The Hedge Funds are coming

INSURANCE / INSIGHT / INTELLIGENCE

MMC SettlementIQ Profi le: White Mountains Re

Bermuda capital managementExecutive Forum

Glacier Re

SPRING 2005 ISSUE 13

The intelligent quarterly from the publishers of The Insurance Insider & Insider Week

...but are they welcome?

RUN-OFF 2005: comprehensive 15-page section inside

At Agnew Higgins Pickering, we specialise in the natural and renewable resourcessector. This means that when clients talk to us, they are never taken for a ride. Asa leading natural and renewable resources broker, Agnew Higgins Pickeringspecialise in delivering practical solutions not lofty ideas. If you think this is a rarecommodity, come and talk to us about how we can help you. agnewhiggins.com

Natural Gas.Not Hot Air.

2 Seething Lane, London EC3N 4AT Tel: 020 7459 5500 Fax: 020 7459 5530 Email: info@agnewhiggins.com Authorised and regulated by the Financial Services Authority

CLIENT > AGNEW HIGGINSCCHM JOB NO > AH0005FILE NAME > AH0005 297X210 NATURAL GAS

DATE > 16.02.04FINISHED SIZE > 297x210 mmOPERATOR > Tom

COLOURS > CMYK

PROOF NO 2 PDF

C C H M : P I N G A R T W O R K M E D I A I N F O R M A T I O N

AH0005 297x210 NATURAL GAS 16/2/05 10:17 AM Page 1

3

S P R I N G 2 0 0 5

I Q S P R I N G 2 0 0 5

SUBSCRIPTION ENQUIRIES

Kevin Runc

Tel +44 (0)20 7397 0619

Fax +44 (0)20 7397 0616

kevin@theinsider.co.uk

Annual subscription: £199 ($300)

Editor/Publisher Peter Hastie

Deputy Editor David Bull

Senior Reporter Geoff Spiteri

Sales & Marketing Malene Toubro

Circulation Tim Hayter

Subscriptions Kevin Runc

Design ZEFYR

Printing Buckley Deane Wakefield

2nd Floor Asia House31-33 Lime StreetLondon EC3M 7HT

United Kingdom

Tel +44 (0)20 7397 0615

Fax +44 (0)20 7397 0616 IQ@theinsider.co.uk

All rights reserved ©2005

IQ is published under licence by Informed Publishing Ltd

12 The Hedge Funds are comingIQ examines the influx of hedge funds to the reinsurance sector and asks if it is a good thing

14 Fast exit visas White Mountains Re profiled

16 Cash back Capital management for Bermuda start-ups examined

34 Executive Forum Market leaders gauge discipline at the recent reinsurance renewals

19 Running with innovation: IQ’s comprehensive Run-off section

40 Second Pender collapse Fall of second C&W-backed insurer in two

years strains telecoms market

ISSN 1475-410X

NEWS MATTERS

6 MMC: Sorry is the hardest wordSpitzer settlement brings partial closure on commission controversy, focus shifts to new business model

8 ReinsuranceIQ asks if Spitzer’s probe into finite reinsurance signals the beginning of the end for non-traditional products, and takes a look at 1/1 renewals

10 Wilton Re

In this, our first issue

of 2005, we focus on

the look at the growth

of hedge funds, and

examine the options for

Bermuda’s class of 2001

as the market turns.

In this spring issue,

we debut our

comprehensive exit

strategies section, with

features and views from

across the discontinued

business marketplace...

4 Observations from the editorBermuda continues to attract capital to its buoyant (re)insurance market - as evidenced by the influx of hedge fund backed entities. But with the market turning, the ability to sustain returns to shareholders will be challenged

38 A cool proposition Glacier Re CEO Robbie Klaus tells IQ why the time is

ripe for a new player in the reinsurance market

Glacier Re page 3844 Best form of defence Ascot briefs IQ on its new approach to stand alone terror cover

Running with innovation: IQ's comprehensive Run-off section

IQ, the sister publication of:

...but are they welcome? page 12

The Hedge Funds are coming

20 Exit strategies22 Commutations24 The growth of schemes of arrangement26 Run-off in the US

28 Schemes: a practical guide30 Evolution in Run-off management32 Portfolio transfer33 Claims management

Ca$hback page 16

Steve Fass page 14

BERMUDA FEATURE: HEDGE FUNDS, CAPITAL MANAGEMENT, WHITE MOUNTAINS RE

Indeed, there have been four distinct waves of capital in the island’s history – the post war captives, the excess liability insurers of the mid-eighties, the Hurricane Andrew inspired property catastrophe writers and, of course, the post 9/11 “class of 2001” (re)insurers. But to that list we may one day add a fifth: The migration of hedge fund capital to the island’s shores.

As we document on page 12, hedge funds have been attracted to the reinsurance sector for a number of years but, recently, they have been forming units with a view to competing with traditional reinsurers. And, yet again, Bermuda appears to be the home of choice for many of these entities, such as Nephila Capital, Citadel Investment Group and – most recently – Independence Re.

Where historically hedge funds have been satisfied with participating as counter-parties on catastrophe bonds, these new entities are now showing an appetite for both underwriting parametric type risks with specific loss trigger points, and conventional ultimate loss type exposures, in competition with traditional reinsurers.

While views may be mixed on the influx of hedge funds – with some welcoming the wider choice for cedants, and others forecasting further downward pressure on rates – it is a clear indication that external capital views the sector as attractive with good prospects for healthy returns.

Capital management As Bermuda draws in the fresh, though some might say speculative, capital of the hedge funds, so its present incumbents turn their attention to the issue of capital management as the cycle moves into its downswing.

Particularly under scrutiny are the strategies of the island’s “class of 2001”, the group of (re)insurers that set up in the wake of the 9/11 tragedy, providing an inflow of capacity to shore up the industry’s capital base decimated by heavy underwriting losses and shrinking investment returns.

Since the formation of Bermuda’s youngest breed, the total equity level of companies domiciled on the island has more than doubled from $20bn to an estimated $45bn. And as the reinsurance industry’s total capital base grew five percent to $159bn over the six months to 30 June 2004, the Bermudian contingent grew the fastest, by 7 percent. The 2001 start-ups have seen their capital bases swell from $6.4bn to $10.7bn since they were set up.

