’Connell has pointed out that, since the 1970s, “every soft market has given rise to a flurry of disputes caused by underwriting or broking indiscipline”.

In addition, the rise in recessionrelated claims from clients, together with softening prices and lower premium income means that reinsurers need to become more vigilant about ensuring that they pay out exactly what they owe on claims. >

Details make the difference

GLOBAL REINSURANCE NOVEMBER 2010 29

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Claims “When times become tough and the market is soft – coupled with lower investment returns and less of an ability to release further funds from reserves – reinsurers naturally look to save money elsewhere, including via disputes that would otherwise have been resolved,” Herbert Smith partner Christopher Foster says.

According to Clyde & Co partner Nigel Brooke, the past five years have seen a decline in contract disputes because reinsurers have favoured maintaining healthy commercial relationships over a hard-line claims approach.

But he predicts that, as certain reinsurers start to exit certain markets because of poor rates, these relationships will decrease in importance, leading to greater scrutiny of the claims process.

“I think reinsurers will be looking more carefully at claims than they would have done,” Brooke says.

Outside the comfort zone So why does the soft market generate problems for the claims sector, and what can be done about them? Legal experts warn that one of the main problems reinsurers face is that as underwriters come under increased pressure to win and retain business, they may be tempted to write looser wordings on policies.

Dewey & LeBoeuf managing partner (London) Peter Sharp warns that underwriters may be encouraged to offer more favourable terms to hit premium targets.

He adds that reinsurers can also be tempted to write new classes of business or enter new markets that they have relatively little experience in to drum up more premium. “In a soft market, reinsurers can be persuaded to underwrite some novel or unusual risks outside their comfort zone and they get it horribly wrong because they don’t understand it,” he says.

In fact, Sharp points out that the current soft market has already given rise to such practices and warns: “Reinsurers should maintain their technical underwriting discipline at all times … and not give in to the temptation to write business on uncertain or inadequate terms, because it will come back and bite them. History shows us that it always does.”

But in a soft market, reinsurers can often be caught in a Catch 22 situation.

While looser wordings can lead to problems in the long run, a hard line approach on policy wordings can leak business in the short term. “In a competitive marketplace, if you are seen to exclude more perils, that has

‘In a soft market, reinsurers can be persuaded to underwrite some novel or unusual risks and they get it horribly wrong because they don’t understand it’ Peter Sharp, Dewey & LeBoeuf

“There needs to be a joined-up process, where the experience of the claims department is communicated to the underwriters, so that the implications are taken on board by the underwriters. The drafting of the wordings is an adjunct to the underwriting process,” Miller says.

He adds that it is helpful if underwriters spend time in claims departments as part of their training to foster a greater understanding of the relationship between underwriting and claims.

O’Connell notes that reinsurers, in addition to maintaining careful underwriting, should keep records of conversations, models and calculations and above all “avoid deals that are too cheap”.

Legal experts also urge reinsurers to be more determined about pursuing subrogated claims, a practice that can often be neglected during hard markets. “I think reinsurers need to be more vigilant and more assertive about pursuing subrogation rights where they have them,” Sharp says.

Stay cautious potential commercial ramifications if there are other policies out there that offer broader cover,” Alterra’s claims director Rob Turner explains.

Choose words carefully It seems that now, more than ever, reinsurers need to be vigilant about the quality of their wordings.

Law fi rm Elborne Mitchell partner Edmund Stanley believes that the sector needs to take note of current trends in litigation and case law.

He points to the recent controversial ruling in the employer liability trigger litigation case, which challenged the traditional understanding of which policies respond to asbestos claims, as an example of how insurers can fall foul of poor wordings.

“At the moment, there is a tendency in the courts to look at the literal meanings rather than at the commercial background,” he says. “That is one lesson: people shouldn’t necessarily think they know what something means just because that is what it has always meant in the past,” he warns.

Part of the problem is that the sector suffers from a dearth in expertise when it comes to writing the wording of policies. Consequently, as Beachcroft partner Julian Miller points out, while there have been improvements in the formulation of policy wordings in recent years, terminology inconsistencies remain in the marketplace.

“There is some way to go with wordings. The difficulty is that it requires enormous skill to do wordings and it hasn’t always been adequately resourced by insurers. The people doing it haven’t always been the most experienced members of the team. There has been progress in this area but there is more yet to be made,” he says.

In addition to developing more claims expertise, legal commentators believe that there needs to be greater interaction between underwriters and claims departments.

But while the soft market can create future challenges for claims departments, the current marketplace is better placed to meet these than in the past and is arguably in a better position to throw a sharper focus on the relationship between the claims and the underwriting departments. “Checks and safeguards are in place, and an underwriter is no longer a law unto himself but must report every risk to be scrutinised,” O’Connell notes.

He warns, however, that reinsurers must continue to err on the side of caution and avoid the hazards of the past. “It is fair to say that the market is well placed to face a soft market. It must also, however, be recalled that in 2008 the banking industry was subject to regulation, rating and enterprise risk management. These were not sufficient to protect that industry from catastrophic failure.”

