Global Reinsurance October 2011

www.globalreinsurance.com

October 2011

G LOBAL RE I NSU RANCE

King of the world RFIB’s Marshall King has boundless ambition – and isn’t afraid to use it

• Managing the eurozone crisis p14 • All the debate from Monte Carlo p25 • How risk models coped with the Q1 quakes p38

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23/09/2011 11:04

Cover image: Carl Court

These days it seems no company can announce an offer for another fi rm without a string of rival bids following in its wake

Leader

When it comes to mergers and acquisitions in the (re)insurance industry, it seems three is the magic number.

Echoing the three-way battle to take over Transatlantic Re, embattled Lloyd’s (re)insurer Omega is now being pursued by three determined suitors: Canopius, Haverford and Barbican.

These days it seems no company can announce an offer for another fi rm without a string of rival bids following closely in its wake.

Market conditions have a lot to do with this trend. Despite the recent spate of catastrophe losses, companies are sitting on a lot of excess capital, and rates have not yet risen to the level where they can deploy it. Acquisitions, therefore, are the only option to grow, so when a company is known to be in play, it will attract a lot of interest.

In addition, stock market jitters and recent losses make it difficult to value companies. An offer can provide other would-be suitors with a handy benchmark. M&A competition is a good thing in

some respects. Shareholders can get bigger rewards if the battling suitors try to outbid one another, for example. In addition, the knowledge that rival bids will emerge should make the initial bidder extra careful to make a good offer.

But it can also be a costly and time consuming process. The greater the number of bids, the more management time required to sift through the proposals. Then there is the issue of break-up fees.

All this effort can be to little avail.

Transatlantic now looks likely to go it alone, having terminated its agreement with Allied World and knocked back Validus and National Indemnity’s offers. After its travails, Transatlantic is now $48.3m lighter, having paid Allied World’s termination fee and expenses – one way of using up some excess capital perhaps, but not one that shareholders are likely to approve of.

Ben Dyson Assistant editor Global Reinsurance GLOBAL REINSURANCE OCTOBER 2011 1

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23/09/2011 17:25

October The capital question, page 14

G LOBAL RE I NSU RANCE.COM

IAG’s Julie Batch, page 36

Mastering the models, page 38

News

Monte Carlo

1

Leader

25 View from the top It’s all about version 11 for our CEOs

4

News

29 The value proposition Our cedant roundtable in Monte Carlo debated rates, renewals and relationships

10 News analysis Is Solvency II fit for purpose?; the twists and turns behind the fight for Omega

14 News agenda

Fears over sovereign debt and stock market dips abound, but are reinsurers’ assets really in danger?

People & Opinion 18 Marshall King RFIB is fired up to explore new territories

Special Reports 21 Faculative in focus Assessing the state of the fac market

Cedants 36 Q&A

Claims 38 Finding fault Lessons learnt from the worst Q1 in history

Country Focus 49 Blowing in the wind Catastrophes have taken their toll

41 Location, location The battle of the domiciles continues

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

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

Finance reporter Lauren Gow Tel +44 (0)20 7618 3454 Email lauren.gow@globalreinsurance.com Group production editor Áine Kelly Email aine.kelly@globalreinsurance.com

Managing director Tim Whitehouse Group production manager Tricia McBride Senior production controller Gareth Kime

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

Digital content manager Michael Sharp Head of events Debbie Kidman

Insurance is in the blood for IAG’s Julie Batch

on the USA and its reinsurers, and the worst may not be over

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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 © 2011 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 OCTOBER 2011 GLOBAL REINSURANCE

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23/09/2011 17:22

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22/09/2010 11:32

News

Only ‘Armageddon’ will spur broad hardening ● Change in hard market drivers must be recognised to produce value and returns ● Winning companies will be agile, innovative and have embedded risk management Willis group deputy chairman Martin Sullivan has warned From major natural catastrophe events over the past 18 months DATA: WILLIS reinsurers to shape up in light DATE EVENT INSURED LOSS REINSURED LOSS of the slowness in market Feb 2010 Chile earthquake $9bn $8bn hardening.

Mar 2010 Windstorm Xynthia $4bn $3bn Speaking at the Sep 2010 1st NZ earthquake $5bn $4bn PricewaterhouseCoopers Dec 2010 Australia floods $2bn $1.3bn annual briefi ng in Monte Carlo, Jan 2011 Cyclone Yasi $5bn $4bn Sullivan said: “Reinsurers’ Feb 2011 2nd NZ earthquake $12bn $11bn total available capital may no Mar 2011 Tohoku earthquake $35bn $13bn longer be the only driver of Apr 2011 US tornados $8.5bn $1.5bn reinsurance market softening May 2011 Joplin tornado $4.9bn $1.5bn or hardening.”

Jun 2011 3rd NZ earthquake $4bn $2bn He said that the previous Aug 2011 Hurricane Irene $5bn three hard markets have been $94.4bn $49.25bn driven by a reduction of industry capitalisation and short-term difficulty in on differentiation and that a Japanese earthquake is SHORT-TAIL rebuilding and accessing stakeholder needs, going to cause fi rming of US LINES WILL new capital. to help the sector casualty rates.”

HARDEN, Sullivan also issued a demonstrate its value The future growth in the SAYS sharp warning for the potential to the capital market, with the continuing VEGHTE industry that unless there markets,” he said. soft cycle, will be the next big is an “Armageddon” event FIND OUT “The winners are challenge for insurers, MORE ONLINE in the near future, hard likely to be those according to Sullivan. goo.gl/wdNnj cycles will only occur in companies that are “If we continue to go forward certain regions and agile and innovative, in a soft market,” Sullivan product lines. have embedded risk asked, “the challenge for “Barring this type of management practices insurance company chief financial Armageddon, within their business executives is ‘how do we the current levels of and are obtaining continue to grow?’” overcapitalisation may be maximum value from reduced by losses and poor diversification.” investment returns,” Speaking to Global Sullivan said.

Reinsurance, XL Re chief ● With the number of “But that should not return us executive Jamie Veghte echoed natural catastrophes in 2011, to the bouts of capital starvation Sullivan and Law’s thoughts on reinsurers may be relying that drove market behaviour in the drivers of market hardening too heavily on a natural some of the earlier hard or softening. hardening of the market. Some markets,” he added.

Veghte believes short-tail market analysts predict that PricewaterhouseCoopers lines are likely to benefit the approximately $50bn in global insurance leader David from market hardening at losses so far would need to be Law said the market needs to the 1 January renewals, doubled in order to make a real recognise that the hard market particularly in loss-affected difference to prices. drivers are changing. “Simply areas. “We have had a ● With Solvency II bearing managing the cycle will no tremendous amount of nat cat down on the smaller players, longer produce adequate activity and there is going to and the likelihood of a returns for investors or be a reaction, as there was at sporadically hardening market, provide meaningful value 1 June and 1 July in our US the selection of acquisition for customers,” he said. renewals. I expect that targets is widening quickly.

Law said this market provides to continue.”

Who will be next? a catalyst for the industry to But he did not expect the ● Sullivan has asked how reinvent itself and demonstrate losses in short-tail lines to insurers will continue to grow the value of alternative prompt any fi rming of long-tail in a soft market. Traditionally, risk management solutions. rates. “I think a turn in the this is the perfect environment “Reinsurers need casualty market is on the for a wave of new, innovative sustainable strategies, built horizon. But I don’t believe products. Watch this space.

Going global: Peo 1 New York Transatlantic Re chief

operating officer Michael Sapnar will take over as chief executive from Robert Orlich on 1 January 2012.

He is also named president with immediate effect.

Reinsured losses

5 1 3

2

4

3 Bermuda Endurance has promoted

Bermudian native Stephen Young to head of global catastrophe reinsurance, replacing Christopher Schaper.

5 Norway Ex-Marsh broker Cato Aamodt

has joined Lloyd’s broker Lockton to head its new Norwegian operation.

Aamodt began hiring a team of nine from 1 September.

Hurricane Irene:

We say ...

4 OCTOBER 2011 GLOBAL REINSURANCE

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News eople moves 2 Virginia Alterra USA chief executive

Douglas Worman is now also chief executive of US Insurance operations.

Alterra Specialty chief operating officer Bryan Sanders has been promoted to chief executive.

6

4 Brazil Eduardo Pitombeira joined

(re)insurer Argo’s Brazillian operation as director of business development and financial lines for its commercial property and casualty business.

6 Switzerland Allied World Assurance

Company appointed Kurt Fleischmann as Allied World Europe vice-president, general casualty and professional lines.

Online top five

Weblog globalreinsurance.com Everybody loves a good mystery and never more so than when it involves one of your own. The whereabouts of John Berger have been intriguing the market since early August, when Berger suddenly resigned as Bermudian reinsurer Alterra’s chief executive to “pursue a new opportunity”.

That new opportunity has fi nally surfaced, with Berger joining start-up company Third Point Re. But the mystery continues, as it is unclear what role he will assume at the company, who is behind its formation or what business it will write.

Taking second place in the top five this month is the storm that almost tipped the market. While Hurricane Irene’s losses are expected to be worse than Floyd, most in the market agree that losses will not be enough to drive a really hard market.

T To contribute to the website, email Lauren Gow at lauren.gow@globalreinsurance.com

2. IRENE LOSSES WORSE THAN 1999’S FLOYD – AIR Irene is currently a category 3 hurricane on the Saffir-Simpson scale 3. BUFFETT’S TRANSATLANTIC OFFER OUT OF TIME Validus is now pursuing Transatlantic’s shareholders directly 4. DAY ONE: MONTE CARLO DAILY Feeling the heat at the Rendez-Vous 5. TROPICAL STORM KATIA THREATENS US EAST COAST Katia expected to strengthen to a hurricane

Insurers buy up sideways cover

e: Insured losses hit $5.5bn

● Greater protection against multiple events is needed ● Industry warned to ‘buy before the storm’, not after

PHOTO: REX FEATURES

STORMING ON Hurricane Irene hit the US East Coast on 27 August, after tearing a path through the Caribbean. The storm caused arround $5.5bn insured losses according to risk modelling firm RMS. The storm made US landfall as a category 1 storm before making two further landfalls in New Jersey and New York. Weakening to a tropical storm, Irene then cut through Massachusetts before crossing the border into Canada.

The seemingly never-ending saga of who will buy Transatlantic hit a dead end after Warren Buffett’s $52-per-share offer ran out of time, leaving Validus and Allied World to fight it out.

In fourth place was the Global Reinsurance team’s daily coverage from the Monte Carlo Rendez-Vous. The dailies included the bold comment’s from PricewaterhouseCooper’s European insurance market reporting leader James Quin, who declared: “Sovereign debt is just a sideshow for reinsurers.”

And fi nally, as Irene blew over, Tropical Storm Katia blew in, with the market braced for yet more East Coast losses. Instead, Katia proved to be little more than a storm in teacup.

1. ALTERRA’S BERGER JOINS START-UP REINSURER Former chief exec’s role at Third Point Re is not known

Demand for second event sideways cover has increased as insurers digest the possibility of further natural catastrophes before year-end.

Specialist broker BMS senior vice-president Stefano Nicolini believes the market is on the move after a period of relative quiet.

“After Japan, we saw a little period of quiet. Now we are seeing demand increasing for coverage from now until the end of the year. Currently, we are seeing big demand for sideways cover for multiple events,” Nicolini said.

Nicolini added that while the industry seems comfortable

with its fi rst event coverage capacity, multiple events are a real concern. “If there is an event between now and the end of the year, they will be in trouble. We are seeing people buying second event to cover this issue,” he said.

Nicolini has also warned the industry to buy cover early.

“One thing I tell my clients is if they know they need an industry loss warranty, buy it now because you never know what will happen in the next two months. If there is a hurricane or earthquake in the USA, the price of every ILW will increase. Buy before the storm, not after.”

GLOBAL REINSURANCE OCTOBER 2011 5

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News Bid&Ask Barbican offer J

The battle for Omega

I 25% stake

G

H

What next for Transatlantic? ● Allied World and National Indemnity offers declined ● ‘Friendly’ negotiations with Validus still considered

Novae withdraws

Novae chief exec Matthew Fosh M cconfirms interest

F

E

Barbican approach

£500m C £1.40 per share £

Two US-based buyers

D Cash and shares bid B Canopius chief

Michael Watson makes unsolicited approach £1.20 per share re A A 7 January: The first rumours of

an Omega buyout begin circulating the market. Canopius is believed to be in talks to buy the fellow Lloyd’s insurer. Rumours suggest that Omega shareholders could accept an offer of £1.20 a share from Canopius.

merge to create a £500m business.

F 13 June: Barbican reveals via

the London Stock Exchange that it has approached Omega about a merger.

G 31 June: Novae withdraws from

B 10 January: Omega confirms a

possible approach by Canopius, in a statement to the Stock Exchange. The insurer says it has received an unsolicited approach from Canopius, with an offer comprising a mixture of cash and unquoted share consideration.

merger talks with Omega after it fails to find a satisfactory deal for its shareholders.

H 12 September: Bermudian

investment firm Haverford offers to buy a 25% stake, 60.2 million shares, for 83p a share.

I 13 September: Canopius quickly

C 13 January: Talk of a merger

intensify as analysts speculate that Omega shareholders won’t accept less than £1.40 a share.

D 18 March: Omega confirms

that it has received further approaches in addition to the Canopius bid. Rumours suggest approaches from two US-based insurers.

E 31 May: Lloyd’s insurers Novae

and Omega Insurance confirm they are in talks over a potential merger. Novae was forced to confirm its interest following reports that the two firms could

responds with an “indicative proposal” of the same amount per share for the whole company, subject to due diligence.

J 22 September: Barbican proposes

to buy 24.57% of fellow Lloyd’s insurer Omega for 84p a share in an all-share transaction with no acquisition premium. Omega shareholders are offered the option of a partial cash alternative immediately following the completion of the deal.

For the latest on the deal and a detailed analysis of the Barbican offer, see News Analysis, page 12

The Transatlantic Holdings further $66.7m if it enters a takeover saga has taken a new competing merger agreement twist, with shareholders before 15 September 2012. growing increasingly restless.

Transatlantic said it will The collapse of the merger continue to evaluate “any agreement between serious proposal or opportunity Transatlantic and Allied World that offers its stockholders full on 16 September unexpectedly and fair value”. brought the National Indemnity It has also launched a $600m deal back to the table. share buy-back plan, which National Indemnity president adds $455m to the company’s Ajit Jain wrote to ADVISER TELLS existing share Transatlantic’s outgoing SHAREHOLDERS repurchase authorisation. president, Bob Orlich, The departure of Allied TO SHUN TRANS-ALLIED on 19 September, World and National reinstating its $52-per- MERGER Indemnity from the share takeover offer. bidding war leaves only FIND OUT Jain said the company MORE ONLINE hostile suitor Validus. goo.gl/OjS1E had reviewed Allied Validus chief executive World’s offer, adding: Ed Noonan took his “I am confident the proposal directly to the Allied World merger shareholders on 25 July, agreement can be revised with market reports into a merger agreement that suggesting he has also made would reflect our agreed terms.” steps towards replacing the The National Indemnity offer, Transatlantic board. which expired at close of Transatlantic maintains it is business on 19 September, drew willing to engage in “friendly” a line under any future offers. negotiations with Validus if a “I want to confirm to you suitable confidentiality that, should this proposal not be agreement can be met. accepted by the Transatlantic Validus’s share price has Board, we will not approach dropped 9.1% to $24.78 since it the Transatlantic shareholders began its hostile bid in July. directly with a proposal and we Transatlantic’s share price has will not be renewing this offer,” also fallen 6% to $48.77 during Jain said in the letter. the same period.