It is well documented that the “class of 2001” have employed their plentiful capital in diversifying underwriting into new lines of business, with an increasing focus on casualty – as well as broadening horizons geographically.

With the turning market, the prospect of consolidation on the island continues to gain support too as pressure to sustain

returns to shareholders mounts. A glance at the history books reveals that no less than five of the post-Hurricane Andrew start-ups launched in 1993 followed the path of consolidation.

Of the property cat companies that came to the island with close to $4bn of capital that year, CAT and Tempest Re are now part of ACE, while main rival XL absorbed Mid Ocean Re and Global Capital Reinsurance. LaSalle Re is now effectively part of Endurance, after the post-9/11 start-up acquired the former Trenwick unit’s property catastrophe business.

Indeed, only three of the start-ups, Renaissance Re, Partner Re and IPC Re have made it past their tenth birthdays on a stand-alone basis.

On page 16 of this issue, we note that, so far, the evidence is that Bermuda’s “class of 2001” are actively handing back capital to shareholders, with Endurance, Montpelier Re and AXIS Capital embarking on share repurchase programmes.

The ante was upped for some with New York attorney general Eliot Spitzer’s criticisms of brokers’ founding investments in (re)insurance companies. Benfield and Aon have divested their interests in Montpelier Re and Endurance respectively. Marsh is expected to cut loose the interest it holds in AXIS through its Trident investment funds – most likely through the divestment of MMC Capital.

Balance sheet strength Bermuda’s (re)insurers continue to display their considerable strength. Despite a year of record losses from natural catastrophes, the companies released results that, to date, have revealed little sign of damage to balance sheets.

Naturally the deluge of hurricane and typhoon losses damaged earnings. Nevertheless, at the time of going to press only three companies – Renaissance Re, PXRe and Quanta – recorded negative results (at the nine month stage), with only five reporting nine month combined ratios above 100 percent.

And balance sheets stood up to the challenge. According to Benfield, total shareholders’ funds of the 16 companies it surveyed increased 8 percent to $42bn in the nine months to 30 September 2004. This led commentators to describe 2004’s catastrophe losses as an “earnings event”.

Bermudian (re)insurers have consistently rewarded their investors, and the island’s environment continues to attract investors in search of bumper returns. The real challenge they now face lies in the ability to sustain these returns amidst the pressures of maintaining underwriting discipline and adequate capital to satisfy the quasi-regulatory appetite of the rating agencies.

4

EDITOR ’S COMMENT

I Q S P R I N G 2 0 0 5

Capital challenges

Bermuda’s status as the industry’s magnet for new capital remains as vigorous as ever.

It was three months in the making, and involved torturous semantics in the expression of contrition, but Marsh & McLennan’s settlement with the New York attorney-general Eliot Spitzer enables the company to face the year ahead with far greater certainty than it could have dreamed of in the dark days of October 2004.

On 31 January, MMC announced that it had formally entered into a settlement agreement with Spitzer and the New York insurance commissioner Greg Serio – the two frontrunners in what has now become a nationwide probe into insurance brokers’ practices.

At $850mn, MMC will be required to hand over more than any other financial services firm targeted by Spitzer but, despite the eye-watering quantum, (equivalent to the Placement Service Agreement fees collated by Marsh from insurers in 2003) it is a sum MMC will be relieved to pay. First, the settlement is tax deductible and Spitzer has agreed that payment can be stretched out over four years but, of equal importance, MMC will hope the deal will take the sting out of the class actions and regulatory investigations that swarmed around the broking giant after Spitzer’s 14 October lawsuit.

Hence the importance of the wording. In the statement, the company neither admitted nor denied the allegations in the Spitzer complaint. Instead, the broker “apologise[d] for the conduct that led to the actions filed by the New York State attorney general and superintendent of insurance”. Marsh continued by focussing the fault on errant individuals within its organisation: “The recent admissions by former employees of Marsh and other companies have made clear that certain Marsh employees unlawfully deceived their customers. Such conduct was shameful, at odds with Marsh’s

stated policies and contrary to the values of Marsh’s tens of thousands of other employees.”

This might seem both contrived and illogical, but it was vital for Marsh as it now looks to resolve its next set of liabilities. A full apology would have trodden all over the firm’s defences as it negotiates with regulators, attorney generals (Connecticut’s attorney general has, for instance, recently initiated separate proceedings against Marsh and ACE Ltd) and, in due course, the plaintiff bar.

Nonetheless, in the press conference, Cherkasky was realistic enough to recognise that the settlement in itself will not put a stop to all litigation: “The class actions are not going to go away overnight”. “But we are hopeful,” he added, “that a series of corporate clients will see this as a fair and fulsome opportunity to opt in.”

And, as Cherkasky points out, what would be the point of other insurance commissioners or attorney generals pursuing their own investigations in isolation?

“If they want restitution,” he notes, “then they already have it.”

As part of the settlement, Marsh has devoted a certain amount of the restitution fund to each state (for example: California has $131mn; New York $94mn; Pennsylvania $58mn; Texas $55mn; Illinois $45 and humble Montana a mere $449,000) and has until the 30 April to calculate the allocations to its 100,000, or so, relevant US clients. Any US policyholder who retained Marsh between 1 January 2001 and 31 December 2004 will be involved. Nor will US clients who purchased insurance in the international markets, such as London, necessarily be excluded. “‘US policyholder clients’ means US-domiciled policyholder clients and policyholder clients who retained Marsh’s US offices to place, renew, consult on or service insurance,” explains the settlement.

As a consequence, said Cherkasky: “We don’t think it will be necessary to individually negotiate with all 49 other states… We think this is obviously the first mover and our position is that this settlement will hopefully have a material impact on the necessity and interest of other state regulators.” It would not, he added, be in the “public interest” to simply replicate the litigation.

Nonetheless, MMC has further liabilities

arising from these errant employees. IQ’s sister publication The Insurance Insider estimated last year that total costs – including class actions – are likely to be in the region of $1.5bn-$2bn; Morgan Stanley also calculate a figure of around $2bn in all. “Its hard to quantify,” acknowledged Cherkasky, before adding: “We are confident that we can handle it.”

