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.

Dear Friend,

Lloyd’s and Bermuda (re)insurer Amlin had some great results out today – the banner headline read “Record profits despite worst natural catastrophes in history”.

Great stuff – Amlin ran a paltry 57% loss ratio last year and what’s more, looking ahead to 2006 it says prices are well up in its key lines of reinsurance, property and energy.

But the results announcement contained a very interesting strategic admission — Amlin is going to buy less retro cover this year — and here’s the reason quoted:

“Retrocessional reinsurance, which is the reinsurance of reinsurance portfolios and which we have historically purchased to protect against extreme frequency and severity of loss, has become so expensive that we believe it appropriate to run more catastrophe risk internally whilst reducing our peak exposures”.

And this after getting some spectacular value from its retro underwriters last year:

Amlin said its gross estimated ultimate claims were $860.9m “which reflects the severity of the 2005 hurricanes. The resultant claims were better absorbed by the reinsurance programme purchased by the Group which is designed to deal with severity of losses.”

Yet Amlin went on to reveal that the 2005 storms cost it $236.7m, net of reinsurance, meaning a staggering $624m in retro claims. The high-level Cat design of Amlin’s retro protections meant that it estimates that it only ended up retaining 27% of Cat losses in 2005 against 53% for the more attritional but less severe 2004 season.

In 2005 it could be argued that Amlin’s retro programme saved its results, protected its capital and even allowed it to be in a strong enough position to raise the funds to start Amlin Bermuda.

Yet after all that — in 2006 this life-giving cover is suddenly “so expensive”.

Last month Wilhelm Zeller said that he was confident that Hannover Re was more “weatherproof” going into 2006 than it was going into the 2005 season.

It only remains to be seen exactly how much less peak exposure Amlin plans to underwrite now that it has decided to retain a higher proportion of its Cat exposure for 2006. I am awaiting guidance from the company as to how much more or less weatherproof it plans to be as I write.

It takes opposing views to make a market — buyers need sellers and ultimately everyone needs and respects net underwriters. But I wonder if Amlin has stopped to think what sort of message its actions are giving to its own customers wishing to remove peak exposures in Florida and the Gulf of Mexico from their balance sheets?

“I’ll sell some to you, but at these prices I’m not buying much of it myself!”

Dear Friend,

I had a great time at the World Insurance Forum over in Bermuda last week —the weather wasn’t up to much, but the list of attendees at this biennial event was a veritable who’s who of the industry.

In fact the line-up was so illustrious that it is perhaps best described by listing those who didn’t attend. Well, Warren Buffet couldn’t make it and neither could Jacques Aigrain of Swiss Re (and I guess Eliot Spitzer probably wasn’t invited!) but that is just about it — everyone else was either on a discussion panel or in the crowd watching and avidly taking notes.

The format was very relaxed and the fact that we were in a hotel well outside Hamilton meant that many attendees didn’t immediately rush off to client meetings. This meant that you could find yourself making small talk with some very senior people during coffee breaks.

The conference took the form of open discussions with the speakers sitting on comfy chairs — yet despite this cosy atmosphere, some pretty hard-hitting discussions were had on the future of the industry.

But what you want to know is in such a glittering firmament, who shined the brightest?

For me the hands-down winner was Nikolaus von Bomhard. I was surprised at how well Munich Re’s CEO comes across — whereas in other more set-piece press conferences he has seemed a little stiff, in the relaxed atmosphere he seemed to blossom — he even cracked a few good jokes.

And one of the most surprising things he said to our privileged gathering was that despite the benefit of over a hundred and twenty five years of corporate experience behind him he still admits that luck actually does still play an important role in the business of underwriting.

This is pretty amazing stuff when it comes from the CEO of a company that has more benefit from the law of large numbers than any other player (with the possible exception of Swiss Re, depending on whether or not you count the GE acquisition).

It got me thinking — if the CEO of Munich Re sometimes feels like he could do with a bit of good luck, I wonder what the CEOs of the class of 2005 feel, as we all march boldly towards the next hurricane season?

Dear Friend,

Before I say anything, if you have any ongoing financial interest in the New Orleans region, I think you should read this article from the Washington Post:

http://tinyurl.com/pa629

So, just two months before the Atlantic Hurricane season is due to start (and hey, with sea temperatures where they are, there’s no reason why it shouldn’t start a little earlier) it appears New Orleans is at best going to be in a the same position than it was a year ago in terms of sea defences.

Whole swathes of the city are currently not protected to the most basic insurable standards.

What is surprising is not the apparent backsliding from senior politicians, but the sheer scale of the problem.

If New Orleans is seeing the cost of levée rebuilding and improvement tripling to $10bn in less than a year due to our increased understanding of the risks it faces, what other unknown costs are waiting to be loaded into our catastrophe models above and beyond the 40% that RMS has already announced?

This will run and run — and judging by the weather forecast, we know for almost certain it won’t be long before the next chapter in the saga is written.

In April’s issue of the magazine I borrowed a phrase coined by a Benfield report used to describe this “hard on top, soft underneath” market. That phrase was crème brûlée — the pudding that sees a soft and squidgy custard topped off with hard, but brittle caramel.

Well, this year I can only see this crème brûlée dessert getting more and more inedible.

The hard bits are going to be positively toasted — but they’re more brittle than ever, especially with the whole of the class of 2005 and assorted surviving Cat writers perched precariously on the A- ratings precipice. Meanwhile the soft bits everywhere else are going to start losing their shape and turning positively runny.

How this burnt and sloppy pudding is going to maintain its appeal to investors over 2006 is beyond me — but then there’s no accounting for taste!