Dear Friend,

A lot of direct writers are in a bit of a squeeze between the proverbial rock and a hard place.

I’m going to play you two quotes — and you won’t believe they come from the same source (in fact they are only lines apart in a 1st-half results announcement).

Here’s the rock of a soft market grinding away at the prospects for profitable growth:

“The absence of any significant claims activity in the early part of 2006 and the benign start to the hurricane season have already contributed to a market wide sense of complacency that, regrettably, shows signs of converting to a lack of rating discipline and excess capacity across the board. Certainly there are areas of business which are already subject to weakening.”

And here’s the hard place:

“The areas of business which were subject to substantial losses in 2004 and 2005, US catastrophe-exposed property business, both direct and reinsurance, and Gulf of Mexico energy risks, are subject to unprecedented rating increases.

“Reinsurance cover for these risks is, as we predicted, not available at an affordable price and certainly this has raised interesting issues about the dynamic between premium, exposure assumed and reinsurance cost and about our risk appetite. This has led to our decision for 2006 to underwrite our US catastrophe-exposed book without the benefit of reinsurance. We are, however, now underwriting the business in such a way as to reduce our exposure to a repeat of the losses experienced in 2004 and 2005.”

This is clearly not a very pleasant place to be — you’re forced to write net in the best-priced segment just when you want to be gearing up to write a lot more, whilst you need diversity or your risk profile is going get completely lopsided.

(I mean, not that many people want to buy the shares of a 100% net US Gulf coast Cat writer — and if they did, they’d probably do it by backing a sidecar or a start-up themselves).

So where does one go for relief in diversity? Aviation is soft as hell, with a raft of new start-ups not helping one bit. Marine is tough too. There is a bit of decent international and other specialist non-marine business to be had — so for the time being you go after that.

The company in question here is Hardy Underwriting at Lloyd’s. Hardy is a well-run and well-respected outfit, with an enviable track record. It has come through plenty of difficult markets and catastrophes and has always lived to fight another day.

And it is doing all the right things this time too.

But this candid and commendably honest assessment of today’s market tells us loud and clear:

“The party’s nearly over — time for prudent underwriters to be on their mettle, and preferably standing near the door — this could get ugly.”

Dear Friend,

The annual meeting that spawned the Monte Carlo rendezvous, the IUMI mega marine conference, has been going on this week in Tokyo.

Every year Eric Alexander, a regular correspondent of Reinsurance and a former London market marine underwriter, goes out and covers the event for us.

I’ve just had his IUMI report run across my desk.

What everyone has been worrying about this year is a huge new class of container ship (or to use the marine jargon, an ultra-large container Ship — ULCS) of which the first, the Emma Maersk has been built and is sailing.

This is an awesome construction – designed to hold 11,000 (and maybe even on occasions up to 14,500) containers in one go.

We’re talking some pretty hefty values here — $145m for the hull and around $880m for the 11,000 containers — a $1bn boat!

But there’s more — the Emma Maersk carries lots of fuel — almost half an Exxon Valdez worth! In fact enough to cause a $500m pollution incident.

Add in those extra 3,500 containers to bring it up to the occasional 14,500 max load and Emma is close to becoming a $2bn floating exposure.

Now just get two of these babies to collide in heavy fog the English Channel…

I had no idea that cargo was becoming a such Cat-exposed business.

But here’s something amazing — Cargo underwriters don’t have any method to allow them to handle aggregates.

The standard practice of writing open covers means that they don’t have any reliable way of measuring accumulations.

So if you thought property Cat retro players were writing by the seat of their pants, you should check out these guys!

If the Emma Maersk went down tomorrow – no-one would be able to tell you how many of the 11,000 containers were theirs — until the claims started coming in.

There’s bound to be a technological way to solve this problem — say by using Radio Frequency ID tracking devices on individual containers, so that underwriters can track aggregates and buy cat cover as needed.

And in fact Swiss Re just mentioned all this technology in their pervasive computing report that was also out this week.