Crucial to the success of resolving the regulatory investigations will be MMC’s ability to implement its new business model. Cherkasky has spoken of the need to inject greater ethics and transparency into the organisation. First to go is Marsh Global Broking, the market-facing organisation that structured many of the now abolished commission arrangements with insurers.

MMC will continue to “leverage the Marsh organisation for the benefit of its clients,” explained Cherkasky, but not for itself. Instead, Marsh is decentralising and its executives have been taken back into the “core of Marsh businesses”.

The broker – like its rivals – is currently debating how best to structure new transparent fee arrangements to take account of the services it does undoubtedly perform on behalf of insurers (in the London market, for instance, some underwriters are resisting the new trading terms suggested by Marsh and Aon which include sliding scales of commissions), but under the settlement it has agreed to strict rules of disclosure. In particular, Marsh cannot accept any payments from insurers unless: “(a) Marsh in plain, unambiguous written language fully discloses such commissions, in either dollars or percentage amounts; and (b) the client consents in writing”. It has 60 days from the date of the agreement to impose these new terms.

Inevitably, they will hurt MMC’s revenues (as will the client departures such as Prudential plc, Boeing, Goodyear and Fortune Brands which have migrated part, or all, of their business since the controversy began). But Marsh can also take heart that these requirements will inevitably also be imposed upon its rivals which – in the case of Aon and Willis – may well be coerced into not dissimilar regulatory deals.

Cherkasky summed up the settlement neatly: “I can’t say it’s a day of great rejoicing but it is a day of relief and a day we will mark as a new beginning.”

6 I Q S P R I N G 2 0 0 5

N E W S - S P I T Z E R

MMC: Sorry is the hardest wordSpitzer settlement brings partial closure on commission controversy as focus shifts to implementing new business model

Cherkasky: Delivered a managable - and tax

deductible - settlement to MMC shareholders

To deliver solutions that are of practicaland financial value.

7I Q A U T U M N 2 0 0 4

To deliver solutions that are of practicaland financial value.

I Q S P R I N G 2 0 0 58

N E W S - F I N I T E R E

With the resolution of Eliot Spitzer’s investigation into world’s largest broker Marsh, so attention has focussed once more on the campaigning New York attorney general’s lower profile probe into the widespread industry practice of finite reinsurance.

As reported in the December 2004 issue of our sister publication The Insurance Insider, several companies, including Swiss Re, Ace, St Paul Travelers, Platinum Underwriters and Zurich Financial Services, revealed in November last year that they had been subpoenaed by either Spitzer’s office and/or the Securities and Exchange Commission (SEC) to provide information about finite products they sell.

Finite reinsurance, aka retroactive or financial reinsurance, is a generic term covering a broad spectrum of products designed to offload liabilities from the balance sheet of the cedant to the (re)insurer, allowing the

buyer of the product to limit the potential for volatility in its future financial results.

Such deals, where transfer of actual risk has occurred, are both legal and legitimate. But in the post Enron world it was perhaps inevitable that the transactions would come under regulatory scrutiny.

US regulators have already shown interest in finite insurance transactions with AIG’s $126mn settlement with the SEC and US Department of Justice late last year over deals it structured for banking firm PNC Financial and telecoms distributor Brightpoint.

Berkshire Hathaway’s General Re caught the attention of regulators for its role in transactions identified following the downfall of collapsed Australian insurer HIH. The use (or abuse) of finite reinsurance was evident in the downfall of UK liability carrier Independent Insurance, as well as the failed Fortress Re aviation pool.

The subject gained further public attention late in January when investor magazine Barron’s published an article suggesting that the sale of finite products are, in some cases, used for the purpose of altering financial statements rather than transferring actual risk.

The article alleged that finite reinsurance “invariably leads to higher near-term earnings for users of the strategy”.

“Likewise, it’s no accident that the most avid buyers of finite reinsurance tend to be the dead-men-walking of the insurance industry, eternally hoping that stronger premium rates can bail them out if they can just stay alive for another year or two,” it continued.

Industry commentators have long predicted the increased scrutiny in this area, and seem to have reached a consensus that disclosure and transparency are key to future use of the products.

Vinay Saqi, an equity analyst with Morgan Stanley, recently suggested: “Greater scrutiny into the product could lead to some rule changes about what qualifies as (re)insurance and what should be considered a loan for accounting purposes.

“Also, in the near-term, we expect demand for the product… to moderate, as worries about the regulatory scrutiny could continue to hamper the product’s progress. In the long haul, however, we do expect the product to continue to be used, though with perhaps a more defined structure.”

The end for f inite reinsurance?

1/1 renewals: soft and softeningWith 1 January 2005 renewals complete, the indications are of a softening climate across insurance and reinsurance markets, with little sign of any significant impact on rates from what turned out to be the costliest year for natural catastrophes on record.

There are exceptions to the rule, with some property catastrophe markets - particularly on the reinsurance side - holding and, in some cases, hardening on loss-struck accounts in worst affected areas.

But this is counteracted by fast falling rates in other lines, with particular concerns over the market for D&O cover.

According to rating agency Standard & Poor’s (S&P), reinsurers maintained a

degree of discipline at the 1/1 renewals, keeping price cuts to “sensible levels”.

“Early evidence from the 1 Jan treaty renewals is that while reinsurance premium rates are still softening, the declines remain orderly - generally in the region of 5-15 percent for loss-free accounts,” said S&P credit analyst Stephen Searby.

“For loss-affected accounts and Caribbean risks, generally rate rises of up to 35 percent have been achieved, but this is only a small subset of the industry.”

But reinsurance broker Benfield warned there were already signs that underwriting discipline was not holding up in the face of competitive pressures.

“Against conventional expectations, the reinsurance market came through 2004 largely untroubled by the procession of major storm losses. As a result, 2005 renewals saw a familiar disconnect between the avowals of continued discipline by senior reinsurer management and actual underwriter behaviour, suggesting that the ‘feelgood’ factor coming from robust balance sheets is driving a renewed focus on market share and fuelling competitive pressures,” said Benfield in its renewals report.

