Dear friend,

I was interviewing the CEO of a big Bermuda/US/London specialty (re)insurer the other day and what he had to say about the trend towards securitisation in our industry gave me plenty to think about.

Here was a man who had bought a chunky Cat bond or two in his time and was fresh from a dabble with an ultra-sophisticated, non-standard risk transfer deal. No grizzled old Luddite he — no chips on shoulder about new-fangled ideas — this man was a veritable duffer-free zone.

So what this progressive had to say about the dawn of the age of securitisation was a little shocking. Here’s what he said:

The issue is that hedge funds view their obligations in a very legalistic way, whereas the equivalent product bought from a reinsurer will be viewed not only in a legalistic way, but also on a relationship basis.

So working with this lot is a bit like trying to get a reinsurer in run-off to follow your (adverse) fortunes. Check out that Wasa vs Lexington case over a contamination claim by Alcoa for the latest (by the way, we’ve got an article on that in the next issue). There’s more…

For example, many of the casualty claims arising from the asbestos and pollution issues of the 1980s were not settled within strict policy terms and conditions…. Why did people settle? Because they had other business and they held the prospect of future revenues. If you move to the capital markets approach you’re likely to be governed entirely by the contract.

So what is a fellow to do? Nail down the windows, hide the silver and send in the legal eagles…

…that means you need lawyers – you need to spend possibly $100,000 just getting the legal work in place. If the people on the other side of the trade are saying “let’s test the wording, lets see if we have to pay,” and if there is a way out I’d expect them to take it. In fact they would have a fiduciary duty to their investors to take a way out were it to exist.

That is not the case with an insurance or reinsurance company which can say “yes, we can take a way out, but our shareholder interest points us in a different direction.” That is the risk as I see it.

The moral of the story here is before you get into bed with these guys, make sure you get them to sign a pre-nup. They might be seductive young sirens when you first hook up and say ‘I do’, but once the ink is dried on the marriage licence, the metamorphosis to bunny-boiling psycho might be all too swift and painful.

They might end up with half of everything — and the dog!

It’s all a little depressing, but that’s the way of the world. There’s no point being nostalgic for more civil and gentlemanly times gone by — and anyway fragmenting risk and punting it round the four corners of the global capital markets is undoubtedly a good thing for our industry.

The trouble is – once you’ve atomised your business, you lose touch completely with who your risk carrier is. I’ve written something like this before

It looks like we’re just going to have to get used to the legal equivalent of open heart surgery every time we want to get something placed.