Dear friend,

Remember we ran an article in the November issue of the magazine about the “class of 2007”?

This is the regulation that is going to see large numbers of “non-essential” foreign workers on Bermuda have to leave after spending six years on the island.

Well, now that the deadline is looming for the first batch of workers, waiting to see if the Bermudian department of immigration has given them exempted status or not before they have to pack their bags in April 2007.

D-Day looms for ex-pats

The local Bermudian comment columns are humming with stinging criticism :

Six-year work permit rule is bad for Bermudians

and

Govt. must admit its term limits policy is a mistake

I just thought you’d like to read all this for yourself — it is a fascinating insight into the bitterly divided political tensions of Bermuda, which are always simmering under the surface, waiting to bubble over.

Check out the debate on the popular Bermudian blog A Limey in Bermuda

As one of the comments posted on the blog says:

"I hear the women in Dublin are beautiful. And the beer and golf are pretty good too”.

Maybe he has a point!

But one thing we know about Bermuda is that, despite all the political tensions, the powers that be are extremely pragmatic and practical.

I’m sure that if they see this well-meaning rule (designed to promote opportunities for locals) causing damage to the territory’s standing as a good place to do business, they would amend it immediately.

After all, if Bermuda accidentally starts driving key people away, its loss will be someone else’s gain.

Dear friend

Famous last words, but not much seems to be happening today, unless you count Lloyd’s’ soon to be Bermuda-domiciled Omega releasing unchanged (but creditably good) syndicate results forecasts for its 2004 and 2005 years as earth-shattering news

But it’s sometimes nice to have a quiet news day to catch up on a bit of reading.

I came across the full legal text of the SEC fraud complaint against Mssrs Stanard, Merritt and Cash of Renaissance Re at a really cool legal blog called www.reinsurancefocus.com and I’d been meaning to wade through some of the legalese to see if there was anything interesting.

Well I’ve had a read-through now and as rap sheets got this one is eminently readable. Here is the main charge:

“Together , they [Stanard, Merritt and Cash] orchestrated a scheme involving a transaction that had no economic substance and no purpose other than to smooth and defer $26.2 million of RenRe's [link] earnings from 2001 to 2002 and 2003. In effect, the transaction enabled RenRe to create a "cookie jar" into which it put excess revenue from one good year, to be drawn upon in a future period to increase income”.

This is how the SEC [link] said they did it:

“First, RenRe purported to assign at a discount certain assets ($50 million of recoverables due to RenRe under certain industry loss warranty contracts) to Inter-Ocean Reinsurance Company, Ltd. in exchange for $30 million in cash, for a net transfer to Inter-Ocean of $20 million. RenRe recorded income of $30 million upon executing the assignment agreement. The remaining $20 million of its $50 million assignment became part of a "bank" that RenRe planned to use in later periods to bolster income.

“Second, RenRe entered into a purported reinsurance agreement with Inter-Ocean that was just a vehicle to refund to RenRe the $20 million transferred under the assignment agreement plus the purported insurance premium paid under the reinsurance agreement. The reinsurance agreement purported to cover losses in excess of certain specified amounts, conditioned upon the occurrence of a particular kind of loss event.

“For this purported reinsurance coverage, RenRe paid Inter-Ocean a $7.3 million premium. This reinsurance agreement was a complete sham. Not only was RenRe certain to meet the conditions for coverage; it also would receive back all of the money paid to Inter-Ocean under the two agreements plus investment income earned on the money in the interim, less certain transactional fees and costs. In other words, the two parties consented to a round trip of cash. RenRe's claim under the reinsurance agreement would be paid with its own money”.

And, as the Christmas season approaches, the SEC allegations allude to a fitting image:

“In November 2000, two senior executives of RenRe recognized that 2000 would be a financially strong year for the Company. In e-mail correspondence, they discussed a project called the "4th quarter challenge" and "project Christmas present" and considered structuring a transaction that would help some other company meet earnings expectations for the fourth quarter of 2000 while possibly helping RenRe defer earnings”.

Have you been a good boy this year?

If you haven’t Santa might bring you something you didn’t ask for in your letter!

Dear friend,

Here’s a great entry from guest blogger, Paul Moss. Paul is head of claims for QBE’s European operations.