It seems that the challenge for reinsurers is to ensure a compromise between its underwriting discipline and its claims departments during a soft market because, ultimately, it is this balance that will protect against problems in the future. GR FIND OUT MORE ONLINE: IN MY VIEW: YOU CAN’T BE TOO CAREFUL To read this article, and for more on the best ways to prepare for a soft market, see globalreinsurance.com or goo.gl/8tY9

30 NOVEMBER 2010 GLOBAL REINSURANCE

GR_29-30 Claims.indd 30

25/10/2010 16:19

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34: Fac to the future 36: When the going gets soft 38: Renewable optimism

Facultative reinsurance has evolved to new levels of prominence

Rates are under pressure to fall, but reduced capacity may play its part

Reinsurers are focusing on energy sectors to achieve growth

SPECIAL REPORT: FACULTATIVE REINSURANCE

Prize pickings Reinsurers are utilising facultative reinsurance like never before

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Special Report: Facultative Reinsurance Brokers are credited with bringing facultative reinsurance back from the brink, and technology and improved analysis are powering increased global trading at a more local level. Fac also helps buyers to take a more strategic view of their needs

Fac to the future Facultative reinsurance – also known as standalone reinsurance – has evolved from being a tool used simply to buy or sell a treaty book of business to being an important product in its own right. In both the property and casualty standalone markets, cedants are increasingly taking a more strategic approach to their decisions when buying reinsurance: they are blending the purchase of treaty books with single risk cover used to plug any gaps.

Treaty purchases still dominate but these are complemented by fac buying.

As treaties have become larger and more global, it has allowed cedants to buy facultative reinsurance with more accuracy than before, thinks Aon Benfield fac chief executive Elliot Richardson.

He says: “In the past people would buy fac and it would overlap with treaty.

There was too much wasted buying.

Now they’re buying it to complement their treaty and to protect their net, and they’re doing it consistently.”

This increasing sophistication in reinsurance purchasing has resulted in a competitive facultative reinsurance class, featuring a growing number of players and markets, and a competitive broker scene. “It’s more competitive than I’ve seen it in my 20-odd years in the industry, and fac continues to be headline news. The fact you’re writing this article would not have happened ten years ago,” says Miller Insurance head of facultative reinsurance Mike Papworth.

reinsurance-buying toolbox,” he says.

“When you’re looking at how to protect your capital, you look at treaty and various alternatives. One of them will now certainly be fac. This has created a lot of interest from brokers because it’s potentially seen as a good business.

Buyers like it because it’s seen as a quick solution to a short-term problem.”

It’s dynamic, it’s enjoyable

Two for one For some buyers of facultative reinsurance, the soft market might provide an opportunity to gain new business, potentially from those who do not typically purchase cover from the standalone market. Depending on the risk, facultative cover can be bought on a more cost-effective basis, thinks Papworth.

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“Because there is oversupply of fac capacity at the moment, there has been the re-emergence of very specific or opportunistic fac-buying, whereby somebody is offering capacity that is out of sync with others,” he says. “The deal sells purely because it’s opportunistic and not necessarily because it fits in with their overall strategy.”

Nevertheless, he sees a continuing move towards more strategic purchasing. Facultative reinsurance has become very much part of the

The growing involvement of the reinsurance-broking community in fac distribution has seen a massive investment in talent, with competition becoming increasingly fierce. Entire teams have been poached, resulting in expensive legal wrangles in 2006 and 2007. This was when 20 senior members of Benfield’s facultative solutions team – led by Elliot Richardson – left to join Aon. The move cost Aon £9.5m ($15.1m) to settle, but it went on to buy Benfield in December 2008. Following this, Guy Carpenter’s dedicated unit GCFac lost its fac team – including Ron Whyte and Julian Samengo-Turner – to Integro, which was looking to establish a new wholesale and facultative division.

The battle for talent in the fac arena highlights its growing importance, thinks Richardson. He says: “Some of the best people in the industry are working in the fac market because it’s dynamic; it’s enjoyable and because you’re able to trade regularly, whereas some other areas of the business have become a bit more commoditised.

“Over the last two or three years there have been a few investments in the area of the broker market from certain large brokers who had taken fac seriously a little bit late.

“One of the large brokers has seen a huge departure in terms of talent,” he says. “The problem is that a decade ago people weren’t investing in talent for the fac market, so it’s difficult to conjure up a group of people that don’t exist. We’re investing in young talent and making sure we train them well, give them a sense of purpose and make sure they become the next generation, because if fac continues where it’s going, just hiring from each other and paying more

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Special Report: Facultative Reinsurance and more money isn’t the answer.”

He describes how the market has evolved: “A decade ago most people felt facultative was a dying or dead product.

It was very much the frontier end of the business and, as a result, a lot of people overlooked it. It was still popular with the line underwriters but senior management didn’t like the lack of control and the execution risk.”

He credits the broking community with bringing fac back from the brink.

“Brokers really started to eliminate the execution risk. We also embraced analytics and technology – things like the quality of data and information.

At the same time, treaty business was going a lot more global and, as a result, people were having significant retentions on their net positions. This prompted underwriters to look at fac as a way of protecting their net positions.”

As the brokers attempt to gain more presence in the market, business that was previously placed directly is increasingly fair game. The market is worth about $22bn, with $8bn placed through the direct market. One way of accessing this business is through electronic placements, something that Aon Benfield is trying through its FAConnect platform, which has recently linked up with the Lloyd’s Exchange and seen its users grow to 350 in 10 months.

Role of the broker Richardson says: “Historically the broker market has been very good on larger risks, the more distressed business or heavily cat-exposed business, but it has not been able to find a way of placing smaller premium business into the broker market efficiently.

“The only way to do that is to go the electronic route. What we’re trying to do is give something to clients and allow them to trade freely on markets they wouldn’t otherwise see.”

The role of the reinsurance broker has evolved with changing distribution channels, thinks GCFac head of international facultative reinsurance Massimo Reina. As emerging markets have grown and big-ticket risks have been increasingly retained within them – from large industrial, mining and energy risks, to property and engineering, and through to specialty liability risks – direct and facultative writers require a more global presence to benefit from local opportunities.

