Dear friend,

Imagine you and I are poker buddies who meet up to play a regular game every Friday night.

Nothing flashy, just small stakes. We’ve been playing for years — it’s really a social thing — we have a few drinks and a few laughs and no-one loses too much.

Then one night we have a few drinks too many — after all it is Friday — and it all gets a bit out of hand. Instead of pennies, we start playing for big money.

I end up losing $10,000 to you and write you a hefty IOU before slinking off home.

The next morning I wake up with a hangover to you banging on the door, demanding either the cash or the keys to my brand new car. You drive away in my car.

Stunned, I put it down to experience and resolve never to play poker for high stakes, and certainly never to play again when I’m drunk.

I forgive you and even thank you for teaching me a valuable lesson about reckless gambling. I don’t bear a grudge and call you up the following Thursday to fix up another Friday game.

You answer: “Sorry Mark, I’m not playing any more!” and hang up abruptly.

What am I supposed to think? You are a supposed to be my friend — we go way back. We’ve been playing poker together for years. Frankly I’m shocked — I feel cheated and don’t know if I want to see you again.

If you asked me for another game now I’d probably tell you to get lost.

Well that is what Florida is doing to the property Cat market.

Florida is not going to play any more.

And we thought Florida needed friends. Clearly it believes it can do without such niceties.

The move to double the Cat Fund whilst halving its deductible is a great example of a government being extremely generous with its people’s money.

But unlike something like nuclear terrorism this risk is insurable and there is a competitive market out there to service it. Subsidising this business is irresponsible.

Where is the disincentive to build in unsuitable areas now? It has been removed at the stroke of a pen.

Florida is like a pin in a 100-pin bowling alley – the ball went down the gutter last year — but hang on, what’s that big black thing thundering down the lane?

The sunshine state might one day regret having played Russian roulette with its future.
With the realistic disaster scenario currently set at $100bn, a $40bn hurricane is not a very unlikely event — in fact it looks like a nice primary and first excess to me!

State bond default, mass insurer insolvencies, and tax rises all on top of devastation and death.

Do they really think the voters are going to thank them for that?

Qui sème le vent, récolte la tempête.

Allez — on to the news

Mark Geoghegan, Editor

Dear friend,

“Subject to most favoured reinsurer’s terms” I haven’t heard that since my broking days!

The EU competition commission has just published with an interim report into Business insurance in Europe.

Most of its 164 pages seem to be about teaching the uninitiated about how the (re)insurance market works in Europe (which, of course is essentially exactly the same as anywhere else in the civilised world!)

As such has no value whatsoever to you and I.

But many thanks to my colleague Marcus Alcock for wading through the tedious Eurocrat flab and babble and finding a point of interest, which he duly put up on our news site.
(It’s on Page 87 of the report, if you want the full version)

Over to the EU report and “most favoured reinsurer’s terms for dummies”:

“At different stages in the negotiation of a reinsurance contract, certain reinsurance companies insert a clause to the effect of benefiting from the best terms available to the
participating reinsurers on this contract, without quoting these terms. Our inquiry shows that this clause can appear in treaty as well as in facultative reinsurance. It can be written directly on the contract or appear through the stamp of the reinsurer. It can be imposed by one or several of the participating reinsurers

The clause appears in many different ways. It can be a short text like:

"Subject to best terms and conditions"
"Subject to most favoured reinsurer terms and conditions"
"Warranted no better terms carried"

So far, so darned obvious. Now on to the nitty gritty:

“By lifting the impact of these differences on the final premium paid by the reinsured, this type of clause contributes to maintaining higher premiums in the market than under fully competitive conditions.

“Moreover, this type of clause increases price transparency and can, under certain market conditions, amount to a restriction of competition within the meaning of Article 81(1) EC”

So it might be anti-competitive, might it?

Of course it’s anti-competitive! Naming one price and insisting on another higher one quoted by your competitor is hardly honourable. And it expresses a complete lack of confidence in one’s own abilities as an underwriter.

But you can hardly blame reinsurers for trying it on. You don’t see people insisting on least favoured reinsurer’s terms, do you?