It’s all about how the time has come for the industry to embrace mediation, instead of constantly litigating its way to new legal precedents.

Maybe we’ve heard that view before – but this time something concrete is being done about it. Paul explains all about a new initiative called the International Reinsurance Industry Dispute Resolution Protocol, that I must admit I wasn’t previously aware of.

It looks a really great idea – so I think you should read what Paul has to say.

Over to Paul:

---------

Litigation has got out of control. As Governor Richard Lamb once cautioned – “No nation in history has ever sued its way to greatness.”

Just to put matters in perspective and taking the America Tort system as an example. Research shows that it spends no less than $80bn a year on direct costs of litigation and insurance premiums and a total of $300bn a year on indirect efforts to avoid liability. Litigation on such a massive scale can only stifle the growth of the US economy. Litigation has caused 47 percent of manufacturers to withdraw products from the market. The threat of litigation has discouraged no less than 25 percent of manufacturers from research. America’s major competitor in the creation of wealth is Japan. In Japan, the ratio of engineers to lawyers is 20 to 1 but in America, it is only 2.5 to 1.

Some argue that litigation has become the conduit for the re-distribution of wealth. Under the tort system only 46 cents in the dollar goes to the claimant. The rest is carved-up between lawyers and associated administrative costs

What’s more, in large business lawsuits, the massive egos of certain leading litigators do not predispose them to quick settlement. They relish the chance to compete in the arena. Indeed, the litigators approach – akin to legal warfare – which in itself, tends to heat up the disputes’ emotional intensity. This makes it even more difficult to settle.

We on the claims side of the house have had to adjust to a rapidly changing environment. We are facing pressures of Regulation & Compliance, over-laid with the Claims Minimum Standards. The claims function now falls under the microscope of the FSA – Sarbanes-Oxley lurks in the shadows

And today, the customer is king. Policyholders rightly seek value added claims services combined with lightening timeframes and processes for the settlement of valid claims. We require to keep “Customer” focused; learn more about using friendly alternative dispute resolution solutions in helping to preserve valuable commercial relationships. Mediation is something which must be added to the Litigation Management Tool Box

Up until recently, the legal profession had become so mesmerised with the stimulation of the courtroom contest, that lawyers had forgotten that they ought to be healers, healers of conflict, healers, not warriors, healers, not hired guns. Don’t get me wrong. There are times when a dispute, coverage issue or other complex claim situation should be resolved through the litigation process. We need judicial guidance. We need legal precedent for future reference, but Arbitration? Some believe that the process has become so devalued that we have to question why we continue to adopt Arbitration as our preferred dispute resolution mechanism.

However, there is a new movement afoot, in part driven from across the Atlantic.

The smart lawyers have already detected that clients believe that there is good reason for a shift in thinking. The smart lawyers recognise a significant change is about to happen. The smart lawyers have sought to re-skill, and train in the art of Mediation.

CEDR (The Centre for Effective Dispute Resolution) is the thought-leader for dispute resolution in Europe and the internationally acclaimed trainer in mediation and conflict management skills. An independent non-profit organisation supported by multinational business and leading professional bodies, CEDR's mission is to encourage and develop mediation and other cost-effective dispute resolution and prevention techniques in commercial and public-sector disputes.

CEDR provides practical training solutions for business people and professionals engaged in mediation and other forms of dispute resolution. To become an Effective Mediator you need to learn new skill-sets – it is imperative that every syndicate or insurance group should have a trained mediation capability built in to the claim function resource.

The International Institute for Conflict Prevention & Resolution, (CPR Institute) is a membership-based non-profit organization that promotes excellence and innovation in public and private dispute resolution, serving as a primary multinational resource for avoidance, management, and resolution of business-related disputes. Mediation Principles for insurance and reinsurance disputes is only one part of an arsenal of materials that CPR has created specifically for the insurance community.

The CPR International Reinsurance Industry Dispute Resolution Protocol is a major step forward to complement and support the need for mediation clauses to be incorporated within treaty wordings.

CEDR & CPR are in the process of working together to produce a training module for insurance and reinsurance professionals who wish to become engaged in mediation

I am very excited about the prospect for changing the way we resolve disputes. Collectively, we can do more than just make a significant shift in thinking – we can start to take action. We will need the buy-in of not just the claim professionals, but underwriters, and wordings specialists as well. We need both commitment, and the contractual mechanism for this to be truly effective.