But the $52-per-share offer was immediately rejected by the Transatlantic board, who said the price was too far from ● The exit of Allied World and its $70-per-share book value.

National Indemnity means that “The Transatlantic board of the Transatlantic board is left directors believes that selling with a hostile negotiation Transatlantic for cash at the process with Validus. Can an substantial discount to book agreement be reached in such value represented by the difficult circumstances?

National Indemnity proposal ● National Indemnity’s simply would not deliver fair offer values Transatlantic at value to its stockholders,” $3.25bn; Validus’s offer valued Transatlantic said in a statement.

Transatlantic at $2.9bn as of Following the mutual decision 5 August, while Allied World’s to end talks, Transatlantic has offer valued the company at agreed to pay Allied World a $2.76bn. With National termination fee of $35m and Indemnity’s offer being a reimburse $13.3m of expenses. clear price favourite, what It will also pay Allied World a killed the deal?

We say ...

6 OCTOBER 2011 GLOBAL REINSURANCE

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The forces of nature can strike at any time.

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Plug into www.swissre.com

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26/09/2011 09:48

News

The big ...

Numbers

Total global reinsurer capital hit $445bn at 30 June, according to Aon Benfield Analytics. But the mid-year figure is down 5% from the record high of $470bn at the close of 2010.

Bath

Warren Buffett revealed he was in the bathtub when he dreamt up the idea to invest $5bn in the faltering Bank of America.

Warning

XL’s chief executive Mike McGavick has warned Solvency II will sap the industry of smaller players’ creativity and drive.

TigerRisk takes on top three for US buyers ● New York broker to capitalise on concerns about big brokers’ dominance Reinsurance broker TigerRisk’s in too few hands, as it weakens new UK office is pitching itself as the underwriting process due to an alternative to the big three to the control that market share access Lloyd’s and London market gives those brokers,” Goldsmith reinsurance capacity for North told Global Reinsurance.

American buyers.

“It is a positive development for The UK division’s new chairman the London market that there will and chief executive, John be another reinsurance broker Goldsmith, estimates bringing business into it.” that around 70% of the North TigerRisk UK will focus on American risks are placed placing North American into the London market reinsurance and worldwide Q&A WITH through Aon Benfield, retrocession into the London JOHN Guy Carpenter and Lloyd’s markets.

GOLDSMITH, TIGERRISK or Willis Re, following Goldsmith will shortly be the M&A wave of the late joined at TigerRisk UK by an FIND OUT 1980s and early 1990s. operations director, who is MORE ONLINE goo.gl/RBNjH “A number of currently on gardening underwriters in the leave. “We will be looking to market have concerns recruit brokers and technical about too much business staff,” Goldsmith says.

We say ... ● TigerRisk is right in that there is no shortage of concern about the amount of business controlled by the big three reinsurers. Novae, for example, said in March that it was planning to reduce its dependence on mega-brokers for this reason. ● But there are several mid-tier brokers, including Cooper Gay and BMS, that already offer an alternative.

TigerRisk will need to set itself apart from these. ● John Goldsmith is well known and respected in the London and US reinsurance markets, and is a good choice to run the firm.

8 OCTOBER 2011 GLOBAL REINSURANCE

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23/09/2011 15:36

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23/09/2011 16:24

News analysis Solvency II

Unresolved issues Badly thought out, much delayed, likely to stifle creativity, too dogmatic … Suffice to say the issue of Solvency II continued to spark debate at Monte Carlo, as Ellen Bennett reports

Regulator overload

Other participants, including Berkshire Hathaway’s managing director of reinsurance Manfred Seitz, shared McGavick’s concerns over the structure and implementation of Solvency II, particularly regulators’ ability to approve bespoke models for capital allocation.

Many companies hope to operate bespoke models to help them hold less capital – their capital requirement will be fitted to their individual risk profile. But national regulators will have to approve the models before they can do so.

This has already caused problems in several European countries, including the UK where the FSA has admitted it does not have the resources to review all the models put before it. It has suggested that

insurers pay for validation by an external third party but, as McGavick pointed out, the cost of experts in this area has spiralled out of control, and resources are extremely scarce at any price.

Seitz suggested companies may end up turning away from the bespoke model approach. He said: “There are 600 eligible companies in Germany. If two dozen of them went for innovative models, the regulator would be kept busy for the next decade or so. Then once they have gone through all that expense and effort, they find they save maybe 10% over other companies.”

Investment concerns

Finally, there were major concerns over the investment models favoured by the Solvency II regime in its current format. Deutsche Bank global insurance asset management head Randy Brown said: “On the asset side we see some flaws in the way it is driving investment decisions. The drive towards sovereign debt is, we think, misconstrued.

It’s too static and dogmatic an approach.”

As well as favouring government bonds, Solvency II discourages investment in equities. Brown said: “It’s forcing you to concentrate your risk. It’s a complete failure to understand the asset side of the balance sheet relative to the liability side. If I were a regulator in Germany, would I allow Solvency II to put a large number of my companies out of business? Probably not. So I think you will see some changes before it ultimately emerges.”

Seitz said: “We have an enormous process, and when you look at this time span we have had 9/11, Katrina, the biggest financial crisis in 70 years, and they have always had to come back to the drawing board. Now we have had QIS5 [the most recent quantitative impact study] – a big difference to QIS4 – so the whole industry was up in arms. Now the whole European sovereign situation is under enormous pressure and could fall apart.”

Endurance chief executive David Cash suggested that global regulators should be focusing on other areas of the insurance business.

He said: “The regulators are still fighting the last battle. If there are going to be failures, they will be due to loss reserves. I’ve not heard anyone talk about that for years.”

McGavick said that, unlike their counterparts in banking, insurance regulators did not have a crisis to solve. He concluded: “I wish they would take a year off and pat themselves on the back, rather than trying to invent a crisis to cure in our sector.”

Among the other issues covered in the debate were rates and the market cycle; mergers and acquisitions; and insurer-broker relations.

See page 25-26 for more coverage. GR

ILLUSTRATION: BRETT RYDER

I

ndustry leaders are increasingly worried that Solvency II is not fit for purpose in the current economic climate and are calling for a further review of the proposed regulation.

A gathering of chief executives hosted by Global Reinsurance at the Monte Carlo Rendez-Vous issued strong warnings that Solvency II would create problems in the market, driving out creativity and encouraging insurers to make illogical investment decisions. Originally scheduled for implementation in 2012, Solvency II has now been delayed until 2014. It was first mooted in 1999.

XL’s chief executive Mike McGavick warned that the new regulatory regime would impose the European model across the globe, stifling opportunity for other centres of capital.

“Solvency II is in essence a way for the European system to leverage others on to their approach. The trouble with that is that the world is better off when there are more models of capital formulation rather than fewer,” he said.

“It’s hard to imagine a Bermuda arising in a Solvency II world, and that’s not necessarily good. There are other places of potential capital formation that can help bring about a less risky world. To the extent that these regulatory forays result in essence in two capital formation centres with Bermuda hanging on, that’s not an ideal world. The regulators need to pause and think about that implication.”

He added that this would also limit the potential for creativity and entrepreneurialism in the market. ”The fundamental flaw in the thinking with Solvency II is that so much of the creativity and energy of the industry has come from smaller players – this could drive that out of the market, and that would be a real mistake. If it goes forward as it is, it will result in fewer larger players and I have never understood how the customer wins in that environment.”

10 OCTOBER 2011 GLOBAL REINSURANCE

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10/08/2011 09:51

News analysis Mergers

Three in a bed With no less than three suitors, Lloyd’s insurer Omega in the industry’s heartthrob du jour.

Who will get to walk it up the aisle? Lauren Gow reports

T

wo is a merger, three is a mêlée. Following in the footsteps of the tussle to buy Transatlantic, Lloyd’s insurer Omega now has itself three eligible suitors all vying for its hand in marriage. But unlike Transatlantic, the battle for Omega has become more about exits than entries.

There is no denying the attractiveness of Omega’s dowry. The insurer still has excess capital left over from its £130m ($201m) capital raised in January 2009, which it issued new stock for at £1.40 a share, according to Shore Capital analyst Eamonn Flanagan.

Furthermore, as Omega writes short-tail business, its book is unlikely to contain any of the nasty surprises that might lurk in the business of a more casualty-focused insurer.

While several contenders have come and gone in the past few years, Omega’s latest three suitors seem the closest yet to sealing a deal.

Vying for its hand are fellow Lloyd’s insurers Canopius, Barbican Insurance and Bermudian investment firm Haverford, chaired by former Flagstone Re chairman Mark Byrne.

All three have put forward strong arguments for their offers, but so far only Haverford’s has been 120p agreed with Omega’s board.

24.57% of Omega for 84p a share, on the condition that Omega agreed to a share-for-share merger with Barbican.

Following the deal, the combined entity would effectively buy back 60 million shares at 84p each, providing an exit to those shareholders that want it.

Haverford’s Byrne says it will be difficult for any suitor to buy 100% of Omega because of a strong divide between shareholders.

While one group wants to exit its holding of Omega, another group, which bought the shares during the £1.40 share capital raising, does not want to sell up for only 83p a share.

Considering the options

Observing offers currently on the table, both the Barbican and Haverford proposals acknowledge the shareholder rift, while Canopius’s appears to ignore it. Barbican’s offer is the highest, but contains the added complication of merging two Lloyd’s firms.

Byrne is surprisingly comfortable with Canopius breathing down his neck. “Invesco [Omega’s largest s h a re h o l d e r ] s a y s t h e y a re not sellers at 83p and that is 30% of the company. If they are not sellers at 83p to me, I would assume they are not sellers at 83p to Canopius either.”

But Byrne is not without criticism for his nemesis. “Canopius has been kicking the tyres on this company for two years. How much due diligence do you need? I’m not saying they are not credible but it has taken them a long time to get here.”

Omega’s share price

110p

Shareholder frustration

100p

In early Ja nua r y , C a nopius confirmed it had offered Omega a 90p cash and unquoted shares takeover offer, which analysts at the time 80p said would deter shareholders as many would be unable to hold 70p unquoted stocks in the funds that Omega shares sit in.

60p

By July, reports were circulating that Omega investors were baying 50p for blood, deeply frustrated by the veil of secrecy that the Omega Underplaying 40p board had covered any sales the competition 4 January 2011 - 23 September 2011 plans in.

In its latest offer, Barbican argues “Omega’s share price has that Haverford’s offer does not performed poorly in recent months and has become a real address any of the problems Omega faces. “Omega is sub-scale and, concern for many investors. Shareholders are now becoming frustrated while HBL has yet to outline its strategy for Omega, HBL does at the lack of progress being made by the company and the lack not have any notable insurance operations to drive efficiencies in the of communication we are receiving on the bid approaches from short run.”

Omega and its advisers,” vented a top 10 shareholder to the Barbican also contended that Canopius’s bid “undervalues Omega Telegraph. relative to the value that we believe can be created by combining Omega with Barbican”.

The courtship dance Canopius chief executive Michael Watson remains quietly confident, In mid-September, Haverford stepped in with an 83p-a-share offer for having been patient for over a year. “We are approaching an endgame 25% of Omega which, crucially, had been agreed with the board. which is to the benefit of everybody,” he said.

Canopius quickly responded with an ‘indicative proposal’ to offer the Endgame in sight or not, there is a truism in this saga that cannot same amount, subject to due diligence. be ignored – if the course of true love never did run smooth, so too By late September, Barbican had submitted a proposal to buy the marriage of two insurers. GR 12 OCTOBER 2011 GLOBAL REINSURANCE

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News Agenda

Down but not out?

Low interest rates, stock dips and a potential contagion of eurozone failures – it’s no surprise reinsurers are fearing for their capital bases. But, Ben Dyson asks, is the recent economic hand-wringing really warranted?

W

hile reinsurers are keeping one eye firmly on the Atlantic Basin for signs of capitalthreatening hurricane activity, they must keep the other peeled for equally damaging macro-economic storms.

These storms are brewing on several fronts. Low interest rates are hitting reinsurers’ bond-heavy investment portfolios. And many major stock indices have lost value. For example, the UK’s FTSE 100 large-cap index is down 10.7%, compared with the beginning of 2011. The USA’s S&P 500 is down 4% over the same period.

On top of these concerns is the worry that one of the peripheral eurozone economies will fail, defaulting on its debt payments. At best, this could reduce the value of reinsurers’ holdings of the relevant country’s government bonds, resulting in unrealised investment losses. At worst, a default could trigger further failures in the eurozone, having a widespread impact across companies’ sovereign debt portfolios.

And all this after the worst first half on record for catastrophe losses. Little wonder that some are likening the potential hits on the asset side of reinsurers’ balance sheets to the catastrophe losses they suffer on the liability side.

Swiss Re chief economist Thomas Hess says: “Natural catastrophes cause insurers headaches, but so does the asset side of the balance sheet. It is very difficult to achieve good profitability in these times, but this is not what causes insurers the most headaches – it is uncertainty about their capital bases.”

The domino effect

But, while the threats to reinsurers from the current economic conditions are serious and varied, it would be unwise to overplay them.

Of the financial threats facing reinsurers today, the most publicised is the sovereign debt crisis. There have been jitters surrounding the debt of several weaker eurozone economies such as Portugal, Italy, Ireland and

KEYPOINTS:

01: Reinsurers are not heavily exposed to the bonds of weak economies like Greece and Portugal – the real cause for concern is a domino effect across the eurozone 02: Reinsurers remain robust to government bonds’ increased risk and stock market dips, due to conservative investment strategies and ‘de-risking’ over recent years 03: Inflation could bump up claims costs, but it is not an immediate concern for the industry

Spain, with Greece the centre of the most recent attention.

But exposure to Greece and other weaker eurozone economies is not necessarily a major concern. European insurers’ exposures to these countries bonds is generally held to be small.

“We have found that balance sheets are generally not over-exposed to those specific countries. They represent overall a relatively small proportion of reinsurers’ invested assets,” Fitch’s managing director and head of the EMEA insurance group, Chris Waterman, says.

He adds that, sensing trouble on the horizon, reinsurers have reduced their exposure over the last year to both government and corporate bonds in those countries deemed to be more risky. “There has been a certain amount of de-risking going on,” Waterman says.

Others also downplay the risks of the eurozone debt crisis to reinsurers.

“From my point of view, the sovereign debt issue from a reinsurance perspective is entirely a sideshow,” PricewaterhouseCoopers European insurance market reporting leader James Quin says. “The direct exposure to peripheral eurozone sovereign debt is extremely small. I wouldn’t say it is irrelevant, but it’s not far off.”

But although weaker eurozone economies’ bonds do not feature

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News Agenda heavily in reinsurers’ investment portfolios, the knock-on effect of a default in one of these countries could prove more troublesome for European reinsurers in particular.

“A bigger concern is potential contagion,” Waterman says. “That is the big unknown, and could be the asset-side equivalent of a large natural catastrophe.”

In a worst-case situation such as this, government bond spreads across the eurozone would widen dramatically, severely cutting the valuation of the bonds on reinsurers’ portfolios.

“If the eurozone crisis becomes more acute, then that could have an impact on the spreads of government debt, but perhaps also on some financial institutions’ debt instruments as well,” Moody’s senior credit officer Dominic Simpson says. “This, in turn, could affect the profit and loss account and shareholders’ equity of a company just the same way as their underlying business.”

