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August 2006 Archives

August 25, 2006

Men, not machines

Dear Friend,

How the Gods do conspire against us

— but at least they have a sense of humour.

Everything seems to be subject to a natural equilibrium that doesn’t allow imbalances to survive for very long.

Of course, this equilibrium can be stretched, in fact sometimes it can be stretched so far that we believe we are in a some sort of “new paradigm” or new world order, or perhaps we just achieve a general consensus that things really are different this time and that the bad old days of the past are indeed behind us.

But the elastic of history never seems to break, biding its time until counter momentum slowly builds, eventually catapulting us back to where we came from with a violent crash.

What’s brought this on, you may wonder? Well I’ve been looking at the 1997-2001 accident year numbers again — and I just can’t get them out of my mind.

With reserve hikes to pay for the sins of this period still a major feature of many 2005 results, the subject is still one that commands my attention. I’ve also just been poring through all the second quarter results, looking at the reserve developments on Katrina Rita and Wilma and like a fool, I think I must have just kept on going.

In the 1997-2001 period, you could have asked any broker on the planet whether they thought premium rating levels were adequate and they would tell you the market was not merely soft, but collectively soft in the head. We knew the market was going through one of its periodic bouts of suicidal competition.

We knew it would end in tears and recriminations, but we didn’t know when, where or how.

We were also utterly powerless to stop it. No-one asked our opinion, and if they had, they would probably have ignored what we had to say anyway.

What possessed underwriters to charge the premiums that they did over that heady period? Why was everyone so bullish all of a sudden? How can you lop 20% off a premium every year for four years in a row and expect to leave a profitable rump of business behind?

With the benefit of hindsight, we can now see that rating was woefully inadequate. No rational person should have put business on their books at those prices.

When an underwriter doesn’t do as he should, he is accused of making mistakes. And the average underwriter did do things that might seem stupid to us commentators five years after the fact.

But we’re all the ones making the bigger mistake — although some do a pretty good impersonation, an underwriter is not a cold, calculating, rational risk-weighing machine.

He or she is a human being, with all the fallibility, pride, greed and fear that comes with it. In an environment where there are right decisions and wrong decisions to be made on an hourly basis, it only seems rational that the “wrong” column should end up with its fair share of entries.

That’s why there’s always a lot more behind market cycles than meets the eye, and it is only a matter of time before a new generation of mistakes comes in to supercede the old ones.

To coin a phrase, history doesn’t repeat itself, but it sure does rhyme!

August 18, 2006

Everything and Anything Re

Dear Friend,

I live in an apartment block in central London — there are ten apartments in all and we buy a shared buildings insurance policy.

Not all the apartments are the same size, so we have a system whereby the common expenditure is split by different percentages, according to the portion of the overall floor areas that we occupy. In fact we use these percentages to split all our common expenditure.

Naturally, since everyone in the building knows that I’m the guy who used to work in insurance, I tend to be the one entrusted with the annual renewal negotiations.

And because I also own one of the biggest apartments, so pay a much higher percentage of the final premium, everyone knows that I have the most to gain from demanding the best deal for brokers and will be looking out for their interests along the way.

To tell the truth, whilst publicly moaning about this burden to my neighbours, I secretly enjoy my annual foray back into the world of insurance broking.

Anyway — it’s renewal season again and as I was collating the claims history and checking, terrorism write-backs, sums insured and sub-limits for garden equipment, it occurred to me that my communal insurance arrangements bear some similarities to what Lloyd’s is proposing with the Thunderbird Re cat bond vehicle that it is proposing for the 2007 year.

My own experience with my household insurance is that a degree of commonality, whilst entailing certain administrative complications (in this case, for yours truly), does provide greater peace of mind than when everyone acts entirely for their own account.

What the Lloyd’s authorities are proposing will entail quite a lot of preparation work, but will provide a tangible benefit for members, especially the smaller ones, but possibly for some of the bigger ones too.

At present one of the biggest problems with Cat bonds from the financial market investors point of view is that most issues are so small that the bonds are highly illiquid and not easy to trade — and consequently it is hard to make a meaningful investment in them.

Lloyd’s proposals have got me thinking — if Lloyd’s can do it (and a pool of small European mutuals have already done it) why doesn’t the whole reinsurance industry pull together and issue a series of mega-cat bonds?

Now they really would be a handy tool – investors would able to make market in them with confidence and the bonds would be more keenly priced.

Participant (re)insurers would be able to trade participations between each other to match exposures and the bonds might even become ‘optionable’, allowing (re)insurers to lay off risk or lock in earnings with a minimum of capital outlay.

Let’s call this vehicle Everything and Anyone Re — why leave direct and varied access to the capital markets as the exclusive preserve of the giants of the industry?

Anyone feel like starting the ball rolling?

Let’s all talk about this at Monte Carlo!

August 11, 2006

The perfect market

Dear Friend,

Isn't the market in good shape right now? The dislocation caused by the unprecedented Cat losses of last year is slowly but surely being put back into its place

Now that US coastal Cat prices have been readjusted risk appetite is returning — just look at the second quarter statements of Berkshire Hathaway and recent comments from Partner Re and Renaissance Re for a clue.

Earlier in the year Buffett had been a little ambiguous about whether he fancied a piece of the action — but with the latest numbers we now know he was just holding out for slightly better pricing!

At these prices, US cat business is a great write — the only problem has been an inability to bolt enough capacity together, or often more likely an unwillingness to be seen to be doing business in the geographical region that has just given everyone the biggest loss in history — pure risk aversion.

Another pleasing feature is that on a net basis, KRW reserve levels seem to be stabilising and maturing — overall there were as many reserve releases as there were additions in the second quarter numbers — most were stable.

I feel it's now odds on that the biggest skeletons have already come crashing out of the closet.

I remember I was in Bermuda in February when the shock PXRE reserve increases stunned the market. Perhaps what was most amazing was how calmly and quickly clients and brokers absorbed the news, digested its consequences and moved on.

And move on they have — instant cancellation and replacement has been the order of the day. PXRE has now lost 82% of business in force at 1/1. It's tough, but this is how a healthy market works.

The "slow-motion disaster" theorists have had their day — the slow-motion has slowed to what is almost a freeze-frame.

This market is being driven by, risk perception and the balance between that perceived risk and the reward that is available. It is not being driven by across the board rate hikes from reinsurers who desperately need to rebuild their balance sheets.

One great anecdote I gleaned from reports on the Florida renewals was that even in the US State where the crunch has been hardest, inability to place business has been down to unwillingness for the cedent to pay the new higher price rather than a pure lack of capacity.

Presumably because it is such a painful business for Florida insurers to pass increased costs of reinsurance on to their end eventual customers.

My prediction is for more capacity to be allocated away from softening global casualty and life markets and pumped back to where it is really needed in the property and energy spheres — ie gradual global softening, or stabilisation, rather than global hardening.

You really can't buck the cycle for long.

Editor's blog, photo of Mark Geoghegan

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