So attention modellers and risk consultants — looks like there’s plenty of juicy work in the offing — I’d get working on it right away.

Dear Friend,

One strange thing about our annual trip to Monte Carlo is that it is often hell when you’re there, but as soon as you’re back, you start missing it.

This reaction is a bit like Stockholm syndrome, which is the term that psychologists use to describe the phenomenon that sees kidnap victims form a close bond with their captors.

Monte Carlo kidnaps an industry and locks it up for almost a week. The uninitiated will find it stressful and won’t like it at first.

No wonder — they have been stripped from the comfort of family and colleagues and transported to an alien and sometimes hostile environment.

But after a while, new interns soon adapt and start to relax — the steep hills and steps of Monaco become as familiar as home.

Nowhere else in the reinsurance calendar can you spill champagne on such a large and varied collection of CEOs, Chairmen and senior market figures.

And the gathering gives us journalists the chance to play ‘Chinese whispers’ by bouncing comments from one player to another and take rumours and turn them into stories by finding others to confirm or deny, over a glass or two.

So what did I learn this year?

The best bit of news I discovered concerns a new start-up to be headed by legendary Lloyd’s property underwriter, Les Rock.

Anyone who has ever walked around the London market with a stressed property risk will have beat a path to Les’s box at some point in the last 15 years. I remember in the hard market of 1993 he was one of a handful of players quoting primary business on otherwise unplaceable business such as Caribbean beachfront hotels.

Naturally he had a queue a mile long.

Les made a name for himself at Murray Lawrence before moving to DP Mann, which then became part of Berkshire Hathaway’s Faraday operation. In 2002 he joined the newly-formed Heritage underwriting as active underwriter of short-tail syndicate 1200.

At Heritage, Les oversaw growth in premium income from £32m in 2002 to £130m in 2004 and £150m for 2005. In 2006 capacity increased to £215m. Back in May he parted company with the agency in a shock resignation just before its August IPO on the London stock exchange’s Alternative Investment Market (AIM).

Since that moment I had assumed he had not retired and was working on something.

Well now I know my hunch was right – the story seemed to be the open secret of Monte Carlo. Fund-raising is ongoing for a new $500m-$1bn start up.

I don’t have any other details as yet, but I promise I’ll be back with more details as soon as I get more.

No wonder I miss Monte Carlo!

Dear Friend,

Greetings from Monte Carlo, where two-and-a-half thousand people are doing exactly the same things they did last year — and the year before, and the year before that.

All is well in the world, and the meetings are a great contrarian indicator of the state of the market. All you have to do is assume the opposite of the developing consensus view, and you can’t go far wrong.

For example, in last year’s post-Katrina environment, the wishful thinking of reinsurers produced an amazing contradictory theory: “prices are going through the roof, but there will be no class of 2005”.

In this business, if you ask someone’s opinion, people say what they want to happen — and not necessarily what they really think will happen. What the phrase actually meant was, “I’m going to be hard hit, and my prices are going to have go up, but I don’t want there to be a pesky band of start-ups capitalising on my bad fortune.”

No one likes competition, so no one goes around predicting it. But ten start-ups and goodness knows how many sidecars, catastrophe bonds and exotic structured deals later, and we know to take what everyone says with a pinch of salt.

Well, this year, ask anyone what’s happening and it’s all about stability. According to everyone here, nothing is happening. Ratings are stable; capacity is stable; apart from the burn-out, pricing is stabilising; and client expectations are stable. No news, nothing to report. Everything is peachy.

What a load of rubbish! If nothing is happening, what are we doing here, and why is everyone running around so frenziedly?

If people are saying that the market is stable, it is because the market is anything but.
What they really mean is that they desperately want everything to return to stability.

Here is what’s happening:

The retro crunch is driving more start-up activity — there will be plenty of new players on hand come year-end. Their capacity is needed and welcome, and if the wind doesn’t blow, these guys are going to make an absolute fortune.

Europe is going to go soft this renewal. Reading between the lines, we are being psychologically prepared for it.