“Distribution is changing and developing – not just with the brokers but very much also for insurers and reinsurers – and in this very difficult climate we are seeing insurers and reinsurers opening offices nearer to their customer base. It is a trend to

have overseas offices in places such as Zurich, Singapore, Hong Kong and Miami for Latin America. The role of the broker in this trend is very important ... it shortens the placement chain and reduces the cost of placement, ultimately to the benefit of the client.”

The USA is still the most important market for facultative reinsurance, followed by the UK and Europe. But it is dominated by longstanding players and has proved a difficult market to break into. Emerging markets, by contrast, are fertile ground and provide lucrative opportunities for early movers.

This is illustrated by Chaucer’s recent decision to exit the US fac market while opening an office in Buenos Aires and expanding its fac presence in Singapore. “The established players are very well established in the USA,” says Miller’s Papworth. “They know what’s happening and the market isn’t growing. It’s very difficult to go in there new and make money, because the existing players dominate that world.”

The London market, with its concentrated expertise and reputation for covering distressed risks, remains a major centre for fac, with risks entering Lloyd’s and the company market from around the world. But fac is going global, and electronic placements and an international network of offices will allow the major fac players to maintain their access to the business.

“We could place a US account in India nowadays – the market’s becoming more global and there is no onesize-fits-all approach to facultative,” says Richardson. “People are looking at writing business from wherever they’re based, and we need to make sure we’re there so we can place that business. Ideally face-to-face and then using the markets around the world to bring it alive 24 hours a day using the technology on the smaller business.”

The BRIC countries (Brazil, Russia, India and China) are proving increasingly popular for (re)insurers looking to diversify their portfolios geographically – a general trend among (re)insurers in recent years. The opening of the reinsurance markets in Brazil and China has seen rapid double-digit premium growth, and the influx of international (re)insurance companies wanting to establish a presence. Much of the focus in these markets is on providing facultative cover for risks that are too big to be placed in the local markets.

“Where the opportunities perhaps lie is somewhere like Latin America where 50% or more of the ceded reinsurance premium is written on a fac basis – clearly this would imply that there are more opportunities,” says Papworth. “The

caveat is that while a mature market like the the US is saturated you must remember that they represent about 50% of global reinsurance premium.

Latin America, despite all the inherent opportunities, is still less than 7% of global premiums. So if you’re basing your global fac strategy on less than 7% of the global premiums, of which half of that is fac, then you’re not ever going to make a huge difference to your revenue base.”

An essential purchase There may be fewer opportunities for straight arbitrage, but fac is still an essential purchase, says Reina. “There are still some opportunities to arbitrage, but maybe not as many as we’ve seen as the past. But that’s not the only reason people buy facultative anymore – it depends on the class of business. In the

‘What we’re trying to do is give something to clients and allow markets to trade freely on markets they wouldn’t otherwise see’ Elliot Richardson, Aon Benfield Fac

past facultative reinsurance and treaty reinsurance were handled very much separately, but this is changing very quickly and we’re making increased use of analytics to fi nd the best solution for our clients: whether that’s facultative reinsurance, treaty reinsurance or both.”

Reina thinks there are various drivers to a more tactical reinsurance purchase, including better treaty protection. “It’s partly driven by increased retentions – this is having an important effect on the purchase of facultative reinsurance and on a desire to protect the treaties – to safeguard the treaties from losses that are a little bit different from expected losses.

“I think that reinsurance is still considered by the buyers to be an expensive commodity. They want to make sure losses that can be reinsured by facultative reinsurance don’t go into the treaties, because this will result in an increased cost of reinsurance for them.” GR FIND OUT MORE ONLINE: CHAUCER HIRES SINGAPORE PROPERTY FAC TEAM To read this article, and for more on the facultative market, see globalreinsurance.com or goo.gl/QtEQ

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Special Report: Facultative Reinsurance The direct and facultative market is getting softer, but demand is up and capacity cutbacks should prevent a freefall. Senior insurance figures say it will take a sizable loss or a series of significant losses to turn the market

When the going gets soft While rates in the facultative reinsurance market have been under downward pressure for some time, there are mixed feelings about where things are heading as the industry approaches 2011. Some feel prices will fall dramatically, while other experts think direct and facultative (D&F) players will pull back on capacity, allowing underwriters to hold their lines with more success. The recent decision

by Chaucer to exit US D&F suggests that players are willing to pull back where the market is too soft and competitive.

Integro Insurance’s managing principal, international insurance and reinsurance division, Ron Whyte, says: “I don’t think we’re going into freefall because I do think some people will cut back. I’m not going to be saying to some of our major US retail clients, ‘we should target 25% off’. I think we’ll start by saying for those that are cat-driven you need to try to hold your renewal.

“If we can get something off that’s fi ne, but I am worried we might bleed some capacity overall from the market.

If and when rates push up, new capacity will come in, so it’s never going to go up too much or for too long.”

according to Whyte. “Generally speaking, as the market softens there’s more activity on the fac side because there’s more available capacity,” he says.

“For a while now there has not been a naïve fac market so the opportunity for a straight arbitrage has largely gone.”

Whyte does not see massive softening because he thinks there will be a clear out of capacity, which will bring some discipline into the market. “You just don’t fi nd those ridiculously cheap deals out there anymore,” he says. “On the cat side, I don’t think there’s necessarily going to be more capacity around, so

where you can really show the value of fac. I think it will hold fac in great stead come the market turning.”

More activity

those looking to buy fac on cat risks may struggle – with rates where they are I think that a number of syndicates will be cutting back on capacity. Some have pulled out of writing North American property business.”