The implications could be worse still if the withdrawal of a troubled country destabilises or even derails the eurozone.

“If the eurozone breaks up, there will be big issues on the asset side [of reinsurers’ balance sheets] and big issues for the economy,” Swiss Re’s Hess says. “It would create a very turbulent phase. It would bring a recession and there would be an increase in defaults and big problems in the banking sector – insurers would be hit on the asset side.”

Bonds safe as houses?

The eurozone crisis, coupled with the Standard & Poor’s downgrade of US sovereign debt to AA+ from the highest rating of AAA on 5 August, has sparked much discussion about whether government bonds are the safe haven they once were. This is a potential concern to insurers and reinsurers, as government bonds typically make up the majority of their bond holdings.

But some argue that government bonds in general remain highly secure.

“The instruments that markets have traditionally looked on as being close to risk-free remain pretty low risk. It’s just that in relative terms we think some of them are marginally more risky than they were a year or two ago,” says Standard & Poor’s managing director of financial services ratings Rob Jones.

“That applies whether we are talking about the USA, Italy, Spain, Portugal or Ireland. They are somewhat riskier than they were, but all of those countries have investment-grade credit ratings.”

Quin agrees, arguing that the S&P

downgrade of US sovereign debt was practically a non-issue. A week after the downgrade, the US government auctioned $72bn of three-, 10- and 30-year bonds, and yields fell to an average of 2.13% from 2.59% in the previous auction in May, according to Bloomberg, as investors hungrily bought the bonds.

“Nobody is going to convince me that a 2% yield on 10-year US treasuries points to any real concern in the US bond market,” Quin says.

While eurozone contagion could be a big risk for reinsurers, the actions they have taken to make their investment portfolios more robust should stand them in good stead. “Contagion across the whole eurozone could potentially have rating implications for European insurers and possibly some reinsurers, although reinsurers have typically taken less risk on the asset side of the balance sheet,” Waterman says.

Nevertheless, while the risks to reinsurers from the sovereign debt crisis are remote, rating agencies say they are watching developments carefully.

“Typically, the sovereign debt that is held by reinsurers is highly rated. But obviously sovereign debt is a hot topic at the moment so we do pay close attention to reinsurers’ holdings,” Simpson at Moody’s says.

I think the industry has proven that it can generally move pricing in the right direction over a period of time,” Quin says. He adds that low interest rates can be a positive in some respects because in general, unlike inflation, they signify benign loss cost trends.

“It’s not all bad news,” he says.

And while the low interest-rate environment looks set to continue for at least another year, interest rates in

‘Contagion is the big unknown, and could be the asset-side equivalent of a large natural catastrophe’ Chris Waterman, Fitch

some countries are almost as low as they can go, and the short-term nature of non-life insurers’ bond portfolios limits the risk of unrealised losses.

“The average duration of reinsurers’ fixed-income portfolios is generally short. This could mean that investment income can’t decline much further, although the low investment yield remains a challenge,” Simpson says.

Standing firm

As reinsurers also invest a small part of their portfolios in equities, they are also exposed to troubles on the global stock markets. Their stock holdings are typically counter-cyclical to their bond holdings, performing well when bonds are weaker. As they are riskier, they are also higher yielding than bonds, giving a welcome boost to investment portfolios.

But, since the financial crisis of 2008 and 2009, reinsurers have pulled back from the stock market. Equity holdings make up between 5% and 10% of many reinsurers’ overall investment portfolios, and some have even eradicated them from their portfolios altogether.

“Investment portfolios are very conservative – more conservative than they were going into the financial crisis,” S&P’s Jones says.

Of greater concern to some is the low interest-rate environment. This has depressed profits at a time when rates in several lines of business are still soft and the additional earnings cushion of prior-year reserve releases is slowly but surely dwindling.

But, even here, some feel reinsurers are capable of weathering the storm by adjusting their prices to compensate.

“The low interest-rate environment is a bit of a threat in the short term, but

‘The threats are there’

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A further threat on the horizon to reinsurers is inflation, which some economists are putting forward as a possible remedy for the financial woes.

Inflation could be bad news for insurers and reinsurers, as it can bump up claims costs, particularly in areas such as bodily injury.

But it may be some time before reinsurers need to consider inflationary risks. While acknowledging that there is a risk to reinsurers from inflation levels returning to normal from their current low point, Quin says: “It is not the most immediate threat given that, commodity pricing aside, deflationary pressures probably outweigh inflationary concerns in the short term.”

The reinsurance industry has remained resilient to financial shocks so far, and it looks likely that it will continue to stand firm. But there is still much uncertainty. “There is a lot of volatility and a lot more can happen,” Swiss Re’s Hess says. “There are not big hits on the balance sheet yet, but the threats are there.”

It may be unwise to overestimate the financial risks to reinsurers, but it would be equally foolish to ignore them simply because they have not caused big losses to date. GR GLOBAL REINSURANCE OCTOBER 2011 15

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Bravely exploring uncharted territory in the world of specialty insurance and reinsurance.

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‘‘ Profile

I don’t come with any baggage …

I just come and see what’s in front of me

‘‘

A powerful combination of organisational and entrepreneurial muscle, RFIB leader Marshall King has made sure his company is in good shape for taking on emerging markets. Lauren Gow meets the Pied Piper of Lloyd’s

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Profile

PHOTO: CARL COURT

M

arshall King furrows his brow momentarily. “We are not a firm of clones,” the RFIB chief executive says, before relaxing into his slightly crooked smile.

RFIB was born in the 1980s, a Lloyd’s broker that typified the traits that define Generation Y: self-assured, demanding, ambitious, confident and innovative. King is a leader unafraid to embrace those characteristics.

Upon his arrival at the Lloyd’s broker in September 2009, King swept the office clean of dead wood, weaving modernisation into the brand in order to remain nimble in a competitive environment.

“I’ve encouraged the firm to embrace the outside world. I felt it was hiding under a bush a bit and being a bit introverted,” he says. “I have told the team that we have great things to talk about here. People in the market want to know about us.”

Evidently, King is correct. Market interest is swelling for the “little broker with big risks”, as King describes it. Results for year ending 30 June 2010 show that RFIB’s operating profit rose 17% to £3.5m from £3m, with brokerage also increasing 15% year on year to £43.5m.

So how did it all begin? Robert Fleming Investment Bank formed Robert Fleming Insurance Brokers in 1980, before changing the name to RFIB Group in 2004. Its staff have a majority share in the business along with independent investor, FF&P Private Equity, which owns a significant minority share.

RFIB offers coverage on a wide range of risks, from kidnap and ransom to marine and aviation.

But the emerging markets sector is the area in which the broker really excels, where natural growth in terms of penetration is considerable and the market’s interest has been piqued.

“A lot of the London market is now finding those exciting territories to deal with,” King says.

He has assumed his role as Pied Piper of Lloyd’s with gusto, leading the market into the riskiest of territories. RFIB was one of the first Lloyd’s players to establish practices in Kazakhstan, Saudi Arabia and Russia.

GLOBAL REINSURANCE OCTOBER 2011 19

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Profile But gaining respect from local insurers, understanding risk idiosyncrasies within each market and overcoming cultural disparities is not a task for the impatient.

Swinging around in his chair, King points to an A4 piece of paper taped above his desk: a licence from the Saudi Arabian Monetary Agency to broker insurance and reinsurance businesses in the country. “I have put it on my wall because it took so much time, effort and work to get it,” he says.

While some Lloyd’s brokers might be happy to take a free ride on the Lloyd’s reputation train into these new markets, King is adamant that the name is merely a cloak to be draped on or heaved off when needed.

“Lloyd’s is very well known,” he says. “It is a franchise that we leverage. However, only half of our business is placed at Lloyd’s. We are a Lloyd’s broker, but we are not just a Lloyd’s broker.”

Although King’s passion for insuring emerging territories is infectious, his aims for the Lloyd’s broker are far from altruistic. He believes there are substantial profits to be made from successfully infiltrating these under-subscribed markets.

“Just look at the penetration of all types of insurance in the developed markets versus the emerging markets, and you will see a huge difference. From motor to health to home, things that we in the West would assume are insured are quite often not in these markets,” he says.

Nevertheless, corruption is an unavoidable reality of conducting business in developing nations, and the quest for sizeable revenues comes at a price.

When questioned about how RFIB deals with the issue of bribery, King pauses uneasily before answering.

“Obviously we are aware that there is corruption in these markets, but we are very clear. We don’t engage with people who are of that ilk. We are extremely clear on our principles about business and integrity.

Without that, we have nothing,” he says, adding: “Our business relies entirely on trust between parties and that is completely the antithesis of corruption.”

Under pressure to elaborate on what “not engaging” actually means for RFIB’s bottom line, King leans back in his chair and sighs deeply.“Yes, we sometimes suffer in terms of not winning business. Perhaps our competitors are not playing as straight as we do, but that is just life,” he says.

THE MAN

THE COMPANY

Age: 45 Hometown: Dublin First employer: Bane & Company Interests: Yachting, family In his own words: ‘Management is all about making decisions. If your batting average is good, you make more right ones than wrong ones’

Brokerage: £43.5m Employees: 300 Market view: RFIB is known for being among the first to step into emerging markets.

Its diverse product range keeps the dynamic steady in this young company. Definitely one to watch.

Containing the competition

Moving on to discuss his competitors, King has some unexpected views on the issue of market share of the big three brokers. He believes the Lloyd’s market doesn’t want to rely too heavily on the big three and has formed its own natural suppression strategies.

“There is a natural pressure to keep the big three contained,” he says. “I don’t think they will continue to grow in the same way. I think

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the mid-market brokers will start to pick off niches, do it successfully, make good money out of it and prosper.”

But for every gain, there must be a loss and, according to King, David will lose to Goliath in this particular battle. “Conversely, within the smaller brokers, those with a £30m-£150m brokerage or smaller will struggle with regulation requirements and the costs it takes to run a firm.”

Small fish splashes out

King himself is all too aware of the difficulties of being a small fish in a big pond. After training as an engineer at Trinity College in Dublin, Ireland, and completing an MBA in France, King satiated his entrepreneurial spirit by starting a dotcom-style company from his bedroom.

“I really enjoyed the entrepreneurial side of growing a business. I raised money and grew it into a mid-sized claims-handling business, which is how I got involved in insurance. It went from me in my bedroom to, by the time I left in 2007, probably 400 people and £60m in turnover. That was a good ride.”

After a two-year career break, King says the offer to work with RFIB was too good to refuse. “Along came this opportunity that seemed very interesting and embraced entrepreneurial ambitions, included independent-minded people and was private equity-backed.”

He says it was a workable fit for both parties because RFIB needed a boss with more organisational skills than is traditionally required within the broker market.

“I bring a certain amount of analytical structure in my approach,” he says. “I don’t come with baggage. I don’t come with any particular relationships. I just come and see what’s in front of me.”

When questioned about whether the natural compatibility of entrepreneurialism and organisation is like mixing oil and water, King throws his head back and laughs.

“Granted, they are different skills, but they are not incompatible. To grow a really strong business, you need good organisational skills.

You need to find people, put them in suitable roles, give them responsibility, give them authority to move things forward, reward them, motivate. That all requires organisation and planning.”

“I look at what is in front of me and, hopefully,” King says, crossing his fingers, “I make better decisions than I would otherwise. Management is all about making decisions. If your batting average is good, you make more right ones than wrong ones.”

Turning once again in his seat, King glances at a laminated map of the world on his wall to indicate his next move.

“We’re forever engaging in new ideas, new opportunities and new territories to enter,” he says. “The issue for me tends to be picking winners from losers. But there is plenty here to keep me interested.” GR

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22: Divide and conquer

A run of natural disasters is making the benefits of fac more obvious

23: SPECIAL REPORT: FACULATIVE PRESENTED IN ASSOCIATION WITH:

Facs of the matter What effect will heavy catastrophe losses have on the market?

24: Q&A with Dom Tobey

How will recent major updates to cat models affect the industry?

focus Faculative in

GLOBAL REINSURANCE OCTOBER 2011 21

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Special Report: Facultative

Divide and conquer Considered by many to be too awkward and time-consuming, fac has been given a back seat by insurers. But natural disasters and improved risk modelling are making its benefits more appealing Facultative reinsurance has not always had the best of reputations.

Many insurers prefer treaty, or blanket, coverage, as pulling out individual or groups of policies is perceived to be more time-consuming and administratively burdensome.

However, there is evidence that insurers are becoming more comfortable with where and when they should use what is colloquially referred to as ‘fac’, as risk modelling becomes more technology-based and sophisticated.

Hannover Re, for example, said that premiums in its fac division “increased considerably” in 2010, enlarging its North American business in property and casualty.

Cedants offset their risk by removing the more worrying-looking policies from their treaties. The recent flurry of natural disasters, such as the New Zealand earthquakes and Japanese tsunami, makes fac more attractive.

“The most sophisticated buyers look at a blend of treaty and facultative reinsurance to protect their portfolios in the most efficient way possible, and this has increased the use of analytical tools,” says Guy Carpenter’s head of international fac business, Massimo Reina.

Finding risk-averse mix

Reina adds that although different cedants have different strategies, they are all looking closely at their buying strategy to find the most risk-averse mix.

Willis’s head of fac, Jason Howard, agrees and says that the increased use of actuarial models has allowed “for more of a portfolio approach rather than just a one-off purchase”. As insurers have improved their maths, so they have been able to work out that having several fac policies would

FAC SPECIAL REPORT PRESENTED IN ASSOCIATION WITH:

Catastrophe losses and the benefits of fac Catastrophe, wind and earthquake fac has proven to be useful in mitigating losses from those natural disasters.

Hannover Re pointed out in its 2010 annual report that its fac division took a hit from BP’s Deepwater Horizon disaster in the Gulf of Mexico, suggesting that cedants had wisely separately reinsured policies with major oil companies.

Fac is also useful for insurers looking to reduce their exposure to the power generation and energy sectors. These are considered to be volatile, with losses stemming from breakdowns in new, relatively untested, technology and fuel supplies.

provide better protection than having one or two on particularly large risks.

“It’s beneficial to use fac where there is a risk or accumulation of risks pushing up exposure in a particular area,” Howard says. “Analytics allows for a good understanding of your portfolio – and then you can use fac to take out peak risk exposure.”

Miller Insurance Services head of facultative reinsurance Michael Papworth says: “Another area where fac has been useful is on contingent business interruption. There were losses in Japan [following the earthquake and tsunami earlier this year], as there was interruption to supplies to Japanese manufacturers.”

For example, US carmaker General Motors was forced to close a factory in March, after vital spare parts could not be shipped from Japan. Toyota and Subaru limited production so that they did not run out of parts.

As a result, Papworth predicts that Japanese and New Zealand cedants will look to increase their fac levels, having seen how useful the policies were at the height of their crises.

Burgeoning middle class

Similarly, Willis’s Howard believes that countries that are experiencing high

growth will see their reinsurance markets evolve to mirror the more blended portfolios of established western markets.

‘It’s beneficial to use fac where there is a risk or accumulation of risks pushing up exposure in a particular area’ Jason Howard, Willis

He says: “I expect that demand for reinsurance in general will increase in areas where there is a burgeoning middle class, like India and China, with a corresponding demand for more fac.”

It may be more awkward to administer reinsurance policies for very specific risks, but to create an overall portfolio that can withstand losses from particularly awful one-off events, fac is worth the effort. GR

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Special Report: Facultative

Facs of the matter The first three months alone of 2011 marked the year as one of the worst ever for facultative reinsurance losses. Some say rates will rise, others argue that demand will decrease. How will the market will be affected?