Everyone is pointing to how underlying direct European prices are softening — coded language for “we are under severe pressure to drop prices this renewal”. Brokers are also noting massive interest from Bermudians looking to diversify. Since there is no shortage of capacity in Europe, this must come at the expense of a cheaper deal.

But what seals the deal is that other classic justification for price reductions: “Terms and conditions are holding up well”, which really means: “Okay, prices are going to come down, but at least terms and conditions are holding up okay for now — we’ll probably be easing them next year.”

In the square outside the Café de Paris, the sun is shining. A tall Bermudian squints hopefully at random passers by, secretly dreading that he has been stood up by his blind date. The guy next to him smiles suggestively, with a look that says, “please be my three o’clock appointment.” It’s a bit stressful.

A middle-aged lady turns visibly pale as it dawns on her that her three o’clock is long gone. Her round head drops as she gazes forlornly into her Blackberry, praying for divine intervention.

A short, red-faced broker curses his PA for lack of organisation — “Why the hell don’t I have this guy’s number in my agenda?” His companion is calmer, accepting his own responsibility for small failures.

In front of me a mobile phone runs out of batteries at a bad moment. “I left my charger at home,” a man explains to no-one in particular with limp resignation and a newly acquired Gallic shrug.

A lawyer stands perplexed. I imagine what he is thinking: “Now, was it the Café de Paris or the Hotel de Paris? And whose idea was it to give the two main meeting places right opposite each other almost identical names?”

It’s not just the unloved singletons who are having a hard time. Other pairings have already met their partner for the next half hour, but are now having trouble finding anywhere to sit.

Everything is just the way it should be. Nothing is happening indeed. Nothing ever does!

Dear Friend,

Ask any successful investor how they make money, when so many of their brethren lose time after time and their secret is nearly always startlingly simple.

What they say is nothing to do with capital allocation, return on equity market timing or anything else — when you subtract all the mumbo-jumbo, the simple formula usually boils down to this — they only take on investments when the rewards on offer far outweigh the risks.

If they do this consistently for long enough, the law of averages brings them handsome returns.

If I could toss a pound coin for keeps and could win £2 every time I won, but only paid out a pound every time I lost, I should soon be a wealthy man.

In my imaginary coin-flipping scenario, the only necessity, other than persistent faith that the odds are right, is to have enough risk capital available to be able to suffer a run of bad luck. If calling heads or tails presents a 50/50 chance of success or failure, then losing 10 times in a row happens only one in over a thousand attempts.

So if I turned up to the coin-flipping match with ten pounds in my pocket I would have a 99.9% chance of being invincible. But we are men, not machines.

The trouble is that in the real world historical events influence our behaviour. The way the market works is that the price fluctuates according to our perception of risk, rather that the risk itself.

In the real world if a player wins the coin toss five times in a row, he will start to accept 50p for risking a pound — since his experience-rated logic says that he is bound to win every time.

Similarly if a player loses five times in a row, you’ll have to offer him at least £2 for a win to tempt him back in the game — and for some people no odds will convince them that they’re not going to lose their shirt.

Back to the reinsurance world — and right now in the Gulf of Mexico there are plenty of reinsurers who have had second thoughts about the game.

Never mind that the statistical evidence is that Hurricanes don’t actually go into the Gulf that often, but three losses in two years has convinced enough that they are on to a loser here.
That’s why prices are rising to levels that are tempting the true long-term winners come into the game.

This is not scientific but in blunt terms, on the best deals they are getting $2 reward for $1 of risk — for such prices, no wonder they are prepared to have a go.

In this industry we’re always beating ourselves up about how often we leave money on the table for others to pick up.

Well, right now there are plenty of people in our industry doing it all over again and reducing their writings either because they are running out of stake money or they are losing their nerve.

In the long run this is a losing strategy. In our business, risk selection is always over emphasised.

Successful reinsurance should always be about getting the price right — in the end, nothing else matters.

Let’s discuss this further down in Monte Carlo!