I am reminded of what Henry Ford once said. “Coming together is a beginning, staying together is progress, working together is success” I am convinced that if we can get London fully engaged, with the US market ready to act; then there is absolutely no reason why we can't go global with this initiative!

-------------------
Thanks Paul! That was a breath of fresh air – now let’s get out there and start sorting out our problems man to man – (and maybe cut some of our legal bills down to size).

Dear friend,

The news that the UK’s financial regulator, the FSA is going to fine GenRe’s UK subsidiary over a million pounds for well-documented finite troubles is no surprise. After all, the SEC and everyone else has been hauling GenRe over the coals for this for over a year now.

Read the story here

But what I find interesting is that the FSA offers a prompt-payers discount of 30%.

Just like a parking fine or a speeding ticket, it seems quick settlers merit money off.

But surely this is wrong? What the FSA is punishing is serious accounting malpractice — there should be no discounts available – fines should be punitive and non-negotiable.

If something is a capital offence, you should be hung for it.

Can you imagine the judge saying this? "You have been found by a jury of your peers to be guilty of the gravest of offences and so you shall be taken from this place to be hung by the neck until dead, may God have mercy on your soul. Pause.

"But since you were quick to admit guilt, you qualify for the happy hour discount. I think we'll just give a bit of a scare with the blindfold, rough you up a bit and and let you go!"

Another unfortunate and unintended consequence of the way this punishment is structured is that it could end up looking like a revenue-raising exercise for the UK Treasury.

Everyone hates parking fines and often legitimately see them as a “stealth tax” on ordinary people. If we allow FSA fines or punishments meted out by other regulators to be construed in such a cynical fashion, we will be doing our industry a major disservice.

Over to you. Click on the word “comments” below this entry to add your thoughts.

(It takes about two seconds and you don’t have to register to do it).

See you later.

Dear Friend,

I’ll have to admit that when I stepped into this job I think I had an irrational fear of ratings agencies and the power they weald over our industry.

But the more I thought about it and the more I tried to replicate even a fraction of what they do, I saw what a valuable service they were providing to our business.

I mean they routinely distil thousands of pages of complicated financial information and turn it into simple A or B ratings that even a simpleton like me can understand. In an industry that is based on buying promises written on pieces of paper, the agencies show that some pieces of paper are better than others.

In short – they add value. So these days I’m very loath to criticise or question.

But one question about this Scottish Re business:

Scottish Re’s balance sheet looks just fine —— the assets outweigh the liabilities handsomely — the trouble is all about short-to-medium-term cashflow — those assets are tied up while the company has a few bills to pay pretty soon.

I’m no financial whizzkid, but surely the ratings agencies look at cashflow? And if not why not?

I was just reading one affirmation of Scottish Re when it still had an 'A' rating back in June – no a mention of cashflow problems there. Surely it’s not fair to be talking about cashflow now if only 5 months ago you weren’t talking about at all?

What do you think about this? Click on “comment” at the bottom of this item

I really want you to comment – after all you pay for these ratings.

Use the comment link below to share your thoughts now.

Dear friend,

It’s great to see a ratings agency tackle an issue head-on and try and engage the industry in a debate. Often ratings agencies give the impression of being preoccupied more with the recent past than what the future holds. How often have we seen (re)insurers affirmed only to be downgraded immediately as soon as new information comes to light in the very next quarterly results?

And since our industry is all about buying bits of paper that hold the promise of cover for 12 months into the future, not the past, this is rather an important perceived failing on the agencies’ parts.

So hats off to Fitch for launching into an open letter on the vexed subject of (re)insurer diversification.

This week it released a very frank commentary entitled In Pursuit of Diversification: Treatment in Economic Capital Models and Prism. To paraphrase and summarise Fitch’s point, the moan from the industry is that in the light of last year’s massive catastrophe losses and model tweaks, it feels it is somehow being bullied into diversifying to avoid being loaded with hefty extra capital charges.

So far so good. Here is Fitch’s key response:

“All else equal, an insurer that is diversified will require less capital than one that is concentrated. This is logical because non-correlated risks within risk types, across risk types, across entities within one jurisdiction and across jurisdictions can be offsetting, lowering the variability of a more diversified company’s performance. In fact, one of the historical criticisms of rating agency capital models was failure to reflect such diversification benefits.”