For its part, broker Willis, in its “Marketplace Realities and Risk Management Solutions 2005” overview, described the underlying factors of the softening market as “familiar to all who have previously experienced a turn in the market cycle”.

Will Spitzer’s probe spell the

end for finite reinsurance?

Clarity from complexity

PRO Insurance Solutions

Lee BrandonDirector & Chief ExecutiveTel: +44 (0)20 7337 8900Fax: +44 (0)20 7623 3318

e-mail: lee_brandon@pro-ltd.co.uk

Both live and run-off insurance companies, and Lloyd's syndicates, know the importanceof dedicated professional service providers. More and more industry leaders

are discovering the value of PRO Insurance Solutions.

For a clearer view of our services and solutions contact:

One Great Tower Street, London, EC3R 5AA, UKBruton Court, BrutonWay, Gloucester, GL1 1DA, UK

Steve RylandExecutive Director

Tel: +44 (0)1452 782500Fax: +44 (0)1452 782582

e-mail: steve_ryland@pro-ltd.co.uk

www.pro-ltd.co.uk

IUA Pro Insurance_MC 2/9/05 4:19 PM Page 1

I Q S P R I N G 2 0 0 51 0

NEWS - W I LTO N R E

Start-up life reinsurer Wilton Re has been assigned a financial strength rating of A- (Excellent) and an issuer credit rating of “a-” by AM Best, following the company’s launch in December 2004.

In an announcement on 7 February, 2005 AM Best drew attention to Wilton Re’s “firm capital commitments” which enable it “to underwrite and strongly support a meaningful volume of traditional life mortality business.”

Added Best: “Moreover, Wilton Re’s business model includes complementary administrative reinsurance whereby reinsurance and stock transfers will be employed to acquire discontinued and subscale blocks of business.” Less positively, the rating agency pointed to a number of offsetting factors, including “the lack of operating history and the uncertainties surrounding the successful execution of its business plan”. It added: “In addition, AM Best believes the rate of growth of the US life reinsurance market has slowed, which may pressure Wilton Re’s longer term growth prospects.”

Bermuda headquartered Wilton Re was launched at the end of 2004 with the backing of broker Marsh & McLennan, which provided the start-up with $200mn of capital raised through its private equity arm MMC Capital Inc.

Other investors include buyout firms Vestar Capital Partners and Friedman Fleischer & Lowe – together providing the life reinsurer with total capital of $628mn.

Chris Stroup, who will serve as chairman and CEO of the new firm’s Bermuda based holding company, said Wilton Re would concentrate on two areas: traditional mortality business and life insurance run-off business.

Stroup was involved in the Admin Re programme during his time as chief executive of Swiss Re Life & Health North America – and he said Wilton Re’s Connecticut-based life subsidiary aimed to emulate his earlier strategy of buying closed books of life business and administering their run-off.

He added that the new life reinsurer is well placed to take advantage of a market where consolidation and the exit last year of established

players such as Employers Re and ING Groep has reduced capacity and increased premiums.

According to Stroup the company will compete with Swiss Re, Munich Re, Scottish Re and Reinsurance Group of America.

John Tiller, former head of Employers Re’s global life reinsurance arm, will be CEO of Wilton’s Re’s Connecticut based US life operation, through which most of the company’s business will be written.

The launch of Wilton Re has been cited as evidence of increased interest on the part of investors in the life reinsurance sector.

On 3 January 2005, this was further underlined by an announcement by Scottish Re Group that a private equity firm, The Cypress Group, had invested $180mn in its operations. Scottish Re said the investment be used to strengthen its US life reinsurance business acquired from ING Groep on 31 December 2004. It added that in return for the investment Cypress Group received a 9.9 percent stake in Scottish Re’s ordinary common stock.

New life reinsurer takes to Bermudian waters

A new member of The Insider familyIntroducing the new monthly publication from the

team that brings you The Insurance Insider, Insider Week, and IQ magazine…

Incisive coverage and in-depth perspectives on the retail investment, insurance and pension sectors.

www.lii.co.uk

EnquiriesEDITORIAL Melanie Claisse - Editor tel: 020 7397 0618 melanie@theinsider.co.uk

Geoff Spiteri - Deputy Editor tel: 020 7397 0615 geoff@theinsider.co.uk

MARKETING Tim Hayter - Head of Marketing tel: 020 7397 0615 tim@theinsider.co.uk

FIRST EDITION-MARCH 2005

Bermuda I Boston I Dublin I London I www.awac.comALLIED WORLD ASSURANCE COMPANY, LTD

You get a big plus with AWAC.In fact, you get several. Few insurers have the depth of underwriting experience and expertise that we are known for.

Few will give you the decisions you need – fast. That’s how we do business.

And we provide the security of more than $2 billion in equity capital – which in our case is another plus: an A+ (Superior) rating by A.M. Best.

Property ReinsuranceCasualty

you need a financially strong insurer

one that will be around when your claims need to be paid

plus:

I Q S P R I N G 2 0 0 51 2

Hedge funds were once content with relatively passive investments in reinsurance, positioning themselves as counter-parties on catastrophe bonds and SWAPs, or holding equity stakes in underwriters, but that is no longer the case.

Last year saw the emergence of an intriguing new trend: hedge fund backed entities seeking to replicate traditional reinsurers by becoming active risk carriers. Although the number of deals completed thus far is small, they are likely to continue in 2005 as new operations come on stream and buyers become increasingly comfortable with their existence.

Typically, these entities have been most comfortable underwriting parametric type risks that have specific loss trigger points (such as a windstorm over a certain scale: if the storm is registered then the claim is made regardless of actual loss suffered) but they are also showing a willingness to underwrite more conventional, ultimate loss type exposures. But is it a development to be welcomed?

A number of reinsurance brokers certainly appear to think so. For instance, the chairman of Guy Carpenter’s Europe and Asia Pacific operations Geoff Bromley welcomes these new entrants. “It is helpful to have alternative sources of capital available to cedants,” he told IQ, before adding: “We have always looked at ways to diversify in terms of price and capacity and we welcome the additional choice.”

It is a stance echoed by Willis Re’s managing director, Mark Hvidsten, who comments: “They are a really good addition to the marketplace," adding: “Enhanced liquidity, derived from the collateralised structure, is a very compelling feature of these deals.”

