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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.

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