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August 2007 Archives

August 31, 2007

2.5 plus 2 is still 4.5

Dear friend,

Why do brokers bother with this nonsense?

Come to think of it why does the market put up with this nonsense?

What am I banging on about? Well our weekly UK sister magazine Post has unveiled a lot of detail about something that Willis has been supposedly calling ‘Project Camomile’ for its UK retail market business.

The long and the short of it is a flat 2.5% fee on brokered business (we know not whether it is on the gross or the net or payable by the client or the insurer). The charge is to be actively disclosed to Willis clients.

Apparently because it is transparent and non-contingent it doesn’t conflict with the new client-friendly Willis way of doing things.

Apparently a communiqué to staff also said that the 2.5% levy is brokerage, pure and simple.

This only begs the question – what is the point? (and what is remotely simple about it?)

The first law of insurance is that clients want to squeeze brokerage to keep their gross down and insurers want to squeeze brokerage to keep their net up.

Meanwhile brokers want to expand brokerage for obvious reasons.

But a competitive market sorts this out beautifully.

You can sometimes lose business to other brokers who decide to work for less and give their brokerage to the client. Of course you often get that same business back again a couple of years later when they realise that servicing the business is losing them money.

Similarly, we all know that big volume players get bigger discounts. There’s nothing wrong with that — just go to Wal-Mart and see what I mean.

So there’s no reason on earth why a big player like Willis shouldn’t get a bit more brokerage than a small broker — especially if it’s transparent. But why on earth separate your commission out into different silos?

After all, if you get 15% on the deal and 2.5% for your ‘Camomile’ or whatever it is, everyone knows that adds up to 17.5%. Why not just go out and ask for 17.5% straight away? If you need and deserve it, you’re probably going to get it.

In this post Spitzer environment I find it amazing that anyone would bother to do anything otherwise. In my opinion fiddling around will just make your clients suspicious.

And, when you disclose your good fortune to them, what makes you think your clients won’t ask for some of your 2.5% for themselves?

I wrote about this a couple of years ago and rounded off with a story about my old proprietor.

I’ve just remembered another story from when I was working in Madrid in the particularly soft market of the mid-to-late nineties.

A whole posse came round to visit from a world number 1 or 2 reinsurer, practically begging us for income. They looked slightly desperate.

We duly obliged with an offer of a share on a very nice CAR facility. Two days later we got a call:

“Hi Hans, how’s it going?”

“Fine. Look we’d like to take that share on the CAR, in fact we’d actually like a bit more — the only trouble is the brokerage is 32.5%...”


“…and we are only allowed to give maximum 25%”

“Pity – the client would like you on, but it’s overplaced already.”


Another two days later, and another call.

“Hi Hans”

“Hi — look we’ll do you that line on the CAR thing at 32.5% commission”

“Great — but how did you get around your 25% maximum?”

“Oh, we just input 25% commission and 7.5% fees!”

And that, my dear long-suffering friend, is the way the cookie crumbles!

Call it what you like — but if it doesn’t add up it just ain’t happening.

August 24, 2007

Monte madness

Dear friend,

Like an enormous game of reinsurance Pokemon, the pre-Monte Carlo machine has roared into life once again.

Everywhere phone lines hum to the tone of conversations that run a little like this:

“I’ll swap my 10am Richard Ward for your 3pm Grahame Chilton”

“I’m jolly well not meeting at the Café de Paris again — can’t we meet somewhere else?”

“…I’ll be the one wearing a pink polo shirt and chinos…”

“Give me you cellphone, just in case.”

“Where shall we have dinner this year?”

“By the way, what do you look like? I’ll email you a picture.”

Ah, Monte, Monte, Monte…

Bring plenty of notepads — I can feel a lot of new layers coming on — especially lower attaching ones. It’s also time to sharpen up the old underwriting pencils and protect your share on the good stuff. It’s probably best to get your discounts in early before some other bounder does.

Oh, and pack some binoculars and an umbrella— the former may come in handy in your search for income and you never know when you’re going to need the latter (and you probably can’t buy a brolly for less than €200 within a kilometre radius of Casino Square!)