Prices might be low but demand for fac cover has increased dramatically as the treaty market has softened. “The amount of trades is up 25% on the prior year. We expect a significant amount of that to stick, even if the market terms improve,” Aon Benfield Fac chief executive Elliot Richardson says. “More people are buying facultative to allow them to get through this cycle. I would say we’ve got at least another 18 months, if not two years, of that left, barring a large event.

“People will avoid the word arbitrage because they don’t like to be accused of doing that, but every fac deal is an arbitrage position,” he continues. “You should be improving your net treaty position on that account. I’m looking forward to another tough 18 months

despite some losses in 2010 – including the Chilean earthquake, Deepwater Horizon spill and New Zealand earthquake.

While the losses – particularly in Chile where economic losses are expected to reach $30bn and insured losses about $8bn – will dent earnings for the year, they were not sizable enough to turn the market. “Do we expect rates to go up as a result of the Chilean earthquake? Not really,” Whyte says. “I think it will have affected people’s overall property portfolios, so maybe there will be a little cutting back on where they put their capacity.”

BP has set aside $20bn to pay claims from the Deepwater Horizon explosion and resulting three-month-long spill, during which 53,000 barrels of oil a day leaked into the Gulf of Mexico.

The insurance industry has avoided exposure to the worst of the disaster, with Lloyd’s anticipating it may see claims of $300m-$600m.

In the third quarter, typhoons in Asia

Whyte says: “If you look at the D&F market when rates are softening, it’s the area that comes under most scrutiny.

If people don’t think the market is in a particularly good situation, they’re going to start easing back.

“If they’re looking at allocation of capital, syndicates take a hard look at what capacity they need for next year. I fully expect some of the Lloyd’s ones to cut back. The area they’re likely to cut back fi rst is the D&F side so they can control their treaty writing a bit more.”

Traditionally, facultative reinsurance has been bought to fi ll gaps in cedants’ treaty programmes. In times gone by, a soft market would have presented arbitrage opportunities.

These, however, are fast disappearing,

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Property portfolios The major European treaty renewal at 1 January is a good indicator of what is likely to happen to prices in the facultative reinsurance arena.

Both markets tend to be influenced by the same macro-level influences when it comes to pricing. Overall, as the industry prepares for the BadenBaden Meeting, all the indicators are that rates are going to fall again. This is

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Special Report: Facultative Reinsurance and the New Zealand earthquake have added to the loss register. A magnitude 7.0 event on 4 September is likely to cost NZ$1.5bn-NZ$2.5bn (US$1.14bn to US$1.9bn) in insured losses, with the bulk falling to the New Zealand Earthquake Commission. As at Q3, insured losses globally are about $36bn – $12bn more this time last year – with 42 incidents over $50m, according to statistics from Aon Benfield.

“It’s attrition, it’s cat and it’s been constant throughout the year,” says Richardson. “It’s a pretty bleak picture.

There’s too much capacity and the combined loss ratios are still allowing underwriters to make money. We’re at around 101% for the combined loss ratio and traditionally the market doesn’t turn until the loss ratios exceed 115% combined.”

Property rates continued downward in the third quarter, according to Aon Benfield, with US cat-exposed accounts seeing a drop of about 10%; overall, North America fell by roughly 13%.

Rates in the London market fell by 7.5%, while prices in Asia Pacific were down by an average of 11%. Globally, casualty rates were down by about 5%.

“This is pretty bad bearing in mind how much they’ve been softening in recent years. There’s no sign of that stopping in Q4,” Richardson says.

“We think it will be an even more competitive landscape coming out of the end of the year.”

“We are in a soft market and we don’t expect it to change in the immediate future because there is still a fair amount of excess capital in the market,” says Massimo Reina, head of international facultative business at Guy Carpenter’s facultative reinsurance unit, GCFac. “There have been quite a few losses – the fi rst half of the year was particularly busy with some large losses. Realistically, we don’t expect that these losses will have an effect on a global basis.

“The Chilean earthquake has had an effect on facultative property rates in Chile,” he says. “But if we are looking at the whole of Latin America the effect has been very limited because the insurance and reinsurance market is in quite a healthy fi nancial state at the moment – certainly healthier than last year – and we don’t expect this to change in the immediate future unless we see some particularly large losses and probably more than one.”

Predictions of a more active hurricane season in 2010 did not result in major landfalling storms or sizable industry losses. At the time of writing, the season is not over, but the USA appears to have escaped the worst of it. Cyclones

Earl, Hermine, Karl, Igor, Matthew and Nicole led to some instances of heavy flooding, but losses are expected to be in the hundreds of millions rather than billions. Total losses in Mexico from Hurricane Karl could reach $4bn.

“The areas where it’s more difficult for insurers and reinsurers to compete is in the main cat areas,” Reina says.

“So we’re talking about US exposures or northern European wind – the rates will probably hold a little bit fi rmer than in other classes. It doesn’t mean they will increase or even stay stable but it will be more difficult to reduce prices in those areas.”

Eating away at profitability The glut of capacity and lack of major claims activity will make it difficult for most reinsurers to prevent rates from sliding further at 1 January. “In general, rates will continue to fall – by how much I don’t know,” Whyte says.

“Non-catastrophe property rates will come off again. In major catastrophe areas they’ll be looking for maybe 5%-10% off next year – so I don’t think they’re falling off the map.”

“There have been a number of events this year, such as the Chile earthquake which have eaten away at people’s profitability,” he says. “It looks like it’s going to be a non-cat year in the US but results won’t be as good as people would have hoped because Chile surprised them. If we suddenly do have a big windstorm or a California earthquake or something, you might get a sudden post-Katrina type reaction – maybe for a while – but my view is when you get these events the hard cycle is a lot shorter than it used to be because capital can flow so quickly into the market.”