Quite right, Munich Re has been arguing this for as long as anyone can remember. But now for the killer blow from Fitch:

“The key is that “all else equal” is never true in the real world.”

Bravo! How refreshing!

Fitch goes on to warn of the dangers of ill-conceived diversification, (with which anyone who lived through the late 1990s is no doubt painfully familiar).

Why should someone who is second-rate at lots of different skills have a rating that is better than someone who is top of the tree at just one speciality?

Over to Fitch again:

“To some extent, a well-run yet concentrated insurance company simply needs to accept the fact that its capital requirement will be higher than that of a well run diversified company. But a well-run concentrated company should take comfort from the additional fact that its capital requirement (and rating) should be more favourable than that of a company that has embarked upon an ill-advised diversification strategy.”

Hooray! Well-run companies get better ratings.

And if you’re a mono-liner there are lots of other ways of combating the age-old problems of frequency and severity:- get yourself a Cat bond or two, stop worrying and concentrate on charging the right price for the job.

Fitch’s Prism model represents a change in thinking:- rating agencies are now starting to try to get under the industry’s skin and make much more qualitative judgements about who is good at what they do.

This will cause a lot of fireworks — but it is healthy for the industry.

It will also make things more fun!

PS. There is still just time to help us reward the best in our industry by giving them a gong with our 2006 readers’ awards. The awards nominations are closing next week, so get your skates on:

Reader awards 2006

Dear friend,

Two irrelevances:

Irrelevance number one.

My wife is Spanish and hates the BBC, the UK’s public-funded state television and radio network.

When I say she hates the BBC, what I mean is that she hates the compulsory television licence used to fund it. Every household in the UK that owns a television must buy one of these pieces of paper at a hefty annual cost of around $200.

As far as I know the UK is the only country in the world that goes in for this sort of thing. In return for this the BBC has a charter to provide good service the consumer and doesn’t run adverts to spoil the public’s viewing pleasure.

But it is rather sinister in the way it tries to scare the populace into paying up for the licence, regularly running unpleasant Big Brother-style advertising campaigns. These tend to imply that if you don’t get a licence they’ll be onto you like a shot and have you in a forced labour camp until you pay up.

Anyway, being used to free television, my wife doesn’t understand why the BBC can’t run adverts, stop trying to scare us and cease to be a financial burden on our household.

She seizes upon any negative to reinforce this conviction — and last night she got some unlikely ammunition in the form of irrelevance number two.

Irrelevance number two

Last night on the BBC’s flagship evening news programme, as near-civil war raged in Iraq and the foreign policy debate twisted after the US mid-terms, the BBC devoted a full five minutes to the death of a horse.

Of course this was no ordinary horse. It was a much-loved racehorse called Desert Orchid (or Dessie to his friends). The British people loved Desert Orchid because he usually won.

Betting on Desert Orchid in his prime in the late 1980s was a near dead-cert for punters and a nightmare for bookmakers.

They still had to quote prices on all the horses or lose their reputation — but for some high-profile races they knew they were in for a financial clobbering if Dessie romped home — and romp home he usually did.

I’m no horse racing fan, but even I had heard of him. The whole country had a lot of fun making a few pounds at the expense of the unloved bookmakers.

With horse races writing a balanced book is dead easy — in theory.

Until a horse like Desert orchid comes along and makes it almost impossible.

So underwriters — beware Desert Orchid-type risks if you possibly can.

But I suspect no amount of modelling or ERM will help you avoid the big one when it comes.

What did my wife make of it last night's offering?

"The BBC is crazy! $200 for news and they tell me about a horse!"

Not even Dessie could win them all!

R.I.P. Desert Orchid – the four-legged Cat loss

I love this industry like a father and I am a father of three — one five-year-old boy and twin three-year-old girls.

Lately I’ve been noticing what remarkable things becoming a parent can do to one’s powers of prediction.

Being a dad means I have developed the amazing ability to see into the immediate future. These days I am a veritable sage:

“Daddy, can I have some of your beer?”

“No — you won’t like it!”

Or “Get down from that chair”

“Why?”