Indeed, this goes to the heart of how these hedge funds differentiate themselves from traditional markets: a willingness to collateralise their exposures.

For some cedants this is a powerful attraction because traditional reinsurance markets are often reluctant to collateralise their exposures – indeed it would be impossible for them

to do so for all their exposures. In contrast, the funds appear willing to do so. For cedants, this helps alleviate security concerns for otherwise unrated entities.

This trend marks a shift in the hedge fund industry’s relationship with the reinsurance markets which began in the 1990s with investments in catastrophe bonds – typically high yielding securitised risks where the capital/interest is withheld in the event of a specific risk. Although Hannover Re is often regarded as sponsoring the first Cat bond in 1994, they really came into their own from 1997 (as of July last year there had been 54 bond issuances with total loss limits of nearly $8bn).

Initially many of the bond counter-parties were themselves (re)insurers, but over time they have been replaced by specialist hedge fund entities such as Nephila Capital, CooperNeff Advisors and Fermat Capital Management LLC (Guy Carpenter estimates that less than 25 percent of cat bond counter-parties are now conventional reinsurers: it used to be in excess of 50 percent).

For the cash-rich hedge fund industry, reinsurance offers a number of attractions. First, although volatile, the sector offers the prospect of high returns; it is also heavily dependent upon modelling – something the hedge funds are instinctively in tune with – and, finally, reinsurance offers little, if any, correlation with the traditional equity and bond markets.

Indeed, there are two types of funds now occupying the sector: on the one hand, there are the likes of Nephila Capital which specialise entirely in reinsurance and are backed by different investors, then there are the wholly backed subsidiaries of large hedge funds, such as the giant Chicago hedge fund Citadel Investment Group which has appointed the former ACE Tempest chief executive Chris McKeown to run a dedicated operation. Both Nephila and Citadel are based in Bermuda, seemingly the location of choice

for these new companies.

But some traditional reinsurers are cautious about the inroads these companies are making and question the commitment to the reinsurance sector from a hedge fund industry that prides itself on being nimble and opportunistic. “If the price of tulip bulbs suddenly becomes attractive then the hedge funds are just as likely to go for them,” says Jim Bryce, the chief executive of Bermudian property cat reinsurer IPC Re.

Bryce adds a further caveat that collateral for one loss event only is not always sufficient. “As the loss events of both 1999 and 2004 have shown us,” explains Bryce, “you must look at frequency as well as severity”.

Hvidsten recognises this, but adds that many of these new participants are prepared to be flexible. “The initial posture was one loss only; but that is not the end of the story. We have structured deals that involve collateral for one event and for multiple losses. One loss only is not the end of the story.”

For reinsurance buyers it is ultimately a matter of weighing up the pros and cons. A choice, therefore, appears to be whether the attraction of upfront collateral outweighs these commitment concerns, especially when these new participants are unrated.

One further attraction for buyers, however, is that the rating agencies appear willing to give credit for the reinsurance provided by the funds. “If it’s quality collateral that is iron clad, then it would be viewed in the same light as traditional reinsurance,” explained AM Best analyst Robert DeRose. This is important, because reinsurance buyers need to be able to account for their protections in order to demonstrate their own financial strength.

But what is the size of the market? This is difficult to gauge with any accuracy, not least because of the hedge funds’ own exposures to cat bonds and SWAPs. Nonetheless, some have estimated that if you include the

Hedge funds are being increasingly drawn to reinsurance. But are they welcome?

The Hedge Funds are coming...

H E D G E F U N D S

paramatric exposures (which tend to be far higher – lines in excess of $100mn are not uncommon) then they may have brought more than $2bn of capital to bear. “They are a real presence in the market now; it is not theoretical. Clients’ awareness and acceptance is much higher than it was, say, a year ago,” says Hvidsten. The corollary of this, however, is that concerns have grown about the possible impact these funds may have on rates. At the Lehman Brothers’ Global Reinsurance Briefing in December, for instance, several executives – including AIG’s Hank Greenberg – echoed concerns about their arrival.

“We’ve heard a lot about this new trend,” said Chris Winans, the former Lehman Brothers insurance analyst. “And while we can’t know what kind of event will bring about the next wave of reckless competition, we think an unabated influx of capital from hedge funds and other capital markets participants could be one potential trigger.”

While Robert Bredahl, Benfield Group executive vice president, said: “More capital has to result in lower prices and prices are dropping right now. We’re in a softening trend without question — hedge funds’ entry into the market will accelerate that.”

But Hvidsten thinks fears of price competition are over-stated. “The impact they have had on rates is zero. Don’t forget, most have well-defined business plans that are focussed on specialist lines outside the commodity business that are most price sensitive. These are not markets setting out to compete primarily on price.”

Bromley agrees, adding: “The funds are heavily dependent upon modelled output and are therefore very conscious of pricing.” He continues: “Where we have seen significant price reductions, the hedge funds and cat bond writers have not been present. The traditional markets have been able to drive down rates on their own.”

There is a flipside to this, of course. Their arrival suggests that, despite the gloomy prognoses of some industry observers, external capital still views the reinsurance sector as offering healthy returns. But with downward pricing pressures, these funds want to make their mark while they can. 2005 is set to be an interesting year.

As the hedge fund industry has mushroomed, so has the challenge for adequate investor returns.

According to Hedge Fund Research Inc (HFRI), the industry has grown from $39bn of assets under management in 1990 to $890bn in 2004. But while investor demand appears unsated, there are signs that the funds’ abilities to outperform more conventional investment strategies are being reined in.

For instance, the HFRI Fund Weighted Composite Index, which is based on the monthly performance of more than 1,600 hedge funds, rose an estimated 7.1 percent in 2004 through to November. In contrast, the Standard & Poor’s 500 index was up 7.2 percent over the same period.

In part, this may explain why the hedge funds have been drawn to catastrophe reinsurance – a medium that is proven to offer both high returns and high risks. In addition, the industry has been familiar with the reinsurance sector for at least seven years, where funds managed by the likes of CooperNeff and Nephila have acted as counter-parties on catastrophe bonds and insurance SWAPS – investments whose returns are uncorrelated to the performance of stock markets.