Australian floods, Queensland’s Cyclone Yasi, New Zealand earthquakes and a Japanese tsunami combined to make the first three months of the year the worst ever for facultative reinsurance losses.

Global reinsurance intermediary Aon Benfield found 10 losses exceeding $50m, compared to 13 for the entirety of last year. In total, reinsured and insured losses were expected to come to more than $50bn for those first three months, up more than 25% for the previous 12 months.

After fac rates reduced in 2010 there was a belief at the start of the year, given these losses, that the trend would be reversed in 2011. Aon Benfield fac chief executive Elliot Richardson said at the time: “We expect that rate rises will now be seen in affected territories as well as other catastrophe-exposed areas. Early signs are that US property cat rates are hardening, which is an indicator that it will not be contained to affected areas only.”

However, there seems to be some disagreement as to whether this has actually been the case. Willis head of fac Jason Howard insists: “There is an increased demand for fac products, which, coupled with recent losses, has led to an upward push on pricing. Fac [pricing] does remain competitive, though.”

That competitiveness was a result of overcapacity in the fac market. Put simply, business was being written at wholly unsustainable rates.

Going the distance

Some argue that this has still not been properly addressed. Head of Guy Carpenter’s GC Fac International business, Massimo Reina, says there is still “no obvious shortage of capacity”.

Reina adds: “There is an expectation that rates will rise, which has not happened – the exceptions being property catastrophe, where we are seeing some increases. Overall, demand is at least stable.”

The property catastrophe uplift has clearly quickly filtered through from the first quarter. This would have been compounded by the severe property

damage caused in several catastrophes last year, including the Chilean tsunami and initial earthquake in New Zealand in September last year, which was believed to have damaged as many as 100,000 homes.

Given the number of natural catastrophes over the past 18 months, as well as more manmade disasters like oil spills, it is perhaps surprising that demand for fac has merely been “stable”. The rationale behind fac would suggest that insurers would be keen to separate out potential losses from riskier aspects of broad treaty

‘There is an expectation that rates will rise, which has not happened’ Massimo Reina, Guy Carpenter

portfolios, so that they did not turn from profitable to loss-making over a single incident.

Looking long-term

Head of facultative reinsurance at broking group Miller Insurance Services Michael Papworth goes as far as to say that demand in certain areas has even slightly decreased. He thinks that insurers believe that over a significant period of time, perhaps a decade, they are getting little financial benefit.

“The market is generally looking at anything that reduces cost and saves a bit of money,” Papworth argues. “I know of two global, multinational cedants that [are looking to pull out of fac] as they have spent more on premiums than they have recovered in claims.”

FAC SPECIAL REPORT PRESENTED IN ASSOCIATION WITH:

Papworth concedes that catastrophe, wind and earthquake fac are still popular given recent events, and that demand for the policies will grow in the recent big trouble spots of Japan and New Zealand.

This demand will likely increase as the full extent of the rebuilding programme in Christchurch, which has been estimated at 10-15 years, becomes more apparent and further claims are processed.

Location, location

Research released by Aon Benfield in September – Reinsurance Market Outlook – agreed that rate changes have varied by geography and business line. For example, North American property facultative catastrophe rates rose 4% at the end of the second quarter as a result of severe tornadoes and floods earlier this year, while Australia and New Zealand soared by 25%.

In France, some facultative reinsurers stopped offering multi-year policies for catastrophe loss. This suggests that they believe rates will continue to grow and so do not want to be tied to policies that fail to reflect this change.

By contrast, non-catastrophe rates in the Middle East and Africa fell by 3% and 2.5%, respectively. Even for catastrophe fac rates, Africa was flat.

The report says: “In those areas that have not suffered devastating losses, we have seen a continuation of facultative market softening.”

In this latest report, Aon Benfield did maintain its argument from the first quarter: “The first half of 2011 will go down in history as being one of the worst on record for the facultative market due to the severity of the losses.”

Given the emergence of Hurricanes Irene and Katia during the third quarter of the year, 2011 is unlikely to let up its pressure on fac. Eventually, that pressure must filter through to rates or at least lead to constraints on capacity in the market as reinsurers realise that the prices are not reflective of recent losses. GR GLOBAL REINSURANCE OCTOBER 2011 23

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Special Report: Facultative

& QA

WITH

Dom Tobey

Catastrophe modelling is becoming increasingly sophisticated. PartnerRe’s head of facultative business unit explains its importance to the fac market Q: What good are cat models?

A: Cat modelling is a developing

science and one that the (re)insurance industry began to get serious about 20 years ago. Models are becoming increasingly sophisticated and help the underwriter make decisions based on scientific data, rather than relying primarily on actual events.

Yet, the leading models commonly generate substantially different estimates and often significantly under- or over-estimate ultimate costs of individual events. There are important scientific debates about phenomena such as global warming and El Niño/La Niña. This clearly demonstrates that, over a short period and for any individual event, the lack of transparency and high variability in model results creates frustrations and limits the credibility of models.

Over the long-run, however, they should logically produce better results.

They should also continue to improve.

Using a good model provides consistency and structure in decisionmaking and exposure measurements.

Q: Are cat models good or bad for the facultative industry?

A: Despite inevitable shortcomings, cat models improve the assessment of risk and should be unbiased over the long-run. They will continue to improve and I don’t see how the market can progress without them.

In fact, they are an important benefit to the industry. They should help buyers and sellers better understand what their cat risk might be and prepare appropriately. Despite limitations, judging cat risk with

the help of models is clearly an improvement over any alternative.

The current difficulty is that the widely used industry model has just changed dramatically. This leads to a loss of confidence and credibility as well as the potential for considerable market disruption.

Furthermore, too much dependence on one model can have negative consequences. At PartnerRe, we will continue to develop our own internal models, which help us to better avoid model biases and disruptions while providing a more balanced view.

Q: How will recent model changes (for example RMS 11) affect the supply of and demand for facultative solutions?

A: I expect the model changes will

ultimately have a significant impact on supply and demand. After a couple of months, the impact on the facultative market so far has been limited. My interpretation is that no one wants to move first.

Whoever imposes such dramatic increases first will lose quite a bit of business. The market adjustment may be gradual but probably more dramatic as soon as a major event occurs.

However, I suspect pressure will start building on carriers, particularly from a risk management perspective.

Pressure should come from rating

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agencies, retrocessionaires, regulators, and company executives (chief risk officers in particular). It will be difficult for companies to attract capital and solid ratings if they disregard what a leading cat model suggests their exposure to be.

Q: How will this impact differ from the effects on more traditional treaty capacity?

A: Individual accounts tend to be

more concentrated in specific areas, occupancies or vulnerabilities, and hence tend to suffer wider swings both in terms of indicated cat loads and probable maximum losses.

Q: Equally, how do the effects on the fac market this time around compare with those during the previous re-versioning?

A: Recent storms have demonstrated

the need for revisions. This time around, the model impacts are much more significant and one vendor model is in a more dominant market position; consequently, one vendor company’s model has more influence than in the past.

Perhaps the resulting market disruption will prompt stakeholders to invest in alternatives that generate more choice. PartnerRe will invest further in its propietary cat model, because we believe that will improve the understanding of our cat risk as well as cost control, re-versioning and user-friendliness.

Q:Will the implications of the model changes be temporary or more permanent?

A: I think there will be a reappreciation of risk leading to a new, somewhat permanent, equilibrium in cat markets. I say somewhat permanent because I believe we will still have cycles; it’s just that both the peaks and the troughs of the cycles will be at higher levels. This will be driven not only by the cat models themselves, but by the realisation that cat models have historically underestimated risk. GR

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Monte Carlo

View from the top

The industry’s leading lights met at the Rendez-Vous to discuss pain thresholds, RMS’s version 11 and the ‘not yet’ market. Ellen Bennett chaired the debate

G

lobal Reinsurance opened the annual reinsurance Rendez-Vous with an early-morning gathering of chief executives. Rates, M&A and insurer-broker relationships were high on the agenda as the sun rose over Monte Carlo in September.

Nothing doing on rates

The conversation opened with a discussion on rates, and there was a clear consensus: nothing doing. The delegates agreed that despite small movements in loss-affected areas, rates were flat – and likely to stay that way.

Berkshire Hathaway managing director of reinsurance Manfred Seitz said: “We have seen rate increases in loss-affected areas. What is clearly missing is a broader movement upwards in rates – we haven’t seen anything meaningful so far. There’s still a long way to go on catastrophe business.”

Numerous factors were blamed for rates being kept down in the face of this year’s heavy catastrophe losses – the lack of a single event and the geographically disparate nature of the events that have happened, for example.

But mainly it was put down to the continuing over-supply of capacity.

XL chief executive Mike McGavick had a name for the phenomenon: the “not yet” market. “It is clearly economically out of order, but there is not yet sufficient impetus for the correct behaviour to take hold. It’s not clear what it will be, but it’s clear that it’s not whatever happened in the first half of 2011.”

“It’s amazing the kind of a pain threshold this industry has,” Seitz added. “We’ve had seven or eight years of declining rates, the biggest financial markets crisis in the past 70 years, catastrophes losses, big

single-risk events and still there is nothing happening.

“Maybe it takes a $50bn event, which is kind of hard to believe. The financial market crisis in itself cost more in my view than the loss sustained by Hurricane Katrina.”

This year’s model

There was one issue identified as having the potential to push up rates – RMS’s new hurricane model, version 11. “RMS has done it again,” Sirius chief executive Allan Waters said. “Primary carriers once again are going to see very large increases in their losses coming out of the model. And despite what our broker

MONTE CARLO CHIEF EXECUTIVE ROUNDTABLE PRESENTED IN ASSOCIATION WITH:

friends are saying, it will affect pricing significantly at 1 January.”

Endurance’s chief executive, David Cash, agreed. “A model change can drive a price increase,” he said. “In Europe, I feel there’s potential for price changes. I expect clients to drop some of the bottom layers and continue to buy the top layers, and not change their actual spend.”

Given the length of this soft market, some pundits are opining that the cycle as we know it is over. But our delegates didn’t agree.

“Having come to the industry late in life, I have had to learn to be a student,” said McGavick, who moved into insurance after a career in politics.

“And every time I’ve heard someone say comfortably that something won’t happen again, it happens.

“The cycle is really a reflection of the unique nature of our business, the unique nature of not knowing the cost of what is sold and the overreaction GLOBAL REINSURANCE OCTOBER 2011 25

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Monte Carlo that comes when you discover how foolish you were.

“We will be collectively foolish. This in the nature of things because the world changes and presents us with risks we weren’t anticipating. That’s the whole point. Part of what’s happening is that the magnitude and frequency of the events in the earlier part of this year are reawakening the psychology that says: ‘I don’t know everything out there and I’d better charge a risk premium’.

“That attitude is one of the preconditions to change. We aren’t yet there, but the conversation has changed.”

Mergers and acquisitions

Despite widespread merger and acquisition expectations over the past two years, there have only been a small number of deals. The delegates at Rendez-Vous attributed this to the market’s low valuations of insurers and reinsurers.

“It takes away the currency – that’s the deflator of everyone’s M&A expectations,” McGavick said.

Seitz added: “What we see now is a universal decline of the valuation of insurance companies. When you look back 10 years, big composite reinsurers

‘Despite what our broker friends are saying, RMS 11 will affect pricing significantly at 1/1’ Allan Waters, Sirius

in continental Europe always had a modest valuation, trading at book value, maybe a little above or below.

“Then you have the specialty companies in Bermuda that sprung up after the catastrophes. The typical situation was a Bermuda specialty reinsurer trading at 1.3, maybe 1.4 or 1.5, up to 1.7 times book.

“Now the world has changed. Now we are all in the same boat. If you look at any of the big European companies – Swiss, Munich, Hannover, anybody – it is more in line with the specialty companies in Bermuda that are at or below book value.

“That has been a development over the past two years, and has accelerated in recent months, where the reinsurance industry has taken a

big nosedive in line with the rest of the financial community.”

Asked whether the Lloyd’s market – where the Omega deal rumbles on – was any different, Alterra at Lloyd’s chief executive Adam Mullan said: “There’s a lot of talk about it and people looking, but the amount being consummated is not that great. The small entity is finding it harder to survive in the Lloyd’s environment.”

He attributed this to Solvency II, which all the delegates agreed would drive M&A in Lloyd’s.

Broker remuneration

Reinsurer delegates were markedly positive in their praise of their broker colleagues and dismissed suggestions that the recent return to accepting contingent commissions heralded a return to the practices of the pre-Spitzer era.

“I do feel today we have a healthier, more ethical market,” Cash said.

“What happened [with Spitzer] was appropriate. I believe that in a lot of ways our industry performs in an ethical manner, with appropriate checks and balances in place.”

Seitz added that the relationship between insurance buyers and brokers had changed to the extent where such old practices would no longer be viable.

“I have just been at a conference in Munich where all the buyers come together,” he said. “This year, they had a well-known keynote speaker from the broker community, and the questions from the floor were always about contingency fees. And this was very pointed – I don’t think the buyers of insurance products will allow that to recur.” GR MONTE CARLO CHIEF EXECUTIVE ROUNDTABLE PRESENTED IN ASSOCIATION WITH:

Roundtable participants Randy Brown, global head, Deutsche Insurance Asset Management David Cash, chief executive, Endurance Mike McGavick, chief executive, XL Tatsuhiko Hoshina, president and chief executive, Millennium Re Nick Metcalf, chief executive, Liberty Syndicates Adam Mullan, chief executive, Alterra at Lloyd’s Dr Kai-Uwe, chairman and principal partner, Dr Schanz, Alms & Company Manfred Seitz, managing director of reinsurance, Berkshire Hathaway Allan Waters, chief executive, Sirius Ellen Bennett, editor-in-chief, Global Reinsurance

26 OCTOBER 2011 GLOBAL REINSURANCE

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Monte Carlo

The value proposition At this year’s cedant roundtable in Monte Carlo, the debate centred around rates, renewals and addressing policyholders’ perceptions of the benefits of insurance.

Ben Dyson reports

G

ather some highly respected and opinionated cedants, brokers and reinsurers in a room ahead of a major renewals date, and it won’t be too long before the conversation turns to the appropriate price for reinsurance. Or indeed before the different factions start to disagree. The Global Reinsurance annual Cedant Roundtable at Monte Carlo was no exception.

Reinsurers hope to talk prices up after a year of losses, while buyers feel caught between a rock and a hard place, with reinsurers demanding higher premiums on one side, and their recession-hit insurance clients

‘When you look at the last few months, I cannot believe there were no casualties in our industry’ Thomas Hess, Swiss Re

demanding lower primary rates on the other.

Pricing discussions running up to the 1 January 2011 renewals will be heavily influenced by the natural catastrophes seen so far this year. Some estimates have put insured losses as high as $70bn from events such as the earthquakes in New Zealand and Japan, and the flooding and storms in Australia.

Broker reports from the June and July renewals this year indicate that rates rose sharply in affected areas, but also incrementally in the USA, which has not seen large catastrophe losses to date. But there is little sign of hardening across the board. While the losses have been large, they have generally been within companies’ expectations.

As a result, some of the roundtable participants were quite relaxed about the renewals.

“As we write a treaty book as well as a property international book, we’ve had our share of these losses over the year,” Beazley head of ceded reinsurance Christian Tolle said. “From our perspective, the losses we’ve had have been within what we expected, so we’re probably not going to change our ways dramatically.”