Speak soon, it’s back to horse-trading for me.

August 21, 2007

To the cave!

Dear friend,

Perhaps understandably I've been spending too much time on the Tropical Storm Risk site these last few days.

It's a bit silly, but it's very addictive. One minute it looks like Dean is going to hit Mexico City as a Cat 2 and then its hundreds of miles away.

I wonder when was the last time the Capital of Mexico got hit by a full-blown Atlantic hurricane?

Anyway I remembered that I wrote a bit about the Yucatan when Wilma was doing its worst in 2005.

The storm surge in Chetumal looks awful, but for everyone else, even those with nothing more than wooden shacks to protect them, one great thing about the local geology is that you can always go and shelter in the nearest cave (provided you watch out for the water level).

Fingers crossed.

August 17, 2007

Doing what's right is also good business

Dear friend,

What a lot of nonsense is being written about the sub-prime ‘crisis’. It makes me laugh.

But then what should we expect?

Let’s face it, most of the time nothing bad happens and our mainstream press are busy chasing after Paris Hilton, the cast of Desperate Housewives or the ghost of Lady Diana.

“$200bn wiped off the value of shares” is one of my favourite headlines. When share prices fall, they fall fast — that’s just the way it is.

When they rise they usually rise more slowly and are less newsworthy. This is why you will never see an equivalent and opposite “$200bn added to the value of shares” headline – because the gains come in $20bn dribs and drabs over weeks and months.

The whole sub-prime debacle is a lesson in market reality and common sense. And it’s as relevant to the reinsurance industry as it is to any other market.

The fundamental fact is that you should never allow a market dislocation to stop you underwriting in a sensible way. There’s even an element of moral justice at work here.

Just because mortgage-backed securities and the woolly CDOs stacked on their backs meant you could lend money to people who probably couldn’t afford to pay you back, (and let’s not forget, to buy houses that were ridiculously overpriced) this doesn’t mean you should have done so. You really didn’t have to do it. You had a choice.

Eventually the whole thing will unravel and you’ll be stuck holding the baby. Just like your consumer who you sold a 2-year fixed rate deal to when rates were 3% is now re-setting to a variable rate at over 6%, there will always come a point where you yourself can’t refinance and you can’t shuffle the default risk out of the door any more.

When that day comes you should be ready, otherwise you might as well walk around the centre of town with a big sign saying “please kick my butt” pinned to your back.

And on the other side of the trade, just because something has a AAA rating it doesn’t mean that it is as good as AAA sovereign bonds — if it were that good, why is it yielding more?

Even a couple of months ago you could throw a new issue of mortgage-backed debt out of the window and it would be placed by the time it hit the floor. Now everyone is taking stock.

But we in the reinsurance business have probably learnt more harsh lessons about market insanity and irresponsible underwriting than most, so we know better, right?

We’ve had many similar times of over exuberance in our own markets — I always love the one about pinning a slip on the tail of a dog and letting it run down Lime Street — and the risk being overplaced by the time you get it back.

In our markets we know that in really soft markets you can arbitrage your position if you are getting cheap reinsurance. The really smart guys also know that while it is always tempting to load up on junk, take your over-rider and take your reinsurer to the cleaners, in the medium term it usually ends in tears, recriminations and lawsuits.

More often than not your friendly reinsurer goes into run-off and then suddenly stops paying, alleging that you were not “putting his best interests at heart” or behaving in a “prudent” way. You spend more in legal fees than you ever made in ceding commission.

Anyway, back to today — looking at the market falls and some of the very solid, very low P/E ratio stocks it has uncovered, it looks like a nice time to buy sensible shares. (By the way this just my opinion, it isn’t investment advice! Always seek professional help, please)

When forced sellers come to the market it should always be seen as a buying opportunity for the prudent and solvent. This is a stupid time to panic. It’s just like after any major loss or when any prolonged market downturn comes to an end. When the upturn comes the people who need it most are always the least able to make the most of the opportunity.

That’s just tough luck.