While there has not been any major loss on the underwriting side of the balance sheet, on the investment side, returns are slowly improving. For 2009, global reinsurance capital made a remarkable recovery, totalling $396bn at the end of the year, bringing it close to the record levels of 2007. Shareholders’ funds even surpassed their pre-credit crisis level for the 30 largest reinsurers, reaching $210bn, according to Aon Benfield’s aggregate index. This was attributed to a low catastrophe year and the improvement of investment returns.

“There has been a mismatch between the direct and reinsurance side for some time and there is one now,” Reina says.

“The reinsurers are normally the fi rst to react to try to turn the trend and to increase rates. At the moment, there is the willingness to try to stabilise or increase rates but with the amount of excess capital, they are fi nding it very

difficult. It’s difficult for reinsurers because at a time of diminishing investment returns they need to make sure they make a profit on the underwriting side.”

Knee-jerk rate increases The consensus of opinion is that it will take a sizable loss or series of significant losses to turn the market at this stage.

That could be two or three Katrina-size losses, thinks a senior D&O underwriter.

“That would certainly get people thinking. The market is the softest I’ve ever seen it and the influencing factors are that there have been no losses since Katrina really,” he says. “The Chilean earthquake provided an uptick in D&F pricing for a while but it seems to be settling back down now. BP went pretty much self-insured so it didn’t really affect the market – there were a couple of knee-jerk rate increases on deepwater drilling but it didn’t affect the market really.

“In the fi nancial institutions market there’s an oversupply of capacity, which just drives rates down,” he continues.

“The brokers don’t need to broke because there’s this surfeit of capacity.

“That’s why the market needs losses because people come in speculatively and rates get driven down. Then there’s a couple of big claims and the newcomers run away. Then people who are in the market and have always been in the market will pick up a big increase in premiums. It sorts the wheat from the chaff, certainly.”

It will take blood on the carpet for the market to turn, thinks Miller Insurance head of facultative reinsurance Mike Papworth. “When will the market turn?

When combined ratios all begin with a one again! At the moment, they’re not there yet. Nobody is losing money yet: there have been no casualties; business plans have not collapsed, and most are still posting good results. With this situation, it’s very difficult to tell your buyers that prices have to go up.” GR

‘There have been quite a few losses – particularly in the first half of the year.

Realistically, we don’t expect an effect on a global basis’ Massimo Reina, GCFac

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Special Report: Facultative Reinsurance The energy sector is established fac territory, but broadly soft rates mean canny reinsurers are focusing on offshore and renewable sectors to achieve growth

Renewable optimism Opportunities in the softening and loss hit energy market are not in the obvious places. An industry consortium for offshore liabilities is one mooted initiative, while the rapidly growing renewable energy sector is fodder for more inventive players.

The energy sector is classic fac territory, but it faces numerous challenges in the run up to the 1 January renewals, with rising losses and softening rates. By contrast, opportunities are growing in the more niche renewable energy sector.

One of the few classes of business to have bucked the trend for softening prices is offshore energy. Rates rose in the aftermath of the Deepwater Horizon disaster, but the spike is expected to be short-lived, with rates flat or down at the July renewals, according to Guy Carpenter, and anticipation of more of the same ahead as the industry approaches 2011.

A poll of delegates at Aon’s 10th Middle East Energy Conference found that more than half of respondents (53%) thought that it would take a further $5bn-plus energy loss to bring an end to the current market cycle.

The expectation of softening rates comes despite the Deepwater Horizon loss, which is likely to cost the industry as much as $3.5bn, according to estimates from Swiss Re. The loss could have been much higher had BP purchased cover in the commercial market. But the energy giant has its own captive insurer with a per-event limit of $700m, and has set up a $20bn claims fund to pay for legitimate claims arising from the event.

Lloyd’s expects net claims from Deepwater to come in at around $300m-$600m, while Swiss Re and Munich Re are expecting hits of around $200m and $266m, respectively.

Hannover Re recently doubled its expected losses from the rig explosion and resulting oil slick to €89m ($125m) from an earlier €40m prediction.

Upstream energy insurers have

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paid out a combined $795m on Deepwater Horizon and the sinking of the Aban Pearl gas platform in the Caribbean in May.

Boosting offshore capacity In the wake of Deepwater, various industry bodies have suggested ways of increasing capacity for offshore energy projects and for encouraging cedants to buy more cover in the commercial market. Should they prove successful, it is likely to provide a significant boost in demand for the product. As part of a joint venture, brokers Aon and Marsh have proposed a facility – in conjunction with specialist insurer Torus – to provide over $1bn and potentially as much as $5bn of excess liability cover to oil companies.

Separately, Munich Re has proposed an insurance solution for third-party liabilities in the oil industry. Board member Torsten Jeworrek thinks a liability limit of $10bn-$20bn across the industry is achievable if a specific cover is mandated for drilling companies.

He suggests the limit currently in place under the Oil Pollution Act in the USA should be increased, with cover relating to clean-up and removal costs, impairment of natural resources and property damage, as well as loss of earnings in sectors such as fishing or tourism. The German reinsurer is willing to double its available capacity per drilling project to $2bn.

Renewable growth Elsewhere, an increasing number of (re)insurers are getting involved in the renewable energy sector at a time when investment is at an all-time high.