Indeed, this is one of the prime attractions of the Hedge fund industry to investors. The insurance companies, foundations and pension funds pouring hundreds of billions of dollars into the industry are looking for investments which are not dependent upon the traditional equities and bonds that make up the bulk of their investments. Reinsurance, along with other hedge fund mechanisms such as currencies, equity hedging

and arbitraging, offers them that opportunity.

“We’re looking for diversification, not return enhancement,” explained Nancy Everett, chief investment officer for the $40bn Virginia Retirement system in Richmond, to Bloomberg Markets in February.

Indeed, hedge funds have been associated with alternative investment techniques ever since Alfred Winslow Jones started the first modern hedge fund in 1949 using two tools – short selling and leveraged stock – to reduce his exposure to the traditional markets. His fund outperformed all the top mutual funds of the day, returning 670 percent to investors from 1956 to 1965 and laid the foundation for the next generation of managers such as George Soros who famously made $1bn by betting against Sterling in 1992.

Hedge fund managers are also handsomely rewarded – at least while the clamour among investors continues. Traditional managers are typically paid a percentage of assets under management – in the US, for instance, equity mutual funds charge around 1.1 percent of assets while money managers typically receive 40-50 basis points for managing equities for pension funds and endowments (a basis point is 0.01 percentage point).

In contrast, hedge fund managers typically get paid a management fee of 1-2 percent of assets and a performance fee – typically 20 percent of profits.

It remains to be seen, of course, whether the reinsurance industry can provide the kind of returns both the managers and the investors expect.

The search for returns

I Q S P R I N G 2 0 0 5 2 1

Nephila Capital Initially formed in 1997 as Willis Asset Management, Nephila Capital Ltd is one of the pioneers in the reinsurance sector investing in instruments such as insurance-linked securities, catastrophe bonds, insurance swaps, and weather derivatives.

The founders of the company, former Willis Re brokers Frank Majors and Greg Hagood, have been trading these underlying products since 1998 and have been based in Bermuda since 1999. Its assets under management are not public, but are thought to be in excess of $500mn.

Nephila, which is named after a rainforest inhabiting spider that spins particularly strong webs, is understood to have participated in a number of reinsurance placements.

CooperNeff Advisors Inc Cooper Neff was formed in 1981 by Richard Cooper and Roy Neff as a proprietary options boutique but in 1995 became a wholly owned subsidiary of BNP Paribas.

Its funds have invested in risk-linked natural catastrophe instruments for some time and, in 2000, it created its Risk-Linked Assets Fund – one of the first hedge funds dedicated to reinsurance by investing in securities linked to catastrophic events.

As of 30 June 2004, CooperNeff had total assets under management in excess of $870mn, including (as of 31 December 2004) $159mn under its Risk-Linked strategy.

Citadel Investment Group The giant Chicago based Hedge Fund has established a Bermudian office under the auspices of former ACE Tempest chief executive Chris McKeown and is a significant writer of reinsurance risks.

Formed by Harvard graduate Ken Griffin in November 1990, Citadel has become a global leader in the hedge fund industry with over

750 employees and over $10bn in investment capitalisation.

Independence Re IQ understands Independence Re is set to become the latest hedge fund backed investment fund to participate in reinsurance.

Based in Bermuda, Independence Re is being formed by former Citibank executives David Govrin and Jeff Mulholland.

HBK Investments LP Based in Dallas, HBK describes itself as an “alternative investment firm”. Formed in October 1991 with $30mn of capital, the group is now one of the largest hedge fund managers in the world managing some $5bn in equity capital. Its desire to invest in reinsurance saw the group provide almost half of the equity capital of $300mn reinsurance start-up Glacier Re last year; but it has also indicated a willingness to participate more directly on programmes.

Fermat Capital Management LLC Based in New England and backed by a number of Dutch funds, Fermat Capital is also a specialist in the reinsurance sector, managers John and Nelson Seo investing in a number of products such as catastrophe bonds.

Hedge Fund players

I Q S P R I N G 2 0 0 51 4

P R O F I L E

Buying troubled reinsurers in the belief they can be turned around is a path often paved with the best of intentions, but the worst of results, so there is little wonder that White Mountains Re’s chief executive Steve Fass is quick to correct suggestions that his acquisition-hungry group has any intention of journeying in that direction.

The Bermuda headquartered White Mountains Re is now the world’s 15th largest reinsurance company after a series of adroit purchases including – in April 2004 - the capture of Scandinavian reinsurer Sirius International and, a few months earlier, the renewal rights of CNA Re’s property & casualty business. But although White Mountains Re has an

appetite for acquisition, it is picky over who it chooses to dine with.

“We just don’t buy distressed companies,” the former Skandia American executive tells IQ. “We buy decent companies…sometimes excellent companies, like Sirius, but we buy them from distressed owners.”

Fass, who until recently had been with White Mountains owned Folksamerica since its formation in

1980 (White Mountains was also formed in 1980 but it was only in June 1996, when it acquired a 50 percent stake in the US reinsurer, that the two companies first combined) points to Sirius as an example of the group’s strategy. “Sirius was a very good company, but it had fallen under the radar screen because of the problems at its parent ABB (the Swiss-Swedish engineering conglomerate which faced an asbestos-driven liquidity crisis).”

As ABB’s problems mounted – the company booked a net loss of $787mn and in January 2003 set aside $1.2bn in reserves for US asbestos claims – Sirius began to suffer on the back of downgrades from worried rating agencies. It was clear ABB needed to sell Sirius; nor was there any shortage of interested buyers drawn

by Sirius’ focus on short-tail reinsurance lines (meaning

it has avoided catching too many US casualty nasties). There was, however, the problem of Sirius’ ill-fated

Bermudian finite reinsurance adventure, Scandinavian Re. In run-off since February 2002, most potential suitors were keen to leave Scandinavian Re with ABB.

“Others would have paid more,” explained Fass “but we got the deal because we took the ugly bits! We did extensive diligence which included evaluating the economics of every contract in force. We were also able to limit our downside by negotiating some seller protections. In

effect, we were paid quite a bit of money to take this subsidiary as part of the transaction.”