“Because you’ll fall off and bang your head”

I can see into the future with the clarity of a soothsayer, and often have the satisfaction of being able to say “I told you so”. (Although the worth of knowing one is right diminishes somewhat when it involves comforting a screaming infant who has just had a head-on collision with a stone floor).

Since arriving as editor here 18 months ago I have extended my gift of concerned parental clairvoyance to the reinsurance market. I can’t always say that the clarity is as good as with my kids, but it hasn’t been too wide of the mark so far.

But that is actually the point — it takes no special gift to see that a three-year-old jumping up and down on a chair is going to fall off sooner or later. When I tell my daughter to sit down before she falls off I’m not really looking into the future — I’m merely stating an obvious fact.

Similarly it is also obvious to most people that reinsurance pricing moves in cycles and not in straight lines. If you accept this premise, at the top of a cycle you should metaphorically climb down from your chair, sit sensibly, behave yourself and wait for the next upturn to come.

But such a premise assumes that people and markets always behave rationally — and our experience suggests that they don’t. At the peak of any pricing cycle there are usually plenty of people telling you that something has changed fundamentally and that the whole dreaded process has been consigned to the scrapheap of history. Either that or people convince themselves that the profitable part of the cycle still has a lot further to run before they start losing serious money.

Such people are toddlers jumping on chairs – and the funny thing is that like small children, they have extremely short memories.

At such times it always pays to rely on what you can see with your own eyes as opposed to what you are being fed. And at the moment across non-Cat exposed US property and casualty classes prices are coming off 10% 20% or 30% over this time last year, and even the burnt out Cat rate rises seem to be reaching a peak.

That is all the analysis you need – this IS a softening market and it’s going to get an awful lot softer. In short — it’s time to climb down from the chair.

Kids, like reinsurers — you have to love them. I’ll leave you with another blast from one of my three:

Does this remind you of anyone?

“Get off the chair”

“Why?”

“Because yesterday you fell off and hurt your head. We had to take you to hospital”

“But I’m not going to fall off this time!”

Our industry suffers from low self-esteem — it doesn’t always feel that great about itself. But when big losses strike, they can be great moments of validation for what is an otherwise extremely unappreciated backwater of the financial services sector.

When the great earthquake of 1906 struck San Francisco, it was famously the making of Lloyd’s, but was also a great opportunity for younger rivals Munich Re and Swiss Re to stand up and be counted and do right by (re)insureds — all came through that trial with reputations hugely enhanced.

The industry has many things to be proud of and it is only when a news-dominating catastrophe event occurs that insurance has the chance to occupy the psyche of a nation and the wider world.

So how come a hundred years on from San Francisco is take-up of earthquake insurance so shockingly patchy across the globe?

It’s not often I’m dumbstruck, but allow me to ransack AM Best’s superb 2006 Annual Earthquake study to put a series of terrible facts to you.

The US is long overdue a big earthquake — Am Best says “cataclysmic ruptures are already considered overdue for the Los Angeles end of the San Andreas fault and the Cascadia Subduction Zone” (Cascadia in the Northwest Pacifc coast area encompassing major population centres of Seattle and Vancouver, amongst others).

And consider this — the last “big one” in the States was San Francisco in 1906 — yet RMS estimates that a $100bn-plus earthquake loss hitting anywhere in the United States is only a 1-in-18 year event.

This is because the contains four major quake zones — of course there is California, with which everyone is familiar, but the Cascadia zone mentioned above is also highly significant, as is the New Madrid zone, which stretches all the way from Arkansas up to the great lakes, taking in Memphis, St Louis and Chicago. Last but not least is a significant fault line that runs from New York to Philadelphia.

And look at the numbers — RMS reckons that a quake of only 6.5 magnitude (it is not until a quake measures 7 magnitude that it is considered “major”) on the New York to Philadelphia fault would cause about $110bn in insured property losses.

It goes on — a smaller 6 magnitude quake hitting Chicago would cause approximately $102bn in property damage alone. AIR models a 7.6 magnitude temblor in the San Francisco Bay Area that would cause insured losses of over $100bn. Here are some more from AIR; Memphis-St Louis $140bn; Pacific northwest — more than $40bn; Los Angeles — more than $70bn. Top these off with another from RMS — Newport-Inglewood, California — $101bn.