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Monte Carlo But reinsurers say their situation is less comfortable. They have taken the 2011 losses so far in their stride and are still overcapitalised, but they face a number of additional challenges.

Re pressure

Low interest rates are depressing reinsurers’ investment returns, and the excess reserve releases from prior years that have been propping up profits are dwindling fast.

Swiss Re chief economist Thomas Hess predicted that reserve releases may run out next year.

“I’m not so confident,” he said. “I think the industry is in good shape, but there are a few challenges coming over the horizon. When you look what happened in the last few months, I cannot believe that there were no casualties in our industry nor among our clients.”

For Brit’s head of outwards reinsurance Reinhard Seitz, the lack of reinsurer failures is contributing to the

‘Policyholders in the USA, where the recession isn’t going away, will not be happy to pay 30% more’ Reinhard Seitz, Brit

Roundtable participants Barbara Bufkin, senior vice-president of business development, Argo Anders Christian Carstensen, head of group ceded reinsurance, Tryg Gavin Coull, reinsurance and insurance partner, Steptoe & Johnson Hans-Joachim Guenther, Europe and Asia chief underwriting officer, Endurance Roelant de Haas, chief executive, Eureko Re Thomas Hess, chief economist, Swiss Re Chris Klein, head of sales operations for the UK and EMEA regions and market relationships, Guy Carpenter Reinhard Seitz, head of outwards reinsurance, Brit Christian Tolle, head of ceded reinsurance, Beazley Ben Dyson, assistant editor, Global Reinsurance

problem of low rates. “Because nobody’s exiting the market, you won’t see a dramatic change,” he said.

Others blamed a lack of action on prices despite the talk. Eureko Re chief executive Roelant de Haas said that when he visited Bermuda a few weeks before the Monte Carlo Rendez-Vous, market participants were downplaying the year’s events.

“They were saying it is an earnings, not a capital event,” he said. “So if there are no big losses in the USA hurricane season, we expect rates to be pretty flat and we assume brokers will push it further down.”

He adds: “At the start of the renewal season, reinsurers firmly state that the price should go up, yet when the game starts, there is no discipline.”

The blame for the continuing soft market despite heavy catastrophe losses cannot be laid solely at the feet of reinsurers, however. The depressed

prices insurers are collecting from the original clients can make it difficult for them to justify paying higher reinsurance bills when reinsurers demand it.

“We all live off the same thing: the premiums the ultimate client pays,” Hess said. “I think we will see a time when that is not enough anymore: the game shifts and everyone gets squeezed.”

He added: “I think we have to think about how to charge a client better for the risks we take.”

But persuading the end client to spend more on insurance in such a tough economic environment is no mean feat. “It is very difficult to force through higher premiums with your policyholder on the insurance side, so as an insurance company, you are being squeezed in the middle,” Brit’s Seitz said.

“Policyholders in areas like the USA, where the recession isn’t going away, will not be happy to pay you 30% more just because a risk modelling company thinks the pricing where their house is located is not adequate. It is very difficult as an insurer to find the balance to run your business profitably.”

Perception problems

A further problem is that insureds increasingly see insurance as a commodity rather than an added-value product, and so are looking to buy as cheaply as possible. The situation is being exacerbated by heavy marketing of cheap insurance deals and price comparison sites pushing rates down further.

“Especially on the insurance side, pricing is going the other way due to the internet,” Seitz said. “All that counts is price these days.”

Guy Carpenter’s head of sales operations for the UK and EMEA regions and market relationships, Chris Klein, agreed that the appreciation of the insurance product’s value is dwindling.

“If you just take private car insurance, for most people it is a grudge purchase,” he said. “You can tell from the number of uninsured drivers in the UK that people will try to get away with not buying it. People don’t see the value because you can’t touch it, you can’t see it, it doesn’t talk to you, and hopefully you’ll never actually have to put the product to the test because you don’t want to have the loss or accident in the first place.

“I’ve long believed that the product we are selling – the promise to pay – has been underpriced and that there

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Monte Carlo has been an unwillingness to pay for it.

That goes right back to the buyer of insurance.”

However, others felt the industry itself is partly to blame for the commoditisation of the product. “The industry made it a price product, so it’s not up to the client, it’s up to the industry to show the value of the product,” de Haas said.

Insurers and reinsurers can be happy to charge inadequate prices for a while at least, because it can take time for losses to develop – if they develop at all.

“It takes some time in our industry before the full cost of our product is realised and therefore until one knows the product is underpriced,” Endurance’s Europe and Asia chief underwriting officer Hans-Joachim Guenther said.

“Companies producing and selling tangible goods will know pretty quickly if they are selling their products at less than production cost. But an underpriced insurance product can still ultimately generate a profit if the expected loss does not materialise, so it can take a long time for a disconnect between risk and reward to clearly surface.”

Pricing is not the only concern.

Introducing more lenient terms and conditions while keeping the price the same can also expose insurers and reinsurers to additional risks they have not priced for.

“Somebody described terms and conditions as the silent killer of your programme,” Steptoe & Johnson reinsurance and insurance partner Gavin Coull said. “If you’re looking for something other than price to offer you an advantage, that’s an obvious place.

It can be two to three years down the line before the effects are noticed.

That’s a real built-in risk.”

Rates watch

A further issue is that insurers are not always free to set adequate rates and terms. In areas where rates are deemed to be too high, insurers can face political pressure to keep them low, even if the risk in a particular area dictates that they should be higher.

One particular example is the hurricane-prone state of Florida, where the industry and politicians regularly lock horns.

Sometimes the politicians do not need to lift a finger. Argo senior vice-president of business development Barbara Bufkin said that, after Hurricane Irene hit the US East Coast in late August, some major house insurers waived the deductibles on their policies.

“For the claimant that’s a good thing, because the industry is wanting to show the value of its product, but, on the other hand, you priced your product for a certain level of deductible and it has been waived before a politician has even had chance to stand up and fight about it,” she said.

“We have what was a specialty product that required more of an excess and surplus lines pricing structure, which is now being absorbed by the standard market at standard prices.

“Understandably, reinsurers are promoting the fact that there needs to be more integrity in the pricing, but we’re challenged by this. Every day we are working with our operating presidents, who are looking to us as group buyers and saying ‘help me out here’.”

Although there is much concern about pricing discipline on both sides, the European Commission’s forthcoming Solvency II capital regime

‘I’ve long believed that the product we are selling – the promise to pay – has been underpriced’ Chris Klein, Guy Carpenter

could be the impetus for more technical pricing decision in Europe at least.

“I think that will change dramatically when we implement Solvency II, with the capital requirements behind it and the precise allocation of the capital to the risk,” said Tryg head of group ceded reinsurance Anders Christian Carstensen. “I think that would improve the situation.”

Despite the inevitable tussles about the right price, some among the group felt that industry speculation about the overall state of market pricing makes little sense, simply because every situation will be different.

“It can be unhelpful when people start posturing and trying to drive prices,” Guy Carpenter’s Klein said. “For me, the important point to remember is that our clients are all individual and have their own needs and wants. In the end, price is what you pay, and value is what you get.” GR

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Monte Carlo

Robust relationships The interdependence of cedants, reinsurers and brokers presents both opportunity and challenges

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edants, reinsurers and brokers may bicker about the cost of reinsurance, but the participants at the Global Reinsurance Cedant Roundtable at Monte Carlo were in agreement that they all depend heavily on one another and that, while more measurements and accountability have infiltrated the industry in recent years, long-term relationships are king.

These relationships have been strengthened in 2011 by the fact that reinsurers have paid their clients’ claims from the unprecedented number of natural catastrophes, and have stayed the course despite the heavy losses they have faced.

“The efficient payment of claims is testament to the longer-term relationships one has between buyers and sellers,” Steptoe & Johnson reinsurance and insurance partner Gavin Coull said. “Certainly the days of the one-night-stand reinsurance buy appear to have gone, and it’s now longer term. We’re seeing three- or four-year deals, and it’s a more monogamous relationship.

“As in all long-term relationships, you have arguments, but we’re not seeing those turn into disputes.”

Valued added

A further strengthening of relationships is coming from brokers offering consultancy and modelling services in addition to traditional placement.

“As far as I’m concerned, a broker relationship with a ceding company is something that works the whole year through – it’s not just the last three months anymore,” Eureko Re chief executive Roelant de Haas said. “I think brokers really understand that, by adding more technical expertise to the partnership, they play a vital part in not only buying the reinsurance but in bringing know-how when it comes to Solvency II and capital issues.”

Cedants are not the only ones benefiting from brokers’ presence.

‘The days of the onenight-stand reinsurance buy appear to have gone’ Gavin Coull, Steptoe & Johnson

“Reinsurers also see the value of a broker more than in the past,” de Haas said. “The big reinsurance companies really see the added value of the brokers, and want to talk to them about their view on risk and how to act.”

Assessing the risks

However, the losses, coupled with low investment returns, dwindling surplus in prior-year reserves, and the potential threat from the eurozone sovereign debt crisis, could arguably bring concerns about counterparty risk back to the forefront of cedants’ minds. No reinsurer has failed yet, but there is no doubt some will have been weakened by the hits they have sustained.

For some, however, the issue has never gone away. “The process has been the same and we monitor all our reinsurers in the same way,” Brit head of outwards reinsurance Reinhard Seitz said. “Claims are being paid and the concern is not there at the moment, but we’re cautious of the situation and keep monitoring it. It will never be off the table.”

Beazley’s head of ceded reinsurance Christian Tolle added: “Solvency II is also underlining that – in the sense that we all have to justify various assumptions we make. This has

MONTE CARLO CEDANT ROUNDTABLE PRESENTED IN ASSOCIATION WITH:

sharpened everyone’s mind about the whole issue of counterparty risk.”

As concerns grow about reinsurers’ exposure to the eurozone sovereign debt crisis, cedants worry about whether the tools they have to assess counterparty risk can keep pace. Cedants often have to rely heavily on rating agencies to decide whom to do business with, and this makes some uneasy.

“We have our own criteria, and brokers and other companies are supplying further information, but it is basically decided by whether they have an A+ or A- or similar,” Tryg head of group ceded reinsurance Anders Christian Carstensen said. “My worry is whether the rating agencies can do the job in the proper way. It is the single source of information, apart from what you know about the reinsurer and your dealings with the company, that is the decisive factor whether you can use that reinsurer or not.”

Adequate choice

One factor that can shift reinsurers’ focus away from their clients is merger and acquisition activity. Some companies, such as Transatlantic Re, are currently under offer and observers suggest that consolidation would be positive for the industry.

As well as taking reinsurers’ attention away from their trusted clients, M&A activity can also reduce choice. While there is arguably ample capacity on the short-tail property side of the business – and if rumours are to be believed more capital is waiting in the wings – some are concerned about the amount of capacity available for more esoteric risks, such as casualty and specialty.

“I think we are already facing some issues about whether we have enough width in the market, especially for us as a specialist underwriter,” Tolle said. He added: “On the long-tail side, we have a very, very short list of reinsurers that we deal with, and if that list gets even shorter, then I would get very worried.”

Others feel that reinsurer choice could become a problem when Solvency II comes into force.

“Solvency II will mean that you have to view your counterparty risk slightly more cautiously, so concentration of risk could be an issue,” Seitz said. “To counteract that, we may need the spread of reinsurers that we have today, so fewer reinsurers could mean a problem on that side.”

So, while mergers may be attractive to reinsurance companies’ senior management, it seems they are not always the best way to maintain harmonious relationships with cedants. GR

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Monte Carlo

The C factor

Chief executives at insurers are getting increasingly more involved in reinsurance buying, but is that a welcome development of the process?

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rokers and reinsurers are increasingly targeting insurance companies’ chief executives and chief financial officers – also known as the C-suite – when selling reinsurance and related products and services.

Participants in the Monte Carlo Cedant Roundtable discussed whether the change is for the better, and how it is influencing the reinsurance buying process.

Q: To what extent are chief executives and chief financial officers getting more involved in buying reinsurance, and how is this changing the process and your jobs?

speaking to our board about buying reinsurance, because we think it is good to inform them and have a dialogue with them about this.

Q: How do sellers of reinsurance believe greater C-suite involvement is changing the process?

Hans-Joachim Guenther, Endurance: I would agree that nowadays we enter into more conversations with the chief financial officers and even chief executives of our cedants. This reflects the importance of reinsurance as a capital management tool, which requires senior management buy-in.

Risk-based capital measurements have introduced a new level of sophistication into the reinsurance decision-making process, which allows us today to have more technical conversations with cedants about efficient reinsurance solutions that can provide cedants with important underwriting capital to achieve their strategic ambitions.”

Thomas Hess, Swiss Re: Reinsurance buying links into several parts of the organisation. The link to the executive board is very much strengthened. We speak to different parts of the organisation for different tasks. For example, we talk to the underwriters and claims managers to improve the claims side.

We speak to the product specialists to discuss how we can help in developing and adjusting products for Solvency II, for example. With the board we discuss broader capital management themes, such as run-off and other relevant topics.

Reinhard Seitz, Brit: From our perspective, it is happening and it has always been the case because the arbitrary reinsurance cost is the biggest spend of the company.

We agree our arbitrary reinsurance buying as a committee. The chief financial officer, chief underwriting officer and chief executive are on that committee, and they have their vote and their voice there. Clearly, as it is the biggest spend, you cannot expect the C-suite to be removed from the decision process.

Bufkin: I would say that reinsurance is essentially as important a risk management tool as it is a capital management tool, and that it really does bridge the enterprise. It’s important therefore to have the links.

Q: Is this an interference or is it helpful?

Seitz: It’s just normal, I would say. It is a very important element of the overall business, so the C-suite should have their seat on those committees.

Hess: We are also tapping into the chief risk officer side. Solvency II is strengthening that link.

Barbara Bufkin, Argo: It’s very helpful to understand how our chief financial officer thinks about cost of capital and how we’re looking at our reinsurance as a cost of capital. We participate at an executive committee level. We speak weekly. There’s a lot of quality and value in that, and that won’t change. I find it very beneficial. The chief financial officer also thinks about things in economic value terms, and that is an important dynamic.

I would also take it beyond our C-suite and say that we are also

Chris Klein, Guy Carpenter: There’s also an element of franchise protection.

With the events of this year, you have to look at each company and how it has been affected by the stream of losses that we’ve seen. Some have been hit harder than others: everyone was expecting losses among the reinsurers and some have experienced outsized losses in relation to their business and their peers and that can be a function of their reinsurance or retrocession purchasing, so it is all about protecting the brand and the franchise. GR

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Monte Carlo Key points Hans-Joachim Guenther, chief underwriting officer Europe and Asia, Endurance: “An under-priced insurance product can still ultimately generate a profit if the expected loss does not materialise, so it can take a long time for a disconnect between risk and reward to clearly surface.”

Gavin Coull, reinsurance and insurance partner, Steptoe & Johnson: “The days of the one-night-stand reinsurance appear to have gone, and it’s now longer term.”

Anders Christian Carstensen, head of group ceded reinsurance, Tryg, on reinsurance renewals: “We all focus a lot on capital management and, during nine months of the year, try to get things right, but when it comes to the transaction period in the last three months, it’s as if people forget their heads.”

Barbara Bufkin, senior vice-president, business development, Argo: “Reinsurance is essentially as important a risk management tool as it is a capital management tool, and it really does bridge the enterprise.”

Christian Tolle, head of ceded reinsurance, Beazley: “On the long-tail side, we have a very, very short list of reinsurers that we deal with, and if that list gets even shorter I would get very worried.”