“Deepwater really will focus people’s minds on the whole energy industry and the risks involved in extracting oil from deepwater offshore locations,” says Warren Diogo, an underwriter for Ascot Renewco. “So it really does open the door again for renewable energy as people consider that you can generate electricity and supply people’s energy needs from renewable sources in a far more benign way.”

A key challenge, however, is sizing up the risk when underwriting new and often unproven technology, Diogo says. “You’ve got to recognise that each

renewable energy technology is quite different and each has its own diverse range of risk issues. If you look at a solar-powered project in the USA, that’s going to present you with a completely different set of concerns and risks compared to an offshore wind farm.

“So you need to have a different underwriting approach for each form of technology,” he continues. “The basic challenge in any new technology sector is that there is very limited operating history and claims data and that’s a fundamental problem that you need to address in how you underwrite this class.”

Along with Ascot, Munich Re and RSA Global Renewable Energy, which have been operating in the renewable space for some time, capacity is being boosted by newcomers to the sector.

Lancashire, the Hartford and Sciemus have launched renewable energy offerings in recent months and new products are continually being brought into the market.

One of the most recent is an insurance product from Munich Re that covers a 25-year performance warranty for solar panel systems manufactured by renewable fi rm SolFocus. The cover is designed to give solar plant operators and investors greater planning security.

It allows manufacturers of modules to take the long-term, technical guarantee risk off their balance sheet.

Globally, the renewable energy sector is expected to attract $200bn in investment in 2010, a rise of 23% on last year as government stimulus funds in the USA and Europe are ploughed into renewable projects such as wind turbines and solar panels. Last year, China replaced the USA as the biggest investor in green technology.

“Renewable energy is one of the fastest-growing sectors in infrastructural investments and at least partially takes over the key role in investments in electricity supply,” says Munich Re spokesman Gerd Henghuber. “The insurance industry needs to respond to that development by addressing the specific needs and challenges of this new industry, and by providing tailor-made risk transfer solutions for this industry to the benefit of all stakeholders.” GR

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Special Report: Facultative Reinsurance

Q & Dom A Tobey with

PartnerRe’s head of facultative talks about the pressures, trends and evolving priorities of the market Q: What is happening with rates and terms and conditions in the facultative reinsurance market?

A:

Worldwide markets are clearly softening, but at a modest pace compared to previous soft cycles. Having learned important lessons from the late 1990s, there is more discipline in the market and greater attention to risk management.

There has also been a general upgrade in the quantitative skills and modelling technology in the industry, so naïve capacity is much harder to find.

In simple terms, demand is down while supply is up. Overall demand is down owing to a variety of reasons starting with the economic recession reducing values, projects and putting pressure on insurers’ top line. This pressure on demand is compounded as cedants try to retain more premium – and risk – to offset the pressure on their top line.

Supply is up for a variety of reasons.

There are several smaller new entrants into the facultative market and several players that have increased capacity in recent years. Part of the excess capacity comes from the fact that in some markets – the UK, in particular – the large direct insurers are taking facultative shares when they are unable to get the business on a coinsurance basis. In contrast to these new entrants and capacity increases, there have been no meaningful exits from the markets.

Insurance buyers now seem to expect reductions almost automatically, and the direct market tries to pass on these reductions to reinsurers. However, as I said, the market today is much more disciplined than in previous years.

Q:

Tell us about loss experience in 2010 – in particular Chile and Deepwater.

How are they likely to affect the market?

A:

There are two exceptions to the softening trend: Chile and offshore energy, where the earthquake and the Deepwater Horizon disaster respectively have led to modified

pricing assumptions. Offshore energy is experiencing rate increases averaging 20%-30% and considerably more for deepwater drilling.

For the time being, these two significant losses seem to have had local impact only. In Latin America, the Chile quake has really only affected Chile prices. In offshore, there has been some improvement in pricing, but without any global knock-on effect.

tend to be more ‘traditional fac’ driven, at least for the time being. A gradual, long-term trend is that an increasing proportion of facultative business is staying in regional markets rather than being placed in London and the international markets. This is because domestic companies are increasingly capable of handling larger, more complex risks and several large multinationals have been writing risks through recently established local subsidiaries.

‘An increasing proportion of facultative business is staying in regional markets’ Nevertheless, 2010 has been a heavy year in terms of cat losses, with most activity focused in the fi rst half-year.

Q: What types of risk does direct and facultative (D&F), including regional markets, generally encompass?

A:

The D&F markets typically cover the largest and most complex property placements – risks that are excluded or only partially covered by reinsurance treaties because of their capacity needs or complexity. This typically includes large industrial and commercial placements, which are coinsured among many global (re)insurers and critical cat-exposed business. Risks typically include large complex properties and construction properties such as offshore oil rigs, steel companies, mining and power generation companies, and so on.

Q: What are the most important markets for D&F worldwide, and how is that evolving?

Q: Tell me about the distribution channels in D&F and the role of the broker.

A:

D&F placements tend to be a patchwork construction that encompasses all elements of the riskbearing market – direct and reinsurance alike. Brokers tend to have a clear understanding of how to build up capacity by targeting players interested in primary, mid-layer and high-excess layers, without looking for a traditional quota share approach.

Q: What are the key trends affecting the fac (re)insurance market?