Right now the chumps are over a barrel — I’d show them no mercy — they don’t deserve it.

August 14, 2007

A sticky matter of liquidity

Dear friend,

I remember at last year’s Monte Carlo one of the keenest observations (I think it came from an Aon exec) was that we had been really lucky that “a hard market for reinsurance had coincided with a soft market for hedge funds”.

Well, the soft market for hedge funds is well and truly over.

Fools bought collateralised debt obligations based on loans made to people who couldn’t pay them back collateralised against hopelessly overvalued housing stock .

And since these things were so complicated, and they were illiquid, they marked them ‘to model’ and not to market. Some of these models thought that the events of the last week were ‘25-sigma’ ones – meaning that they are supposed to happen once every 100,000 years.

How funny then that many separate one-in-hundred thousand year events happened day after day over the last couple of weeks!

Any of this stuff sound familiar?

Are we ever going to learn that you can't let a mathematician run your business for you? How many Nobel prizes did they have at Long term Capital Management - and what the hell good did it do them when they were stuck with a load of junk that non-one wanted to buy (but which the model said was theoretically worth something?

Markets are markets - and maths is only a helpful tool when things are normal. When irrational fear or exuberence stalk the streets, mathematical theory is about as useful as an umbrella made of papier maché.

Back in 2005 and 2006 we were lucky it was so easy to reload the capital barrel and start cranking the handle again.

But now it might not be so easy.

Hang on to that pile of cash marked 'jumbo 2006 profits' for now, it might come in handy.

August 1, 2007

Work for the big boys?

Dear friend,

What a paradox-laden market we have to work in — does it really bear logical analysis?

How much do we really know about anything?

Well, we know that in order to reap the rewards of an extraordinary 2006, we had to survive the unpleasant trials of a disaster-laden 2005.

We know have to be in it to win it. After all, if the purpose of our business is to make money by reinsuring things, we can hardly expect to make any money by not reinsuring things, can we?

But be in what precisely? And to what degree? We also know that if we’re in the wrong place at the wrong time, we’re not going to win anything, except perhaps the scorn of widows, orphans and prosecutors, tinged with the lifelong admiration of liquidators and run-off specialists.

We also know that is it probably better to be a little bit into everything and spread ourselves around. The trouble is, we also know that spreading ourselves too thin will make no economic, or rational sense.

And today the last hard bits of this market have gone soft. There might be the odd tasty morsel to tuck away for the rest of 2007, but 2008 is looking ugly across the board. Everywhere managers are looking at their little rating curves and trying to put there finger on where the walk-away price is.

Just like floodwater inundating the tree-lined streets of a picturesque British riverside village, you can be sure the sandbags of rational resistance will soon be breached and water will be sloshing around at our heels.

The great thing is that it is always someone else’s fault when this happens, isn’t it? “Who let the side down? Who didn’t walk away this time?”

So what’s the solution?

We could always give up and go and work for Munich re and Swiss re. Okay, the pay might not be so good, but the job security is great. Just look at our top 25 reinsurers for some pretty devastating numbers.

The top two global reinsurers do more business that the rest of the top ten put together, and more than twice as much as the sum total of the rest of the players ranked from numbers 11 to 25 inclusive.

But let’s get back to the real human world, where naked ambition and blind greed share brain space with dull rationality and cold logic. Where’s the fun in all of us working for the big two? Think about it for a moment — no stock options, no private equity backers, no bonus plans, no ‘liquidity events’!

No, let’s not think too many rational thoughts, let’s buy each other, and then as much cheap and highly-rated retro we can afford and try and enjoy the party while it lasts. We always forget that when these parties get going they tend to go on for a lot longer than anyone ever imagined.

The time for serious thinking is now past — we’re here at the party so we might as well make the best of it.

My advice: eat a hearty supper, line the stomach with milk, take two aspirins and try and avoid the temptation to make a fool of yourself. And please, please, please don’t try to be too clever — remember that a couple of drinks too many can convince even the sanest person that they are an infallible minor deity.

Editor's blog, photo of Mark Geoghegan

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