Chris Klein, head of sales operations for the UK and EMEA regions and market relationships, Guy Carpenter: “We’ve got suppliers, we’ve got buyers, we’ve got intermediaries and you’re always going to have a certain amount of tension. But that’s how the market functions.”

Reinhard Seitz, head of outwards reinsurance, Brit: “Solvency II will mean that you have to view your counterparty risk slightly more cautiously, so concentration of risk could be an issue.”

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24/06/2011 10:15

Cedants IAG’s Julie Batch talks about the challenges of working in a forwardthinking Australian market and the search for confidentiality and innovation, all while studying for a Masters

Q&A WITH

Julie Batch

‘The last 12 months have surprised us all and the surprise has been both the frequency and severity of the events’

I

nsurance is the family business for Julie Batch, group general manager, reinsurance, for Australia’s largest general insurer Insurance Australia Group (IAG). Born in Norwich, UK, Batch’s mother, father, grandfather and grandmother all worked for Norwich Union (now Aviva), and she says it was inevitable that she would work in the industry.

“I come from a long line of insurers,” Batch laughs. “It’s in my blood that I would end up here.”

Batch’s first job, courtesy of her father, was as a reinsurance underwriter with now-closed Australian reinsurer ReAC. But keen to work with the original customer, Batch has since moved on to roles within insurance that she says she has found to be far more rewarding on a personal level.

Q. PHOTO: FRANK FARRUGIA

How do you expect 2011’s natural catastrophes to influence pricing?

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‘I look for innovators who are driving a different approach

A.

It has been a period of unprecedented losses following a period of benign experience. I think the last 12 months have surprised us all and the surprise has been both the frequency and severity of the events.

There is no question that prices will be affected, and they’ll be affected from both a reinsurance perspective and the passing on of increases to the original customer. We just need to make sure, as a market, that price changes are well considered and original insurance remains affordable.

Q. How do you approach what to buy and the structuring of your reinsurance programme?

A.

We have a fairly unique structure in IAG, certainly in the Australian market. We have a captive called IAG Re located in three different places: Australia, Singapore and Labuan. The group runs a devolved operating model and the captive absorbs the risks of each business within the group.

Because we underwrite each individual risk, it gives us an opportunity to really understand the group exposure and to package that up in a way that suits not just the group risk appetite but also hopefully is tailored to meet that of reinsurers. This way we get a complete view of risk.

Q.

How do you expect renewals discussions to go, based on the events so far in 2011?

A.

We have relationships that go back decades and we respect the capital that reinsurers provide. It is flexible; it understands the risk and generally responds well to the market environment.

I think we’ll have challenging discussions with reinsurers. We hope that reinsurers respect the past and that reflects their appreciation of our organisation.

Q. To what extent are C-suite executives getting involved in the buying process?

A.

Three years ago, IAG restructured the way it looked at reinsurance.

Rather than viewing it as a separate business, we moved it to become part of the chief financial office.

This means the C-suite executives have become integral in the decisionmaking and we report directly to the board. The board is intricately involved

to the price, structuring and analysis of risk’

A.

What qualities are most important in reinsurers?

A.

A.

A.

We evaluate our relationships with reinsurers, not in a formal way but rather in terms of their understanding of our goals and objectives, and their willingness and ability to provide innovative solutions. With brokers, we are really looking for one who is more than an advocate of the organisation.

We need someone who will become a partner in the transfer of risk and will work with us, not for us, in the transfer of that risk. It is particularly important that a broker understands how our reinsurance model operates and can support that.

Q.

How has your approach to reinsurance buying changed over time?

Too much!

Q. To what degree do you use alternative reinsurance structures?

Q.

Q. How do you evaluate the service you receive from reinsurers and brokers, and how could it be improved?

I think Australia as a market has been fairly forward-thinking in the way it has structured its programmes.

Given the number of risks we are exposed to, Australia has looked at solvency and earnings protection as being critical components to protecting balance sheets, and these have served us well.

But now, again, it is time to move forward. We are in a completely different place to where we were a few years ago. The insurance companies that will be most successful in this region will be the ones that can foresee the evolution over time and understand the changing landscape of risk and how to protect it.

Q. How much premium do you usually cede to reinsurers?

in reinsurance purchasing and structuring decisions.

I think the importance of reinsurance as a strategic tool is more greatly valued by the organisation.

The answers I commonly hear or read revolve around trust, but I look at things differently. I look for confidentiality, because with reinsurers who understand IAG’s strategy and who are prepared to support that strategy, we are open to sharing considerably more information. And, also, I look for innovators who are driving a different approach to the price, structuring and analysis of risk.

A.

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We evaluate alternative structures continually. In Australia, it has been difficult to transact in that space for a number of reasons. First, we have very extensive purchasing requirements in terms of solvency protection that are heavily regulated. Australia does not have a good record of keeping market loss records.

Also with ILWs and similar, we simply don’t have the database of information required to work on. Some of the cat models have only recently been developed, so the price of cat bonds, for example, as opposed to traditional reinsurance, hasn’t added up.

Q. Who do you admire most in the industry and why?

A.

My dad. The reason is he devoted his whole career to the insurance industry and got a huge amount of enjoyment out of it. He passed that enjoyment onto me and gave me an appreciation for the value that insurance can bring. He is a great role model for me to be able to bounce ideas and concepts off.

Q. What do you do in your spare time?

A.

I am busy doing my Masters of Finance at university, as well as preparing for the arrival of my first child. GR GLOBAL REINSURANCE OCTOBER 2011 37

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Claims

Finding fault After a first quarter dubbed the worst in history for reinsurers, questions are being raised over the reliability of risk modelling data, particularly relating to earthquakes. Mark Leftly reports

T

he world is becoming more and more unstable. Every year since 2000, there have been at least 137 earthquakes of a magnitude of 6.0 or above around the world, according to the US Geological Survey. More than 320,000 people were killed in 2010, the start of a one-and-a-half year period in which earthquakes in Chile, Haiti, New Zealand and Japan grabbed headlines around the world.

With the exception of Haiti, where insurance was sparse – a total non-life premium estimated at less than $20m – the severe property damage and business interruption has put a huge strain on the industry.

Risk modelling firm RMS has put losses from the Japan earthquake and tsunami alone at $21bn-$34bn, including fire, marine, and shake claims.

Guy Carpenter head of business intelligence David Flandro said January to March this year represented “possibly the worst first quarter in history” for the reinsurance industry.

Zurich-based group Swiss Re made a first-quarter loss of $665m against a profit of $158m in the same period last year.

Number of deadly and distructive earthquakes Worldwide major earthquakes between magnatude 6 and 8 over the last century 40 35 30 25 20 15 10 5 1900

1910

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Tsunami power

Learning curve

The sector has gathered a wealth of information and experience of dealing with earthquake claims over this period, however. This is vital, as the sheer number of variables involved – such as the type of structural damage that different depths of earthquake can cause – make these natural disasters fiendishly difficult to forecast.

Lessons can be learned from New Zealand about the impact of several earthquakes, not to mention 7,500 aftershocks and counting, in one location. This could help make catastrophe modelling – still in its infancy – more sophisticated.

‘Quite a lot of learning processes have been going on,” says chief research officer at California-based cat model group Risk Management Solutions Robert Muir-Wood.

DATA: USGS

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1940

1950

He highlights the impact of the Chile earthquake in February 2010. “People had become a bit blasé about tsunami risk; the lesson from Chile was that tsunami was important.”

Although that earthquake was broadly as expected in terms of its magnitude – 8.8 – and many of its effects, it was the resulting tsunami that overwhelmed the port of Talcahuano that caused most deaths in the country. Swiss Re put the total insured losses for the industry at $8bn.

Then there was the 9.0 magnitude earthquake off the east coast of Japan on 11 March this year. Despite being one of the five most powerful earthquakes since 1900, it was the resulting tsunami that was far more devastating, knocking out the emergency generators vital for cooling the Fukushima power plant.

The problem in both Chile and Japan was that one disaster, a tsunami, followed another, an earthquake. The same is true for New Zealand, where one earthquake followed another.

The first was in the south island’s rural Darfield last September. Although many models had accurately forecast the impact there, it wreaked more havoc on the major city of Christchurch than expected.

Built on a swamp, the soil beneath the city shook and could no longer hold the water between its sandy

1960

1970

1980

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2000 2008

grains. “The whole eastern side of Christchurch has very high potential for liquefaction,” Muir-Wood explains. “Particles of water tighten and the water tries to escape out of the surface.”

Then in February a 6.3 magnitude aftershock struck Lyttleton, a suburb of Christchurch, and travelled in a line from Lyttleton to the city centre. These two events have resulted in 330,000 claims, according to the country’s Earthquake Commission.

“The second earthquake was the extraordinary one as it knocked out the city centre, which really pushed up the losses,” Muir-Wood says.

He believes 5%-10% of earthquakes are followed by severe aftershocks.

“The key lesson is the characteristic of one earthquake triggering others in the vicinity. Something clearly needs to move on from us showing that [a second earthquake could happen] to it being a standard feature of cat models.”

Rebuilding Christchurch

Loss adjuster Cunningham Lindsey’s New Zealand office chief executive Martyn Norrie says that rebuilding Christchurch will take 10 to 15 years.

The company deployed about 500 people in response to the crisis, yet has still not been able to enter some of the city’s most fragile buildings – mostly in the so-called ‘red zone’ of the central business district.

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Claims

Japan $21bn-$34bn

New Zealand $4bn-$7bn

Chile $8bn

“We have not been able to go in and assess claims; it has been too dangerous,” Norrie says. “There’s a large area that will not be rebuilt – liquefaction has meant the cost of reinstating land is totally uneconomic.”

He also points out that the harder, less porous replacement ground could cause flooding.

The building codes in the region proved insufficient to deal with such a catastrophe – they exist to save lives, rather than protect properties. As a result, Christchurch’s commercial district has essentially been wiped out.

Business interruption claims are on the increase, as are contingency claims as major companies find that their suppliers are no longer around.

Swiss Re has estimated the insured losses of the New Zealand earthquakes at between US$4bn-$7bn. Given the uncertainties of future building codes, the prevalence of first-loss policies and the inability of adjusters to even get into properties, reinsurance rates are thought to be rising 50%.

Reinsurers were even unwilling to back New Zealand’s local government primary provider, Civic Assurance. As a result, Civic was unable to cover Christchurch City and Waimakariri district councils from July, leaving billions of dollars of properties uninsured. Eventually, central government had to agree to underwrite the policies. “Reinsurers have been pretty wary,” Norrie says.

New Zealand commercial insurance is based on a first-loss principle, where the insurer agrees to pay the policyholder the full sum insured under the policy without applying the average principle.

Under the average principle, the amount paid out is restricted: it has to be of the same proportion to the loss as the full sum insured is to the total value of the insured item. Therefore, insurers have a far higher claims bill under the first loss principle when a series of large disasters hits.

Residential claims are complicated by a system under which the Earthquake Commission pays the first NZ$100,000 (US$78,000) of any damage, with the remainder unlimited with private insurers. Land damage up to 8 metres from the property is also insured.

Risk models struggle to account for these factors, leaving insurers and reinsurers to make educated guesses.

As a result, there was uncertainty in companies’ ultimate loss expectations.

Not surprisingly, reinsurers are calling for limits to be set on policies, so they can better model risks and keep secondary cover rates reasonable.

Munich Re acknowledges the difficulty of attributing losses accurately when several events hit an area, as well as the near impossibility of making good a policy by reinstating properties rather than paying out.

Unlike some, the company praises the quality of New Zealand construction codes, stating that the ground movement was of low probability.

However, it adds that insurers and reinsurers will have to mitigate losses in future by encouraging “loss prevention on the one hand and clear coverage conditions and coverage limitation on the other”. Construction codes will also have to be modified to take account of liquefaction.

Domino effect

Perhaps the biggest lesson is also the most contentious. There is a growing school of thought that an earthquake in one region leads to another elsewhere – which explains the recent pattern of extreme earthquakes.

Chile, Japan and New Zealand are all on what is known as the Pacific ring of fire, which also includes some Alaskan islands and the coast of North America.

It is a huge arc that comprises threequarters of the world’s active and dormant volcanoes.

But despite the evidence, this has not been proved, so reinsurers will have to decide the extent to which models take account of knock-on impacts from one region to another.

Munich Re is not certain, stating: “There is a temporary increase of hazard in areas directly adjacent to recent earthquakes. Over-regional or global interconnections in earthquake activity are pure speculation; they cannot be proven or disproven.”

Aon Benfield head of international catastrophe management Paul Miller calls this “the unanswered question” that the industry must address.

“These earthquakes were situated in the ring of fire,” he argues. “There is evidence to suggest that an earthquake releasing pressure at one point can increase the build-up of pressure further down the faultline.”

Resolving this issue would, clearly, make it easier to forecast where and when the next earthquake will occur.

But given the doubts over whether this has any basis, it seems unlikely that cat models will be able to quantify such data any time soon.

But with every passing earthquake, no matter how awful, the industry will get closer to perfecting a model that will forecast and cut down costs caused by natural catastrophes. GR GLOBAL REINSURANCE OCTOBER 2011 39

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23/09/2011 11:08

43:Raising the roof

Look at your own company to decide where is best to domicile

45: SPECIAL REPORT: DOMICILES

PRESENTED IN ASSOCIATION WITH:

Return of the natives Can the UK lure companies back with its new CFC rules?

47:Back in the swim

Bermuda is fighting back as the domicile of choice

48:Q&A with Akshay Randeva

The QFCA’s strategic development director discusses Qatar’s vision

Location …

Location …

Location GLOBAL REINSURANCE OCTOBER 2011 41

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Special Report: Domiciles

Raising the roof The right choice of domicile for a (re)insurance company is a complex matter but top of the list of criteria must be the nature of your business, where it is coming from and where you want to keep your capital Companies in the (re)insurance market have proven to be a flexible group over the years, working in a global industry and basing themselves in different locations. But how important is the choice of domicile and what are the factors that need to be considered in selecting the best one for a (re)insurer?

Tax, regulation and the presence of markets, brokers and support services could all influence the decision, along with wider concerns such as economic and political stability.

“There are now a lot of logistics to consider in a move. It is not just a brass plate anymore. There are a lot of changes to be made and you have to hold your board meetings in the new jurisdiction,” Shore Capital analyst Eamonn Flanagan says.

“The reinsurance industry is one of the most mobile industries and we have seen that over the past few years as companies have moved away from both London and Bermuda.

Return on investment is important and so reducing your tax rate is key in staying competitive, especially when a tax bill can be so much higher in one location than another,” says Ernst & Young insurance tax group partner Jeff Soar.

Law firm Holman Fenwick Willan’s head of financial services regulation, Ambereen Salamat, adds: “In choosing a domicile, the applicable tax and regulatory environment are normally paramount considerations in the context of the type of company being established or re-domiciled.”

According to Soar, the first key question for a (re)insurer is: where’s the business coming from? He says:

‘There are now a lot of logistics to consider in a move. It is not just a brass plate anymore’ Eamonn Flanagan, Shore Capital

DOMICILES SEPCIAL REPORT PRESENTED IN ASSOCIATION WITH:

“Where the business is coming from is going to drive you to London, New York or Bermuda, so you will have an entity in one of those.”

Then you will need to decide where you want to keep your capital.

“That’s going to drive you to Bermuda, Ireland, Switzerland, Malta, Gibraltar or the Channel Islands. That’s probably where your reinsurance company is going to be,” Soar says.

Finally, where are you going to parent the organisation from?

“Probably close to the other firms.