Exit visas “What sets us apart is that we have experience of structuring deals that meet the sellers objectives. If they want finality we can give them that; if they want the PR of saying ‘we sold at book value’ we can agree to that. In other words, we give companies the exit visa they are looking for. But it is always on our terms,” he adds.

White Mountains’ success in issuing these exit visas led to the creation of the Bermuda-based holding company White Mountains Re in April 2004 to consolidate its acquisitions and the appointment of Fass as its president and chief executive along with Michael Maloney and Michael Tyburski as managing directors. The group houses Sirius Insurance Group, White Mountains Underwriting, Folksamerica, Sirius America (a primary company), and Fund

American Reinsurance. In all, White Mountains Re has combined regulatory capital of some $2bn and over $2bn in gross premiums. Its US direct operations – principally the northeast insurer OneBeacon (acquired in 2001 for $2.1bn) together with Esurance and AutoOne Insurance – continue to trade separately.

Despite the creation of the holding company, Fass insists he will rule with a light touch

when it comes to company cultures. “We don’t try to shoe-horn our companies into a one size fits all approach – that would be self-defeating.”

Avoiding rivalries “The important thing is developing a seamless approach to clients and avoiding inter-company rivalry. In my experience, some of the most aggressive competition comes from different trading units in the same reinsurance groups. We avoid this by instilling a culture that all the business unit heads work for the same financial goals of the company… in other words it doesn’t matter who produces profit, as long as it is produced,” he asserts.

Indeed, this was a lesson Folksamerica learned the hard way. In 1980, the reinsurer was established with $10mn of capital. But on the back of liability losses and an outdated view in the business which regarded it as bad form to decline renewals, the capital had shrunk to a mere $4mn by 1984. Fass was then promoted from chief financial officer to chief executive and given the remit to turn the company’s fortunes around. “I started with the simple premise that a well run company should never lose 60 percent of its capital,” he recalls.

Fass continues: “A myth had developed that the industry had a cycle consisting of three good years followed by three down years and one simply had to remain in business to produce industry average results. But if we had continued in this vein, Folksamerica simply would have gone out of business.”

Instead, Folksamerica restored its capital base to $10mn and, establishing an “Underwriting Comes First” rule, began to cull its book. “We wrote around $10mn of business in 1983 but only $2mn in 1984. At the time it was regarded as rather radical, but it put us in good stead to enjoy the hard market which began in 1985”.

This prudent approach enabled the reinsurer to grow significantly

Fast exit visasWhite Mountains and its US reinsurance

arm Folksamerica both celebrate their 25-year anniversaries later this year.

IQ looks at a business model which celebrates the acquisition of quality

businesses from troubled owners...

“We buy decent companies…sometimes excellent companies, like Sirius, but we buy them from distressed owners.”Steve Fass, chief executive, White Mountains

1 5I Q S P R I N G 2 0 0 5

White Mountains and its US reinsurance arm Folksamerica both celebrate their

25-year anniversaries later this year. IQ looks at a business model which

celebrates the acquisition of quality businesses from troubled owners...

in the late 1980s and then, as conditions began to turn, Folksamerica was able to again decline renewals. But this strategy was combined with a series of acquisitions that enabled the reinsurer to continue to grow its book while being selective on underwriting. “We were clearly industry consolidators before it became fashionable,” exclaims the New Jerseyan.

It also helped that Folksamerica had no qualms about avoiding sectors that – in hindsight – have caused so many problems, such as medical malpractice and Directors’ and Officers’ cover. “Most of our casualty business tends to be shorter-tail, such as auto exposures,” Fass explains. “The 300 percent, or so, rate increases enjoyed by D&O writers in recent years is, of course, attractive, but we just find the business very difficult to price. Maybe if meaningful tort reform occurred, but until that time we will concentrate on the business we understand,” he adds.

Yet despite both White Mountains and Folksamerica’s 25-year pedigree, it has been the post-WTC years which have really shaped its current guise. From the group’s New Jersey offices on the Hudson River, there is a startling view of the Manhattan skyline – an unenviable location, however, to watch the attacks unfold as Fass did on 11 September 2001.

But as the initial shock subsided, Fass ensured the company responded swiftly. “Prior to 9/11 we had been looking to expand internationally. But the competitive rate environment was holding us back. Therefore we were sitting back and seeing our book shrink in terms of business renewed.”

“Afterwards, however, we really came into our own. We had controlled our book of business and had always worked on the assumption that at some point there would be a $50bn industry loss. I expected it would be an earthquake or other natural disaster, not a terrorist attacks. Nevertheless, at $30mn net our loss was less than 10 percent of surplus. In fact, in the fourth quarter of 2001 we were the only reinsurer to show an increase in surplus, largely because of the gain in value of our holdings in US treasuries!”

The question was how to respond to the new market conditions and the industry’s newfound demand for reinsurance capacity. In the immediate aftermath, Folksamerica doubled its surplus from $400mn to $800mn

with a cash injection from its parent. This was followed up with the creation of a Dublin based managing agency WM Underwriting Ltd, before White Mountains sponsored the creation of two “class of 2001” Bermudian start-ups.

The most prominent was Montpelier Re, formed with $1bn of capital in December 2001 and with the support of White Mountains and the reinsurance broker Benfield Group plc. It has been a high profile success and the reinsurer now has a market capitalisation of $2.5bn and its shares trade the New York Stock Exchange.

But less well documented was White Mountains’ involvement with Olympus Re, a specialist $500mn capitalised property cat reinsurer which – in contrast to many of its 2001 peers – had the aim of remaining in private ownership and providing long-term underwriting returns. Although White Mountains doesn’t own a stake in Olympus Re, the group produces business on its behalf. It seems to work well (in its first two years of trading the reinsurer has earned more than $300mn net income, the equivalent to 60 percent of its start-up capital) and enables Olympus to operate with spartan efficiency from its Bermuda office headed by Sheila Nicoll, the former Marsh executive.

Inevitably, however, for an organisation that has thrived on acquisitions and M&A activity, there is still the appetite for further deals – notwithstanding the market cycle. “It looks like we are again coming to the stage in the market where we will be content to lose business to our competitors. But we still want to talk to good businesses,” Fass explains.