Feeling dizzy yet? I’m not surprised —especially since the AM Best study puts the total annual US earthquake premium pot at a paltry $2bn. And there are doubtless many other hypothetical permutations and combinations that produce $50bn-plus insured loss events

Now think again and consider yourself lucky — compared to the economy as a whole, the industry is getting off extremely lightly. Take that New York-New Jersey-Philadelphia quake — yes insured losses come out at $110bn, but the overall damage is an eye-watering $901bn — and you thought that Hurricanes were a menace.

And so the pattern of underinsurance continues to a greater or lesser extent with the other scenarios. In fact the most shocking finding of the AM Best report is that between 85% and 90% of US homeowners don’t have earthquake coverage at all. Even in quake-prone California — and the only state to have set up a scheme (the California Earthquake Authority) that actively encourages take-up of earthquake cover, take-up is an anaemic 12% for residential customers and a paltry 11% for commercial policyholders.

AM Best reports that in the US earthquake insurance is a standard exclusion from homeowner or commercial insurance — coverage is only usually available via a specific write-back. However, homeowners do get cover for fire following quake and motor policies do include physical damage cover.

But since most people’s home or business is their largest asset, the main exclusion of damage by shaking is a recipe for extreme confusion and financial ruin for many — as well being yet another boon for a certain type of plaintiff lawyer.

Yes – fire following quake is a major peril, but a policyholder confronted with a burnt-out pile of rubble is going to be in for a shock when his insurer applies a hefty average to the claim.

I can just hear the adjuster saying “Yes, sir, you are covered for fire following quake, but since the building was reduced to an uninhabitable mound of concrete before the fire came, I reckon we only need to pay you for fire department expenses and maybe some rubble removal if you’re lucky”.

This situation is bizarre enough in the world’s largest economy, but even more astonishing is that faced with such a challenge, the US industry is currently backing away from the problem. Back in June personal and commercial lines giant Allstate announced that it was going to stop selling earthquake endorsements on its policies nationwide, after seeing its appetite for catastrophe risk severely blunted by massive losses sustained from Hurricanes Katrina and Rita.

But this cannot be the way forward. Insurance is a great product because bad things happen and people need indemnity when they do. Thousands of houses burn down every year, but we don’t have a stampede insurers rushing to exclude fire — customers will not allow it — that is the product.

If Cuthbert Heath’s first words upon hearing of the San Francisco disaster of 1906 were “exclude quake!” it is doubtful as to whether Lloyd’s would still be in existence today.

US Earthquake cover is a massive missed opportunity and a huge failure on our industry’s part. And reinsurance has a massive role to play here — there is no reason on earth why for a reasonable price US citizens shouldn’t get the cover they need, the wider US economy and ultimately the US Treasury gets the protection it is sadly lacking. Get out there and do you duty — and that paltry $2bn premium pot should multiply.

Dear friend,

Remember last week I was talking about my previous job editing investment newsletters?

It’s amazing how useful keeping in touch with different people can be helpful when you’ve moved on. You can help them out and they can do you a favour in return.

So I suppose when I left to come here, my old workplace lost a good editor, but gained a reinsurance guru!

Anyway, here’s what I found in my inbox this morning — an email from a former colleague

Yo, Mr G

How's it hanging?

[that was nice of him to ask – but he soon gets to the real point]

What's your view on all this merger talk in the insurance sector? Could Amlin be part of this consolidation?

PS. I won't quote you!

Cheers
The wider investment community is having one of its periodic love-ins with Lloyd’s vehicle stocks.

Next week it will be gold, and the week after that it will be oil, soft commodities or emerging markets, but for better or worse, all the action is in our camp right now.

This is what I wrote back (excuse the shoddy grammar):

“It's all kicking off - another one was taken out by private equity this morning

- Also Amlin is a probable acquirer — before the Catlin-Wellington deal, they were the biggest in Lloyd’s and got a premium rating from the stockmarket because of that. Amlin might feel under pressure now to buy something just for the sake of staying top - never a good idea.

Please, please stop here and remember that this is a personal email to a friend of mine — it is not intended to be investment advice to you. And anyway, I’m usually wrong!

For the sake of good order, I also declare I don’t hold a position either long or short of Amlin stock.

Now what do you think?

You might be lucky enough to be sitting on stock and options — are you hanging on for more or are you thinking about cashing in?

Let me know (I promise not to quote you unless you identify yourself)