So you end up with having something in London for the business and you will have something in Bermuda for the tax and until now you would GLOBAL REINSURANCE OCTOBER 2011 43

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Special Report: Domiciles have had your parent in Bermuda,” Soar says.

Solvency II, the great leveller

Unsurprisingly, the applicable corporate tax rate is very high on the list of factors when selecting a domicile (see box).

After tax, regulation is often next on the list of those shopping for their ideal domicile. But many feel that Solvency II will be a great leveller in this regard, as it applies not only throughout the EU but also in territories that have equivalence with the new capital regime when it is implemented.

Salamat says: “We have carried out feasibility studies for insurance groups to determine which EU jurisdiction to set up their direct carriers in. Among the jurisdictions considered are Ireland, Luxembourg and the UK. In the past, jurisdictions perceived to have a lighter touch regulatory regime have been favoured but with the implementation of Solvency II, this may become less relevant.”

Switzerland is expected to have SII equivalent status, as is Bermuda.

“Bermuda, Switzerland or Dublin will be under the same regime or at the very least have equivalence, so there is no significant arbitrage for moving for that reason,” says PricewaterhouseCoopers insurance tax leader Colin Graham.

Marsh IAS chairman and managing director David Ezekiel says: “It is hugely important for the Class Four set.

It becomes important that they are seen in an acceptable domicile for the markets they operate in.

“The Bermuda Monetary Authority needs to make sure Class Four companies do not spill over into the Class One and Two captive companies that made the Bermuda market what it is today. When we come through this, the credibility of the domicile will be greatly enhanced.”

There are wider political and economic issues in domiciles, which can vary from unstable or unfriendly governments to recession and exposure to the sovereign debt crisis that is sweeping through Europe’s debtor nations.

Shore Capital’s Flanagan says: “We had corporate clients who moved away from Bermuda to the Isle of Man in the early 1990s because of the political situation there. And that is an issue that comes up every time there is an election on the island – how business- friendly will the incoming government be?

Moves challenge stability

“Beazley moving to Ireland raised a few eyebrows because that tax rate is under

Corporate tax rate – how do country’s stay competitive?

Corporate tax rate is at the top of firms’ lists of concerns and Bermuda has been hard to beat with its 0% rate, says Numis Securities analyst Nick Johnson.

“To remain competitive companies really need a corporate tax rate of less than 20%, but that can be achieved in a number of ways. Amlin, for instance, use their Bermudian reinsurance subsidiary to keep their tax bill down. Most companies have achieved a rate of 15-20% in the UK,” Johnson adds.

Corporate tax in Ireland is 12.5%, which compares with a corporate tax rate of 23% in the UK and 35% in the US. And companies relocating to Switzerland can negotiate through accounting and law firms to obtain a tax ruling from one of the country’s 26 cantons, which may offer tax breaks. Swiss corporate tax rates, including a federal rate of 8.5%, range from 11.8% to 24.2%.

Salamat says: “In recent years, it is largely holding companies that have re-domiciled in Switzerland, principally for tax reasons. There is a double taxation treaty in place between the USA and Switzerland, so that’s one incentive for

selecting that jurisdiction. There are other tax benefits. But the issue with Switzerland is that it is currently outside the EU from a regulatory perspective.”

She adds: “Although this is less of a concern when establishing a reinsurance carrier – with care, it is possible to establish one in a nonEU jurisdiction and still be able to access the European market – a direct carrier that requires access to the EU will need to be located and licensed within the EU.” Tax havens are periodically threatened by discussion from other countries, notably the USA, concerning the exchange of information and tax treaties as they seek to increase their own tax revenues.

“There has been some debate for some time on a number of aspects of running offshore groups but major reform has not transpired. The focus in the US has been around more significant matters such as government debt. It has not gone away, it is stuck in the long grass and could come back. It is on the radar of companies and we have seen a few firms move away from Bermuda,” PwC’s Colin Graham says.

‘What type of business do you intend to write? If it is broker-led business, you probably need to be in London’ Ambereen Salamat, Holman Fenwick Willan

pressure as the country struggles with its sovereign debt. The same is true of Brit’s move to the Netherlands as within the European block France and Germany are starting to put pressure on low tax regimes as unfair.”

Soar adds: “It does cause concern because you don’t want your company to be associated with a bad economy.

Pressure has been exerted, but Ireland has pushed back hard and resisted and said no. The most important thing to the industry is stability. They want to move out of choice, not because of changes to the regime, so Ireland is right to resist change to its corporate tax rate.”

And there are a number of other factors that are specific to each domicile that must be taken into account.

Salamat says: “There are pros and cons with each jurisdiction and these have to be considered in the light of the type of company being established and the business to be written.

“Relevant issues in relation to a jurisdiction include its economic environment, attitude and experience of its regulator, product flexibility, the extent of presence required, the skill of the workforce and strictness of employment laws, the ability to transfer data out of the jurisdiction to within the EU and beyond.”

And other issues may be logistical.

Flanagan says: “The problem in Bermuda is that they don’t have enough space. There isn’t enough housing to go around. I know people who have had to stay on boats in Hamilton harbour. Property prices get pushed up and there is a shortage of office space.”

Not least among a (re)insurer’s considerations is the classes of business the company intends to transact. “What type of business do you intend to write? If it is broker-led business, you probably need to be in London,” Salamat says.

Flanagan adds: “You have got to make sure you move to a place where you can write the business on your book. If your book is UK motor, for instance, moving to Bermuda will not be a benefit to you in the same way that it is for reinsurers of US property and casualty.”

Sadly, there is no one answer to the domiciling question. No location is perfect, they all have positives and negatives and the domicile of choice will have as much to do with the company as the destination chosen. GR

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Special Report: Domiciles

Return of the natives The UK’s pledge to make its tax regime more hospitable has started to lure companies back from more favourable climates. Will the government’s fiscal facelift work its charm in the long term?

For years the flow of (re)insurers has been heading away from the UK, often searching for a better deal on tax, but is that about to be reversed by the coalition government’s proposed new fiscal rules?

Some market watchers believe that is the case and companies may start heading back to the UK, as evidenced

by Lancashire’s recent announcement that it plans to redomicile in the UK for tax purposes (see box, overleaf).

And Lancashire is not alone, although it may be the first from the insurance sector, as advertising giant WPP announced its plans to redomicile in the UK in March.

At the heart of the change is the UK Treasury’s proposal to change its controlled foreign companies (CFC) rules. The Treasury is currently consulting businesses of all sectors on possible alterations and will announce the new rules next year.

“With the new government a year or so ago, there were strong statements from George Osborne and others about tax reform and the desire to make the UK the most competitive place to do business in the EU,” says PricewaterhouseCoopers insurance tax leader Colin Graham.

Graham adds: “The CFC rules tell companies that are headquartered in the UK how they must pay tax on their foreign entities. Over the past few years, these rules have made it difficult to compete with Bermuda or

Switzerland and this, along with a high corporate tax rate, has driven companies away.

“We have still got a little way to go but we have got a better idea than we had six or nine months ago. It looks as if the Treasury has been listening to the industry.”

Ears wide open

‘The UK recognises that it has not been the most attractive place for tax domicile over the past few years’ Jeff Soar, Ernst & Young

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Numis Securities analyst Nick Johnson agrees. “I get the impression that the UK government is listening to the insurance industry, because there’s been a lot of lobbying from the industry, particularly Lloyd’s, and it appears to be open-minded on making changes to the tax regime.”

Ernst & Young insurance tax group partner Jeff Soar comments: “The UK recognises that it has not been the most attractive place for tax domicile over the past few years. It does have a huge number of other things going for it as evidenced by the sheer number of insurers here. If the tax is fixed, it would become even more attractive.”

He adds: “The positive thing is that everyone is trying to move in the same direction in making the UK more attractive. One of the real keys to it is that tax planning has been, in the insurance industry, seen from the need to be competitive commercially and if that is the basis for the new legislation then it will work.”

At present, the UK’s corporation tax rate is 23% of profit, which is average for the EU. But companies in Ireland pay 12.5%, while Bermuda charges a corporate services tax of 4% of revenue, with no tax on dividends or capital gains.

Graham says: “On the UK corporation tax it is now 23% – much lower than it GLOBAL REINSURANCE OCTOBER 2011 45

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Special Report: Domiciles was – which is positive, as is the exemption on overseas dividends and the exemption on capital gains tax from the sale of overseas subsidiaries.

“We have the type of regime that in principle is quite competitive but if the government get the capital gains tax right we may well see more companies returning to the UK.” Lancashire says that if the permanent exemptions do not materialise, it will move back to Bermuda.

There are other benefits besides taxation for insurers in having their holding company in London including the pool of talent, wealth of brokers, time zone and support services available.

Another factor for offshore companies is that a lot of management time needs to be spent in the domicile, which can “become tiresome”, according to Johnson.

Graham adds: “I am not surprised that companies are showing a genuine interest in establishing domicile in the UK, particularly in the insurance market. London is still one of the leading world markets for that sector.

Being able to run your group from London makes life a lot easier for your executives who don’t have to go off to Bermuda to have board meetings.”

Case study: the first returning UK insurer Lancashire is taking advantage of a three-year exemption and currently intends to remain incorporated in Bermuda, which will be its regulatory domicile.

The insurer said it would be among the firms responding to the UK government’s consultation over the coming months with a view to ensuring that the final CFC rules operate fairly.

Lancashire president Neil McConachie explained the rationale behind the move on the company’s second-quarter results conference call.

He says: “This move will result in no change for the corporation tax bill for Lancashire Group.

Lancashire Bermuda is currently subject to Bermuda corporation tax at the rate of zero and after that move Lancashire Bermuda will continue to be subject to Bermuda corporation tax at a rate of zero.

“Lancashire UK has always paid UK tax and will continue to pay UK tax. Most of our profits are generated by Lancashire Bermuda and that isn’t expected to change.”

McConachie continues: “There is a good chance in our opinion that by the end of 2014, if not sooner, there will be legislation in place that will offer qualifying companies a permanent

exemption. This is not guaranteed, but the evidence points to strong cross-party support in the UK for CFC reform, which is what we’re talking about here. And we wish HMRC the very best in getting this done.”

McConachie acknowledged that moving tax residency would give his firm “the ability to act more nimbly, making group decisions onshore in the UK, to also reduce operational and frictional costs by holding board and shareholder meetings in the UK and to recruit group level management and directors from a larger UK talent pool”.

It also reduces the risk that it may accidentally do something in the UK that causes the Bermuda subsidiary to lose the Bermuda tax rate, instead getting the UK tax rate applied to it.

McConachie says: “By Lancashire taking advantage of this legislation and being granted an exemption, we’re not only improving the speed of decisions that we can make, which is vital, we’re also eliminating a very large risk of somehow our Bermuda profits being captured

by UK. And so, yes, it makes life easier for us.

So this is also eliminating an important risk that all exempt insurance companies do face and Lancashire now won’t.”

Key area of reform

Graham says that Lancashire’s ability to safeguard its Bermuda profits (see box, above) raises an important point, adding: “Under the new set of rules, we are hoping that the UK government recognises that these types of vehicles write international rather than UK business and it becomes possible for these vehicles to get a tax exemption.

“Genuine commercial activity that goes on offshore should be taxed in the jurisdiction where it takes place and we should just tax the activity that takes place in the UK. This is a key area of reform that is still up for grabs.”

Of course, there are negatives to the UK. Its economy is recovering from the credit crunch more sluggishly than many other Western economies and is still at risk of the dreaded double dip recession.

Also, some believe that the country’s top rate of income tax, at 50%, has the potential to cause an exodus of talent from the UK. In comparison, last year Bermuda increased its standard rate of payroll tax two percentage points to 16%. But, after lobbying from the reinsurance industry, among others, the Bermudian

‘Being able to run your group from London makes life a lot easier for your executives who don’t have to go off to Bermuda to have board meetings’ Colin Graham, PricewaterhouseCoopers

government has rolled back the rate to 14%.

The rate has prompted a group of leading economists to write an open letter to UK Chancellor George Osborne, warning that it makes the country “less competitive internationally” and “less attractive as a destination for both foreign investment and talented workers”.

The letter continued: “We call on the government to drop the 50p tax at the earliest opportunity as part of a package of measures to stimulate growth. Only by returning to an internationally competitive tax regime will Britain enjoy long-term sustainable economic growth.”

But others are more sanguine about the 50p tax rate, Soar says: “Everyone understands that in the current economic climate, it is necessary. People do not like it, but they understand why and as long as it is a short-term measure people can accept it.”

The UK will never be able to match a zero rate corporate tax but the London market remains a key place for the (re)insurance business.

“The (re)insurance industry is very unlikely to come to the UK unless you have a tax rate of 10-12% but if you have the parent company here you are ensuring London’s place at the centre of the industry with the minds and management of the sector here. It puts us at the forefront of a global industry,” says Soar. GR

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Special Report: Domiciles

Back in the swim

After a difficult few years, during which some big names quit the territory, Bermuda has fought back to reclaim its title as the domicile of choice for reinsurance companies. But there are still problems ahead

When Lancashire revealed plans to relocate its tax residency to the UK from Bermuda, it provided more ammunition for those claiming that the island was losing its prominent position in the reinsurance industry.

After all, Lancashire was just the latest in a line of companies including Allied World, Flagstone and Amlin to move some operations away from the mid-Atlantic.

However, to paraphrase Mark Twain, rumours of the death of the Bermudian reinsurance industry have been much exaggerated.

That was underlined recently by news that New York-based hedge fund Third Point is setting up a new reinsurance business on the island.

Third Point Re has $500m in capital, is seeking to raise an additional $250m-$500m, and will be headed by ex-Alterra chief executive John Berger, according to SEC filings.

One new reinsurer does not mean conditions are right for a ‘Class of 2012’, but it does underline the continued attraction of Bermuda.

“I think it demonstrates, as a lot of us believe, that Bermuda is still the domicile of choice for reinsurance entities,” says Marsh International Advisory Services chairman and managing director David Ezekiel. “The island has consolidated the reasons for setting up here, such as speed of getting to market, in recent times.”

Keeping people comfortable

“We have seen a lot more capacity in the captive area. The BMA [Bermuda Monetary Authority] has done a good job in keeping people comfortable by not setting the bar too high and also by protecting the Bermuda model,” Ezekiel adds.

One of the issues on the island over the years has been the often fraught relationship between the government and international business.

But, with its weighting towards the financial services, Bermuda suffered more than most during the global economic crisis.

GDP shrank by 2.5% in 2009, growth during last year is expected to be poor

‘The government has realised the importance of international business and the service companies that they bring with them to the island’ David Ezekiel, Marsh

and jobs have been lost. All this appears to have focused the government on the benefits it enjoys from international business.

Last year, changes to the payroll tax included an increase of two percentage points to 16% on the standard rate. In addition, the cap over which companies do not have to pay additional payroll tax is to be more than doubled, from $350,000 to $750,000 per employee.

But, after lobbying, the Bermudian government has rolled back the standard rate of payroll tax to 14% for 2011-12, returning $50m of spending power to taxpayers and helping business attract and retain talent.

Ezekiel says: “There’s been a substantial improvement in the relationship between international business and government.

“The recession has focused people’s minds and the government has realised the importance of international business and the service companies

that they bring with them to the island.”

He adds: “We have to keep jobs in Bermuda and to do that we need to stay cost effective. This will encourage people to look at moving functions and tasks, which is very easy for an international business.”

Other positive government moves include extending work permits by up to 10 years and offering permanent residency for ‘job creators’.