But if a builder came to your house and stuck a similar clause on the end of his quote, you’d never want to work to see him again!

There is no reason whatsoever why composite pricing shouldn’t soon become the norm in the market, especially with electronic trading becoming more cost-effective.

It would help with contract certainty, wouldn’t it? No more running around getting everyone to accept minor terms and conditions changes at the last minute.

But here’s a thought — subscription market-style uniform pricing may work against clients in hard markets, but it sure works in their favour in soft ones.

In a soft market a broker can use underwriters’ fear of being left off a placement to force least favoured terms to hold sway.

Composite pricing could actually help smooth the pricing cycle in the longer term.

Now there’s a final thought from a cynic:

In soft markets EU commissioners won’t think they can get any good publicity out of investigating (re)insurers!

After all, no-one moans when premiums go down.

Dear friend,

Looks like what we gained on the swings of a benign North Atlantic hurricane season in 2006 we are already paying for on the roundabout of a stormy and expensive northern hemisphere winter damage season in 2007.

In the US, Californian frost damage trashes a whole orange crop, ice storms bring death and destruction to the Mid-West and the East Coast. And over in Europe Hanno (aka Per) bashed Scandinavia last week and Kyrill another 160kph-gusting storm, lashed the southern UK, Northern France, the lowlands, Germany and Eastern Europe yesterday.

The damage is reported to have stretched as far as Russia and the Ukraine. I expect we will be seeing Kyrill appearing in red ink in (re)insurer first-quarter results statements in April and May this year.

My gut feeling is that it will be the costliest storm for many a year.

I even heard that the Lloyd’s building had to close a couple of entrances as the wind blew down some panes of glass from the new Willis HQ under construction opposite. Of course, the market traded bravely through as ever.

And on a personal note, the perimeter fence on the playground my daughters’ nursery had blown over when I dropped them off this morning — I’ve haven’t seen structural damage like that since the big one in we had way back in 1987.

The other big story we have seen this week is the rush to the IPO market for three more of the class of 2005.

Validus, Greenlight and CastlePoint all made moves to open the capital exit doors with planned floats in New York.

I know these things tend to come in waves and that the timing is almost certainly coincidental, but they do focus the mind. When you add in Flagstone and the London Aim-floated Lancashire, this will make five 2005-ers with a listing.

Top-slicing is the investment strategy where you take your initial stake out of a stock and let the profits ride. And after a blistering first year in the business it distinctly looks like the smart guys of late 2005 are looking to take some money off the table.

Maybe they don’t like the feel of this soft and bouncy market, or they don’t think they’re likely to see a repeat of last year’s meteorological miracle. Or maybe they just think it’s sensible to have a plan B.

Whatever their motives, they have earned our respect and admiration.

Just as kids seem to grow up quicker and quicker these days, so it seems do reinsurance classes!

Dear friend,

I had a good chat with Grahame Chilton of this morning following the release of Benfield’s Global Reinsurance Market Review

It’s a brilliant piece of research — I spent most of yesterday reading it up and I suggest you do too. There’s some really juicy analysis in here, which I’ll be coming back to over the next few weeks.

But in the meantime – let’s hear from the boss of one of the world’s elite group of global reinsurance brokers…

Mark Geoghegan (MG). What is the chance of the market easing you describe in the report turning into a rout as the year progresses?

Grahame Chilton (GC) Last year people were coming to terms with the tremendous claims caused by Katrina, Rita and Wilma and hadn’t had a chance to readjust their book or to raise as much new capital as they may have needed. Therefore it was a very fraught renewal season.

But it was a much calmer market at this 1/1, people were more relaxed, they weren’t clamouring for coverage. So what did that translate into for each individual market?

In international side there was undoubtedly price competition due to some reinsurers trying to maintain market share and other reinsurers trying to get in for diversification reasons.

This lead to a very competitive price environment, albeit with a fair amount of price discipline. So there was price reduction, although disciplined price reduction.

In the US you had a situation on property cat where prices did pay up, but not quite to the level that people had been saying the were going to after what happened in the middle of last year.

MG Do you think that this means that the window of opportunity for start-ups is now closing?