A:

The facultative markets experience both cyclical pressures and long-term trends. The current softening conditions are all cyclical in nature. The two most notable long-term trends are the aforementioned shift to regional markets and a long-term bright outlook for facultative demand. As world economies recover and develop over the long-term, and as enormous economic power emerges from the developing world, large complex properties and individual risk accumulations should develop faster than average, fueling a healthy demand in facultative markets. GR

A:

The US market is still the most important market, plus all US market business placed through the London wholesale market. Emerging markets

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Lines & Risks

No time for auto pilot

Recent aviation losses and overcapacity seem to be leaving the market in neutral. But as one major loss threatens to trigger reinsurance programmes and experts warn that profits must be made soon, hitting cruise control just isn’t an option. Lauren Gow reports GLOBAL REINSURANCE NOVEMBER 2010 41

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Lines & Risks Major 2010 aviation losses 6 February: The roof of a hangar housing corporate jets at Dulles Airport in Washington, DC collapses under the weight of snow. No loss of life but an estimated damage bill of $440m.

At 1pm on 10 June, a large fi re broke out in the Saudi Arabian Airlines warehouse in northern Jeddah, Saudi Arabia. Members from 13 civil defence taskforces and rescue teams spent four hours battling the inferno. No loss of life was recorded but the 18,000-squarefoot building was reduced to rubble – destroying or damaging nearly all of the insured’s aircraft and ground equipment spare parts.

While loss adjusters are still totting up the costs of the damage, there have been some suggestions that it will be as high as $365m, though this figure could reduce. Such a loss could have a significant bearing on the outcome of the upcoming aviation renewal season.

If the fi nal figure is in line with current rough estimates, it will trigger primary aviation insurers’ excessof-loss reinsurance programmes, and could mean rates will only fall by around 5%, according to Ian Wrigglesworth, managing director, aviation at reinsurance broker Guy Carpenter. However, if the figure is lower than currently expected, excess-of-loss policies will remain untouched and primary insurers will retain the loss.

“If the fi nal figure reduces down below the attachment points of the aviation excess-of-loss programmes, there will be no brake on pricing,” says Wrigglesworth.

“That means direct aviation underwriters are able to look for

10 April: A Tupolev 154 plane carrying Polish president Lech Kaczynski crashes near the Russian airport of Smolensk, killing more than 90 people on board.

reductions of their excess-of-loss programmes between 5% and 10%.”

Below trigger point Apart from the June fi re, reinsurers have got off relatively lightly so far this year in terms of aviation losses. “There has been a multitude of losses – around $900m worth of hull and spares losses during 2010,” Wrigglesworth says. “But reinsurers haven’t been affected. Almost all have been below the attachment points of major risk excess-of-loss programmes. Despite the losses in the primary market, the excess-ofloss market has been comparatively unaffected.”

Some primary insurers will be affected more than others by the recent run of aviation losses, of course, as Wrigglesworth says that those writing a global, diversified book of business will have fared better than those focusing solely on international airlines business, which he highlighted as a loss-making area.

By contrast, the US airlines, products and factories business lines have performed comparatively well. As a result, reinsurers have enjoyed profitable proportional treaty relationships with the vast majority of clients, on top of not having to pay losses on excess-of-loss contracts.

There is also ample capacity in both the insurance and reinsurance markets.

Wrigglesworth says the reinsurance market has held 200% capacity for more than five years.

Across the globe Underwriting global aviation business has become more challenging in light of sanctions between countries, which are resulting in changes to contract wordings. Several sanctions and embargoes have been broadened this year, which Wrigglesworth says both the insurance and reinsurance markets will have to appropriately comply with.

“Some regulatory framework has come through in which there has now been a more robust enforcement of sanctioned areas, for example Iran,” says Wrigglesworth, adding that discussions are currently taking place to ensure underwriters and brokers comply with the sanction requirements.

And while rates are falling for reinsurers, exposures are increasing in certain areas. According to Wrigglesworth, there was a degree of contraction in the global airline fleet during the economic crisis, including a number of older aircraft that were decommissioned.

Different parts of the world are recovering from the crisis at different rates, which will result in exposure changes in certain regions. “There continues to be delivery of new aircraft and the airline market continues to expand,” says Wrigglesworth. “There are areas in the world where the expansion continues at pace and other areas where there has been economic slowdown and so fewer deliveries of aircraft.”

But the market is not without its challenges. Some feel that with high capacity and falling rates, something has to give. Aon senior business analyst Magnus Allan says capacity levels in both insurance and reinsurance will need to produce a return in the coming months or risk cutbacks. “I think people will look at it and think: ‘Right, we need

PHOTOS: GETTY IMAGES, REX FEATURES

25 January: Ethiopian Airlines passenger jet crashes into the sea with 89 people on board shortly after take-off from Beirut.

12 May An Afriqiyah Airways Airbus 330 crashes while trying to land near Tripoli airport in Libya, killing more than 100 people.

42 NOVEMBER 2010 GLOBAL REINSURANCE

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Lines & Risks

22 May: An Air India Express Boeing 737 overshoots a hilltop airport in Mangalore, southern India, and crashed into a valley, bursting into flames and killing 158.

16 August: A Boeing 737 Airis Colombia passenger plane carrying 127 people crashes while landing in poor weather at San Andrés Island, and the fuselage breaks up on impact. One passenger is fatally injured and a second passenger dies later in hospital.

10 May: Fire destroys a Saudi Arabian airlines warehouse in northern Jeddah, Saudi Arabia.

No loss of life is recorded, but all the insured’s aircraft and ground equipment spares are damaged or destroyed.

28 July: A Pakistani plane on an Airblue domestic flight from Karachi crashes into a hillside during poor weather while trying to land at Islamabad airport. All 152 people on board are killed.

to get a profit in 2011.’ Or else there could be a reduction in capacity in 2011 and 2012,” he says.

A further challenge is that primary insurance rates are also under pressure, which is influencing reinsurance prices.