“We have not seen the final policy but there’s likely to be an extension, and that’s a positive step. It will provide more certainty for key executives. It gives them more time in Bermuda and more stability in their roles,” says Association of Bermuda Insurers and Reinsurers president and executive director Brad Kading.

Incentives for job creators

He adds: “There are other incentives for job creators forthcoming. If you are a senior executive already in on an exemption class, as long as you have hiring authority, you will be able to get full residency, according to one proposal. It is something that is being used as an incentive.”

One cloud on the horizon is the continued concern about legislation being passed in the USA and its impact on offshore reinsurers. “Senator Neal will introduce a reinsurance tax in the USA on international companies, not just Bermudian ones, and we continue to fight that,” Kading says.

And there have been other, much larger, clouds coming Bermuda’s way this year: North Atlantic hurricanes.

“Bermuda is always well prepared for hurricanes. Building codes are strong and properties tend to be quite wind-resistant,” Kading says. “The island does a good job of protecting people and property and it is business as usual.” GR

DOMICILES SEPCIAL REPORT PRESENTED IN ASSOCIATION WITH:

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Special Report: Domiciles

& QA

Akshay Randeva

WITH

The QFCA’s strategic development director explains why Qatar is an increasingly appealing domicile Q: What is the Qatar Financial Centre Authority (QFCA) working on to make Qatar an attractive domicile?

A: For Qatar to achieve its vision of

being a hub for the three sectors it is focusing on – reinsurance, asset management and captives – there are initiatives that the QFCA itself is undertaking and initiatives that other agencies working with us and supporting us are taking.

The IMF review of the anti-money laundering regulations in the State of Qatar took place last year. Since then, we have also had the OECD tax review for both the State of Qatar and the Qatar Financial Centre (QFC). From a regulatory perspective, the Qatar Financial Centre Regulatory Authority (QFCRA) has released the new asset management regime, which builds on the existing regime substantially.

In July the QFCRA released a new set of captive rules and a new set of insurance intermediary rules.

I see a lot of progress and commitment from all agencies responsible for getting Qatar to the next level. You are going to start seeing the results of this work over the next couple of years as we get our message across to companies that are looking at opportunities to gain a platform in a country that is growing at between 15% and 16%, in a region that is growing between 5% and 6%, in a world that is growing at around 1%.

Q: What are the opportunities in the GCC region for (re)insurers?

A: There is a $6bn reinsurance industry

and a $15bn primary insurance market in the GCC region. It is a very competitive market and you could argue, as some reinsurance companies do, that rates are a little on the low side.

However, the point remains that, because of the low loss experience and the lack of natural catastrophe exposures, it is profitable business to write and it offers diversification, especially considering how international events have become the centre of attention this year.

Another point about the region’s insurance industry is the growth. The QFCA’s GCC Reinsurance Barometer points to a continued expectation for the industry to grow at a faster rate than GDP. GDP is growing at around 5.5%. There has been a doubling of total insurance premium written over the past five to seven years.

The region is also looking at massive infrastructure growth. There is around $130bn to be spent over the next 10 years.

Q: How does the QFC and Qatar set itself apart as a domicile?

DOMICILE SPECIAL REPORT PRESENTED IN ASSOCIATION WITH:

A: The three main tick boxes are the

regulatory environment, the legal environment and the tax environment.

If you are a reinsurance company, you will also be concerned about whether being in this country provides access to the wider region and how much of the region is available to you. On that subject I have heard Qatar being described as the Switzerland of the Middle East.

Qatar is a progressive country that is very stable. The QFC has a world-class regulatory environment with very business-friendly regulators that are focused on our three selected areas of development. The legal environment is ideal because it is not an offshore centre. It is very much onshore. It allows you to do business within the country, in the currency in an English common-law-based system.

On the tax front there is 10% tax on locally sourced profits. If you are using Qatar as a hub for the wider region, that becomes particularly interesting.

Also there are specific advantages available from a tax point of view in the three sectors of reinsurance, captives and asset management.

Q: How many companies are currently in the QFC? A: In the insurance sector, we have

around 24 firms. Eleven of them are insurance or reinsurance companies.

Another 13 are intermediaries. We are still expecting a lot of growth on the captives and the reinsurance side, which is where we have been concentrating our efforts. Our new regulatory regime for captives and insurance intermediaries was released on 1 July and it will be very interesting to see how it is received by the market.

Q: Do you have any targets for the number of QFC-licenced insurance companies?

A: We have some internal ones, but it is more important to position Qatar at the centre of business than count the number of brass plates we have hanging on the doors of our buildings. GR

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Country Focus

Blowing in the wind

US reinsurers are under pressure to turn a profit after several rocky months, but the worst – financially and climatically – may be to come. Helen Yates reports

T

he US property/casualty industry has had a bumpy ride in 2011, with a high frequency of catastrophe losses hitting retentions in the primary market, new catastrophe model releases stretching capital resources and a shaky economy adding to the uncertainty. While the US north-east escaped the worst of Hurricane Irene, the storm season is not yet over and a rare earthquake in Virginia in August was a reminder of the country’s potential for other major hazards.

What it adds up to, particularly with Hurricane Irene still fresh in many minds, is that the US property/casualty industry has had a tough year but has so far managed to stay on top of the situation.

Irene was a severe storm for many north-eastern states, but it could have been a lot worse had it not weakened to a category 1 hurricane before making landfall in North Carolina, then New Jersey, followed by Coney Island, New York. A slightly different track could have resulted in greater losses.

“People are saying that losses could be in the range of $3bn to $6bn,” says BMS Group director of property/ casualty reinsurance Simon Clutterbuck. “Bearing in mind where it was hitting – the eastern seaboard – this is relatively small.

“So you could argue that the market is getting away with it. If you look at the frequency of losses so far this year and let your imagination run riot, you could see a situation where this would be enough to create a hard market.”

The main impact of Irene – an unusually large storm – came from flooding rather than wind losses. More than a foot of rain hit some parts of the Atlantic coast, according to catastrophe modelling firm AIR. Floods were

COUNTRY FOCUS

USA

After a catastrophe-hit year to date, the US reinsurance industry is contending with significant losses and depressed investment returns. New legislation opening up the market to non-US (re)insurers has meant additional capacity for peak natural disaster zones, but also increased competition Population: 307 million (2009) GDP: $14.527 trillion (2010) GDP per capita: $50,000 (2010)

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exacerbated by storm surge, a high tide and record rainfall in August, which had already saturated the ground and raised water levels in major rivers.

Under pressure

At the time of writing, the death toll was 42 and record flood levels were seen at river basins between

Hartford, Connecticut, in the north, to Trenton, New Jersey, in the south.

“Irene wasn’t a market-turning event, but it’s an event that puts additional pressure on the property market – both primary and reinsurance in the USA,” says Insurance Information Institute president Robert Hartwig. “By my estimates, this year to date we have around $22bn in insured catastrophe losses in the USA. That ranks 2011 as the seventh most expensive year ever after adjusting for inflation.”

Many will be breathing a sigh of relief that Irene failed to trigger significant payouts from the residual market, which has expanded considerably in recent years.

The fear is that state and industrysubsidised ‘beach’ and ‘wind’ plans lack the necessary funding to survive a big storm. “The vast majority of them remain overexposed and underfunded. It’s just a matter of GLOBAL REINSURANCE OCTOBER 2011 49

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Country Focus degree, Florida being the most overexposed and clearly having funding issues, although it has made some progress there,” says Hartwig.

“Hurricane Irene was not severe enough to expose the weaknesses in these plans in North Carolina and Massachusetts,” he adds. “They will be paying out for losses but not enough to bankrupt them. They would have potentially been bankrupted if a stronger category 2 storm had made landfall in the north-east.”

Irene is just the latest in a series of catastrophes to hit almost every US state so far this year. Severe weather in the first half, including a record number of tornadoes across the southern and midwestern US states in April and May, cost between $13bn and $15bn in insured losses.

Companies with significant market share in the states affected by these losses could be feeling a disproportionate amount of the pain.

One of the problems is that retention levels among primary insurers have risen in recent years as the gap between original rates and reinsurance rates has grown. This means that, with a high frequency of smaller-scale losses, many will be unable to rely on relief from their reinsurance partners, as the claims will not be significant enough to trigger their reinsurance programmes.

“In general those losses are more retention losses, and hence you get this expression that they are more earnings events than capital events,” says Clutterbuck. “We’ve had big numbers for tornado losses this year – in the billions – but at that level they don’t generally trigger the nationwide programmes.

“You do end up with losses for smaller regional clients – some of their programmes can be totalled. The danger of being localised is that a very small loss can hit you very hard.”

According to rating agency AM Best, total catastrophe losses for the industry in the first half reached $27bn (net of reinsurance), a 127% increase on the same period the previous year ($11.9bn).

While Best believes the industry will be able to absorb the losses effectively, it notes that the industry will be tested through the remainder of 2011, particularly if another event occurs.

However, as Clutterbuck points out, the worst cat losses in the USA traditionally come in the second half of the year during the hurricane season.

“The numbers look pretty bad for the North American property/casualty market, but the second half of the year is the one they really worry about,” he

says. “You could argue that the second half has the potential to be just as bad.”

Low returns

While the industry has seen several cat claims on the underwriting side of the balance sheet, on the investment side returns have remained depressed in the low interest rate environment. A debt crisis was narrowly avoided in the US when president Barack Obama won his fight to raise the debt ceiling, but plenty of economic uncertainty remains, and this will have a direct and indirect impact on insurers.

As the benefit of reserve releases tapers off, the pressure is on to make an underwriting profit despite the competitive environment that continues to exist in both personal and commercial lines in the USA. “Many people are focused on the immediate challenge of catastrophe losses that loom large this year,” Hartwig says, “but the concern for all insurers is to earn a risk-appropriate rate of return in what continues to be a flat market.”

“Preserving or enhancing profitability when rates are flat, where there remains a significant amount of excess capacity in the US system, creates challenges,” he says. “Insurers are by no means in any danger of becoming insolvent, but they are at a point where profits are under pressure from lower investment income and deteriorating underwriting performance.”

An upswing in pricing has already begun as insurers look to compensate for the high number of low-severity weather claims in 2011, although the picture was unsettled during the mid-year renewals.

Hartwig thinks rate hikes will kick off properly with the international reinsurance renewals on 1 January.

“I think the era of declining property catastrophe reinsurance rates is over.

We have passed that threshold of catastrophe losses – not only globally but here in the United States – that comes close to assuring that rates are not likely to drop for 1 January.”

“The question is: will they increase?

And, if so, by how much?” he continues. “Right now, depending on the risk, it seems there is some upward pressure in general. Perhaps more in coastal areas – including the more interior coastal areas, where pressure from RMS 11-type models would be felt the most – the bias is towards upward pressure for 1 January renewals.”

The latest version of RMS’s US wind model (version 11) has put more strain on many insurers’ capital. Using lessons from past hurricanes, such as Ike in 2008, as well as computer simulations, RMS has included new understanding of the effect of storms as they move inland.

For areas inland in coastal states, it shows an enhanced vulnerability and therefore increased exposures for carriers with significant books of business in these areas.

Of course, RMS 11 is only one model, and many property catastrophe writers prefer to use a blend of outcomes to calculate their capital requirements, but it is nevertheless having an impact.

Many anticipate there will be an increased demand for reinsurance at this year’s renewals.

“So far reinsurers have been quite sensible about how they’ve approached it,” Clutterbuck says.

“They might see a 150% increase in the modelled output but they haven’t necessarily charged a proportionate increase. One of their justifications is that customers could be showing reduced total insurable value.” GR

Foreign input Legislative changes have helped to further open up the US market to foreign insurers and reinsurers, bringing additional capacity to peak catastrophe zones, but also greater competition to already competitive markets. The Dodd-Frank Act – the sweeping regulatory reform on US financial services – is responsible for much of the change.

Under Title V of the Dodd-Frank Act – also known as the Non-admitted and Reinsurance Reform Act 2010 – states must allow surplus lines brokers to place or accept business from non-US insurers that are listed with the National Association of Insurance Commissioners. “The removal of restrictive eligibility constraints will enable a more competitive market and a greater choice for domestic US clients,” says International Underwriting Association of London chief executive Dave Matcham.

While the act does not reduce the 100% collateral requirements for foreign reinsurers that exist in many states, it opens the door for reform.

Florida, Indiana, New Jersey and New York have relaxed rules for unauthorised reinsurer collateral requirements, and others are expected to follow.

50 OCTOBER 2011 GLOBAL REINSURANCE

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23/09/2011 11:03

Rewind

Monty

Fine wines, fast cars and beautiful women. It’s a hard life for our inside man Jumping for … joy?

Regiment. While this may well have been good training for the cut-throat reinsurance market, there are some important differences between the two worlds. “When I was a soldier, I was in the business of destroying assets,” Klein says. “Now I work for a fi rm that likes to protect assets. It’s a good job we didn’t have performance-related pay in my old job.”

My friends in the industry are not always known for having a good sense of humour, and when they do, it’s not usually en masse. So I’d like to personally pat the folks from Canopius on the back and do a little jump for joy on their behalf.

The team has recently redesigned its business cards to be all serious on the front and anything but on the back. Besides the usual personal details, the cards have a photo of each staff member jumping in the air, hair astray and ties flying. It’s hard not to chuckle when you see them.

And for those who were lucky enough to attend Canopius’s party at the Hotel Hermitage in Monte Carlo, you could have a similar photo taken in front of their corporate banners. We hear head of business development Sally Coryn was behind the project.

Oh, to be a fly on the wall in their boardroom when that idea was fi rst mooted.

First things first

It’s good to see people come back to the fold, so here’s a warm welcome back to ex-Claytons chairman John Goldsmith, who has been tempted out of retirement to run TigerRisk’s new UK operation.

He’s excited of course, and who can blame him when he’s joining forces with industry luminaries Jim Stanard and Rod Fox? However, there are some more mundane tasks to be dealt with first. When I popped in to ask John what his next moves were, he said “sorting out my computer and my BlackBerry”.

Bah, humbug

September is my favourite month by far. Each year, I positively relish the thought of the finest food and wine on offer in Monte Carlo, as well the beautiful women and fast cars in Casino Square. But one London market broker has decided he is positively fed up with the place. UIB’s new chief executive Philip Tuite-Dalton caught me at a post-Monte Carlo party to complain bitterly about the cost of the fine food and wine. “It really upsets me, you know.” Somehow I doubt he’ll get much market support to move it from the French Riviera to somewhere cheaper.

On the battlefield

Brokers, as you know, are made of tough stuff.

They have to be able to take all those knockbacks from underwriters. But some are tougher than others. Guy Carpenter’s Chris Klein is battlefield trained – he is a retired major of the Staffordshire

Walk this way

Brokers are made of tough stuff.

But some are tougher than others

Eagle-eyed visitors to Lonmar’s offices may note that there’s still an arrow pointing to the casualty and exceptional risks department – which as you may know moved over to rival Gallagher International in June.

Perhaps time to take that sign down, guys – or move the arrow so it points to Gallagher’s office. Having said that, I understand Lonmar has hired a headhunting fi rm to beef up its casualty team again …

All hail the Gher-king

Swiss Re’s iconic Gherkin building in London has probably done more to raise the profi le of reinsurance among the general public than anything else. Unfortunately for Swiss Re UK chief Russell Higginbotham, it means he occasionally gets referred to as The Gherkin Master. Now, there’s an idea for a t-shirt … GR

52 OCTOBER 2011 GLOBAL REINSURANCE

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