GC I always believe that there is an opportunity for high quality businesses to start at any time — however, to a certain extent the opportunity to come out of the box as a straight property cat monoline reinsurer is pretty difficult. And in certain other lines there is a pricing slide, so it’s not what you’d call a great time to be doing it, because to a certain extent the opportunities are less than they were twelve months ago.

MG So as a top reinsurance broker what would you say to a company like Ironshore, that is going to be writing direct US Cat insurance on a fully net basis?

GC At the end of the day I wouldn’t be saying anything to them! They have raised the capital and have obviously put a business case to the investors. Bob Clements has had a tremendous track record of starting up Bermudian companies at times of need. So I would not be so presumptuous as to comment.

They’re looking at a very specific area of still potential need, with a leading market trader who is well known to be a profit hunter in that arena. That’s more of a specialty niche play rather than a general commentary on the state of the market as a whole. I do think that there are still opportunities for good high quality niche players to do start-ups, so it’s totally in line with what we see.

MG What do you think of Marsh’s recent return to the fray with the launch of the new MaRI-ACE primary capacity?

GC It looks to be remarkably like what we did on Starbound in the middle of the year, other than the fact that they probably had to put a very large bet in themselves to get it away. I can’t really comment on a Marsh product, but it’s a bit ‘same as’ some of the products we’ve been doing over the past couple of years. They’ve obviously got their reasons for the timing — but it would have been a lot more useful to their customers if they’d had it last year rather than this year.

MG What chance do you think the soon to be launched Nymex-CME ‘Re-Ex Index’ contracts have of succeeding?

GC I don’t particularly agree with the way it’s being done. It seems to be raking up an idea we had about 15 years ago and trying to make it a new idea. I think the world’s moved on since then.

MG But do you think there is a way of marrying the insurance business with the speculative futures trading markets?

GC Of course there is — at the end of the day a derivative is about taking a risk and therefore finding a ways of taking an understandable risk and having a metric around that is an obvious consequence of where the market was going. I’m not sure that coming up with an index is the solution. There is obviously a lot of action going on in those market but that particular bit of news was an old Benfield idea revamped fifteen years later.

Undoubtedly there will be derivatives trading — because to a certain extent that is what the insurance business is — a promise to pay for something in the future.

MG How do you see the year progressing — how do you see the cycle in 2007?
GC With the new capital that is flowing in, it doesn’t mean that cycles are going away, but the oscillation of those cycles should be milder, because that new capital can withdraw if the pricing isn’t there, whereas if its already wrapped up into forming the capital base of a reinsurer it’s more difficult to take your toys away.

Dear friend,

I’ve just seen the latest on an extension to Hannover Re’s K5 securitisation.

I just love chief executive Wilhelm Zeller’s repeat of a turn of phrase he first coined back in February last year as he unveiled a 22% shrinkage in US catastrophe aggregates.

Weatherproof was the word back then — and weatherproof is the word he is repeating now. Apparently today Hannover is more weatherproof than ever.

Now forgive me for being obtuse — but as far as I am concerned weatherproof is not something reinsurers are supposed to be.

A reinsurer should be no more weatherproof than a coal miner is carbon-neutral.

Reinsurers are supposed to carry risk — for a generous fee.

That’s the job in hand, that’s the product.

Get the product right, get the price right and you will make generous returns from people who want you to take risk away from them.

Now don’t misunderstand me, I can perfectly well see why Hannover is doing this, and what’s more it has an excellent track record of producing above average returns with low historical deviation in results.

But when all non-wind classes and territories are under heavier competition than they have been at any time in the last five years and US Cat rates are busting new highs, surely the smart money is getting a little more wind-exposed rather than weatherproof?

At these prices why not use that extra capital to help you write more good stuff?

I also always thought there was no such thing as a bad risk, only a bad underwriter.

Or am I missing something?

Dear friend,

It’s been such (largely self-imposed) chaos this morning that I don’t have time for anything more than a brief note.

The Marsh deal came right out of nowhere and got the newsroom chattering.