On 6 February, the roof of a hangar housing corporate jets at Dulles Airport in Washington, DC collapsed under the weight of snow, causing insured losses of approximately $440m. However Wrigglesworth said the primary US general aviation market had been unable to push up their rates despite the loss, because of overcapacity. This has, in turn, limited reinsurers’ ability to charge more.

Some observers believe the significant losses in May and August will keep primary insurance price growth around the 5% mark. However, broking group Willis’s business development manager Steve Doyle says: “We are in a situation where the capacity and the losses are currently presenting opposing forces that are bringing the markets to a largely neutral position.”

A clearer view There are positive signs for aviation reinsurers in these tough market conditions, however. While rates may be falling, underwriting is becoming more sophisticated, potentially giving greater protection against future losses.

Aviation insurers and reinsurers generally have little difficulty in gathering information to support their underwriting because a lot of

24 August: A Henan Airlines Embraer ERJ-190 passenger plane overshoots the runway at Yichun City’s airport in the north-eastern Chinese province of Heilongjiang, killing 42 of the 91 people on board.

‘There has been a multitude of recent aviation losses, but reinsurers haven’t been affected. Almost all have been below the attachment points of major risk excess-of-loss programmes’ Ian Wrigglesworth, Guy Carpenter

the data they use is available in the public domain. But, according to Wrigglesworth, underwriting is being reshaped by actuarial data, which has been used increasingly over the last three years to paint an even clearer risk picture for reinsurers.

“The interesting part is how we process risk using actuarial modeldriven analysis. This means reinsurers have a sophisticated approach to how they rate their business,” says Wrigglesworth.

Wrigglesworth says the increased actuarial data use in aviation underwriting is being influenced by the models employed in other specialist lines being written by reinsurers.

“Demand to write aviation reinsurance has been increasing because people have come into aviation who write many other specialty lines, and other specialty lines are model driven,” he says. “A good management tool is making sure a robust model

is used, meaning there is fairness in quoting.”

Despite the increasing sophistication of aviation underwriting, however, there are always going to be unknowns and surprises that the models cannot account for, fi nancial crises being a particularly good example.

However good the aviation reinsurance market’s underwriting, it is to an extent at the mercy of forces governing the aviation industry itself.

As Doyle at Willis says: “The economic issues around the aviation industry are going to be the economic challenges of the insurance market.” GR FIND OUT MORE ONLINE: VOLCANO? WHAT VOLCANO? To read this article, and for more news and analysis on the effects of major losses in aviation on the reinsurance market, see globalreinsurance.com or goo.gl/12Wp

GLOBAL REINSURANCE NOVEMBER 2010 43

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Rewind

Monty Our insider begins to doubt his hero Buffett and has new respect for the partying Markels

Trouble at mill?

that the Monte Carlo Rendez-Vous was in full swing, they decided to moor up in the harbour for a bit of an impromtu do. Now that’s what I call a creative approach to the reinsurance business.

I’m a bit worried that Warren Buffett is not the savvy investor I thought he was. What’s all this about buying Berkshire Hathaway being a $200bn blunder?

We’re all used to him admitting the odd gaffe in his annual letter to shareholders, but that’s a pretty expensive mistake for the Sage of Omaha to be making, even if it was back in 1964.

And as for his admission that he should have bought a good insurance company rather than a textile mill, I could have told you that, mate. It doesn’t take a genius to work out that you can make a lot more peddling insurance cover than cushion covers.

Painful memories You often hear people say that (re)insurance executives have short memories, and that this means they are destined to keep repeating the mistakes of the past. Try telling that to Jack Graham, chief executive of ICAT and now Paraline Group. He can recite on cue the names of all eight storms that hit the USA in 2004 and 2005. “We paid out a lot of money in those 15 months,” he said.

I’ve often wondered how people with lots of kids remember all their names but I think I’ve worked it out now: heavy capital expenditure clearly helps to lodge certain things in the memory.

The cats get the cream That said, I’m still with the Sage on the whole issue of cat bonds. They’ve been doing the rounds for a fair few years now; I remember them being all the rage when I was cutting my teeth as a junior broker back in 1998. But I still don’t get them. Why go to all the trouble of setting up a special purpose vehicle, hiring loads of bankers and getting investors involved for something that only pays out if the whole world blows up?

Tell you what: pay me the equivalent of what you would to set up a cat bond, and I’ll sort you out with some choice reinsurance coverage.

Now that floats my boat You probably know all about the Markel International story, and how Markel came over from the States to sort out Terra Nova. If you’re a diehard socialite like me, you’ll be pleased to know that the Markel family are just as good at putting their capital and ingenuity into the tough business of schmoozing.

Rumour has it that a couple of years ago, Tony Markel and his brother Gary were sailing around in their rather large yacht when, realising

Do us a favour …

Some M&A at Lloyd’s wouldn’t go amiss: it’d save a lot of running on the trading floor

It’s all go at Lloyd’s these days, isn’t it? If it’s not Brit and Apollo, then it’s Beazley and Hardy.

What next, Chaucer and Novae?

Oops, no, that one’s been tried already. I have to admit, a bit of M&A at Lloyd’s wouldn’t go amiss: it’d save a lot of running around on the trading floor.

Not that I’m out of shape, you understand, but this slip case isn’t getting any lighter.

Nobody in the wings You’ve got to feel for Joseph Taranto at Everest Re. There he was, all set to put his feet up at the end of the year after a job well done, when Ralph Jones, the bloke he’d lined up to take over, slings his hook.

I’d love to know what tempted Ralph away from such a high-powered job, but the old grapevine has been remarkably quiet on that front. If you hear anything, you know where to fi nd me … GR

44 NOVEMBER 2010 GLOBAL REINSURANCE

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