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Surprise, surprise, shareholders don't like losses

Dear Friend,

"Shareholders represent a tighter constraint on capital and earnings than rating agencies."

Not my words, but those of Mike Bungert, CEO of Aon Re Inc.

Aon has had the brilliant idea of analysing share price movements in the second half of last year as the Katrina, Rita and Wilma numbers came rolling in. The study looked at how badly analysts downgraded a company’s future earnings prospects relative to its percentage loss of shareholders’ funds from the 2005 Hurricanes.

Future earning prospects are what people buy your shares for — if you don’t have them you effectively cease to have a viable company.

The results are instructive to say the least.

And since the equity of all but a tiny minority of our industry players is publicly-listed and traded on stockmarkets around the world, the conclusions are highly significant.

As Mike points out, Katrina is the first significant natural catastrophe since the Northridge earthquake and Hurricane Andrew to really give the risk and capital management plans of insurers and reinsurers a big enough shake up to see what investors really think of our sector in the cold light of day.

And now that we’ve given our collective backers the chance to show their mettle and hold their nerve, it seems we’ve discovered something that we may have suspected, but have been hitherto unable to prove — shareholders don’t like catastrophe risk very much!

Now back to the brains behind the survey (this time it is the turn of Stephen Mildenhall, EVP Aon Re services):

"Investors clearly understand the differences between insurers and reinsurers and have set differing tolerances for each. Our study confirms that investors expect higher earnings and capital volatility from reinsurers than they expect from insurers.

“Key points in the regression showed that insurers were allowed capital volatility of 3% to 6% and were allowed to lose slightly more than a quarter of pre-Katrina consensus earnings before significant shareholder value deterioration occurred”.

Happily reinsurers get cut a little more slack — we were allowed to lose between 12 and 19% of equity and were allowed to lose an entire year of pre-Katrina consensus earnings before our share prices got caned too heavily.

So – remember everyone — the market says you can lose a year’s earnings and come though it smiling — but any more and you’re in trouble. And of course I don’t need to remind you that ultimately your major shareholders are a lot more important than the guys from AM Best and S&P. Once they’re out the door and your share price has plunged, the cost of raising significant new funds is raised exponentially and your chances of survival severely diminished.

This is not my rule — it’s the collective conclusion of millions of investment transactions bearing the weight of many billions of dollars.

This is something to bear in mind when deciding on whether or not to buy that expensive retro coverage your broker quoted back in January and has been pestering you about ever since.

Bite the bullet and buy it — it could be the best decision you’ve ever made.

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