Pre-Spitzer, Marsh was the first mover bar none in the capital-raising and company formation stakes — what with ACE, XL, Mid-Ocean, Axis and Arch, these guys practically invented Bermuda.

Until suddenly it became politically impossible to be seen to be involved directly in investing in (re)insurance companies, and MMC Capital was spun off as Stone Point.

So it was quite a surprise to see Marsh dive back in to the fray in this way.

And why should they do it now? What has changed between now and 14 months ago?

If you were going to sponsor a start-up all along, why wait? First-mover advantage is long gone.

I know Mr Spitzer is safely ensconced in the Governor’s residence in New York, but surely this is ridiculous.

Clearly it’s not just risk appetite that is back — good ’ole fashioned corporate appetite seems to be making a reappearance too.

Game on! Normal service has been resumed — over to you, Aon.

Dear friend,

Our friends from the World Economic Forum (in this case mostly Swiss re MMC and the Wharton School of Business ) have brought out their latest risk report, Global Risks 2007. It’s fascinating reading — if you’re a manic depressive.

One of the most depressing things is that of the main 23 global risks tracked by the group, precisely none is unanimously deemed to have improved over the last 12 months. In fact they’re nearly all supposed to have got worse since last year.

And if you want to get really depressed, check out all the disaster scenarios on pages 8 and 9.

But the cynic in me says “they would say that wouldn’t they?”

Since when has it been in reinsurers’ interests to say that the world is getting safer, better or cleaner?

Scaring the hell out of everyone is a great advert for the product!

Still, it’s a cracking read — just don’t let it give you nightmares — or stop you taking risks.

When all else are scared stiff, the bold underwriter strides forth to glory.

Here's a good piece of renewal intelligence from Chris O’Kane, CEO of Aspen speaking at the Merrill Lynch January reinsurance renewal conference call last week.

You won't find a better description of the way the market is balanced today.

I particularly like the contrast of the introduction of total sum insured wind deductibes in the Northeast US, with the soft and squidgy aviation market and the story of an Italian specialty account being lost to a 30% price chop.

The account loss was described as "soft market stuff".

"...there is still room for some silly things to go on." shrugged O'Kane.

And then there is the fact that reinsurers simply can't charge much more - insurers and original clients simply buy the same monetary amount becasue their budgets are largely fixed - then they run the rest on their own balance sheets.

"Soft market stuff" indeed!

Dear friend,

Refreshed from a Christmas and New Year break, even before I had time to get back to the office, I dived straight back into the slew of renewal season briefings.

What good did it do me this year?

Well, this season is when we will be able to safely look back and say that the pricing cycle clearly peaked as a whole, (that’s if it hadn’t already done so at some point in the middle of 2006 or even earlier).

I expect you already know the story by now, since this is a dead horse we’ve been happily flogging since writing that Katrina didn’t have to be a market-changing event back in September 2005.

Or you can read Willis-re’s excellent summary here:

1. Because most big diversified players can write half as much US wind as they did before KRW for roughly the same amount of money, that is precisely what they are doing.

2. This is leaving a nice theoretically highly-profitable gap for all the real underwriters, start-ups, bolt-ons, strap-ons and assorted financial exotica to exploit.

3. Meanwhile everyone else in the middle is busy dashing to diversify by class and by geography as fast as the planes can carry them to Zurich, Dublin, Singapore and beyond.

So far so crème brûlée.

But the difference now is that risk appetite is slowly coming back after near zero Cat losses in 2006 — and the rate rises are running their course — even for the most burnt-out crunchy bits on top of the global retro dung pile.

Globally more cover is being given for the same money or marginally less money is being charged for the same cover.

Overall reinsurance is a bit cheaper now than it was last year — that’s all you need to know.

How much cheaper is all down to the skill of your broker.

They can’t quite bring themselves to call it a soft market yet, but watch the language change over 2007.

I guarantee you that all the next talk will be about how the down parts of pricing cycles are so much flatter these days and how there is a lot of fat left in the pricing, (which incidentally is still way, way above the ‘technical’ rate).

Ho hum – a New Year, but the story remains the same!

PS. The weather forecast is the same as last year too!