Indeed, since buying Sirius International, the Swedish headquartered reinsurer has acquired Tryg-Baltica International from the Danish banking group Tryg Vesta and has formed a new aerospace reinsurer unit after recruiting Mario Montelatici and his team from Converium. Both deals were struck last autumn and both new arrivals came from distressed positions (TBI will be put into run-off and Sirius will selectively renew the accounts). It looks like White Mountains will be offering exit visas for some time to come...

1 6 I Q S P R I N G 2 0 0 5

CAPITAL MANAGEMENT

Ca$hbackWith declining rates and signs of surplus capacity, there are signs that Bermuda's class of 2001 is prepared to return capital to shareholders

A declining rating environment unchecked by record catastrophe losses and the prospect of further deterioration on casualty legacies provides a backdrop to one of the greatest challenges to the (re)insurance industry: How to manage capital effectively in the downturn.

The challenge is nowhere greater than in Bermuda, where narrowing opportunities for premium growth compounded by balance sheets swollen with spoils of the hard market harvest have raised capital management to the top of the agenda.

Rapidly maturing alumni of the so-called class of 2001 have grown to witness the total equity level of companies domiciled on the island more than double from $20bn to an estimated $45bn, according to figures from Morgan Stanley.

Broker Benfield’s analysis of the 25 largest reinsurance groups (excluding Lloyd’s) revealed that their total capital base grew 5 percent to $159bn between 31 December 2003 and 30 June 2004. The US contingent grew 6 percent, but it was Bermuda that grew the fastest at 7 percent.

At the same time, an investment community accustomed to each new quarter yielding a record breaking set of results creates additional pressure to retain the high levels of return, while rating agencies pull the other way with demands for conservative reserves and an ever more solid capital base.

In order to balance the need of a growing business with those of shareholders still hungry for sustained and adequate returns,

reinsurers are left to choose between a number of strategies.

If companies stick to the watchword of underwriting discipline, turn away from the temptations of price cutting, and retain capital to satisfy rating agencies, then returns on capital will inevitably decline compared to 2004.

But if participants follow the path of many of their predecessors in past soft markets, continuing to cut rates and write for market share simply to deploy capital, returns are likely to drop less sharply, only for underwriting profitability to suffer down the line.

A third way, in an effort to counter falling rates, is for some of the capacity to be rationalised through consolidation of players in the market.

The evidence to date suggests that, at least for now, Bermuda’s youngest breed is set on a different course – to return surplus capital to investors through increased dividends and share buybacks.

According to reinsurance broker Benfield in its recent reinsurance and renewals report "Outrageous Fortune", the sum capital of the five principal start-ups that launched on the island following

the tragic events of 11 September 2001 had increased by 67 percent between incorporation and the end of the third quarter of 2004, from $6.4bn to $10.7bn.

During 2004, Endurance and Montpelier Re returned a total of approximately $130mn to investors through share buy-backs. And on 14 February 2005, the largest of the post-9/11 start-ups AXIS Capital announced it had agreed to repurchase $350mn founder shares, with $300mn from Blackstone Capital Partners III, and $50mn from DLJ Merchant Banking Partners III.

Montpelier Re, which bought back 1.26 million shares from founding investor AIV Holdings for $43.6mn in June, concedes that it has surplus capital. Chairman, president and CEO Anthony Taylor – a former Lloyd’s underwriter – said that the move followed a number of successful quarters in which the company had “generated excess capital, over and above the need of our growing underlying portfolio”.

A further buyback in August saw the company pay $21.9mn for 625,000 of its shares from another founder, Gilbert Global Equity Partners. Taylor commented: “We will continue to look for opportunities to selectively repurchase shares

as part of our commitment to capital discipline and to delivering superior returns to our shareholders.”

When Endurance initiated the first tranche of its share repurchase in May, buying two million shares from one of its founding investors Lightyear Capital for $65mn, chairman and CEO Kenneth LeStrange commented: “Capital management has and will continue to be a cornerstone of our strategy. The repurchase of shares allows Endurance to reduce significant overhang from on of our initial investors at attractive valuation.”

On 16 February 2005, the company announced it had increased its share repurchase plan by an additional two million shares, taking its total authorisation to 3.2 million shares. Endurance also raised its quarterly dividend to 25 cents a share, an increase of 19 percent.

Growth in buybacks and special dividends was arguably stunted by the record losses in the hurricane season, which hit a number of Bermudian operators hard.

In his well-respected weekly publication IBNR, VJ Dowling, the founder of equity house Dowling & Partners, recently estimated that founder investors in the Bermuda Class

“ Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.” Mahatma Ghandi

SOURCE: BENFIELD

1 7

FOR FURTHER DETAILS OF OUR SERVICES, PLEASE CONTACT

ALAN QUILTERTELEPHONE: +44 (0)20 7481 1010EMAIL: ALAN.QUILTER@CAVELL.CO.UK

ROBIN MCCOYTELEPHONE: +44 (0)20 7398 2750EMAIL: ROBIN.MCCOY@CAVELL.CO.UK

WWW.CAVELL.BIZ

CAVELLCOMMUTATIONSRENDEZ-VOUS 2005NORWICH 13-16 JUNE

Cavell has developed a transatlantic presence and offers clientsdedicated teams of professionals focused on providing exit solutionsas well as run-off management and collection services.

FOR FURTHER DETAILS OF OUR RENDEZ-VOUS, PLEASE CONTACTJIM MORANTELEPHONE: +44 (0)1603 599340EMAIL: JIM.MORAN@CAVELL.CO.UKWEBSITE: WWW.COMMUTATIONS-RENDEZVOUS.COM

“Providing risk carriers with the opportunityto meet and negotiate with counterpartiesfrom around the world”

035095 CAVELL RVNCH05 A4 advert 17/11/04 11:33 pm Page 1

I Q S P R I N G 2 0 0 5

1 8 I Q S P R I N G 2 0 0 5

of 2001 sold approximately $2bn worth of shares in 2004, compared with just $500mn in the whole of 2002-3.

On top of the share buybacks, in the region of $980mn of market value was remarketed through secondary offerings for AXIS and Endurance stock. Endurance closed a secondary offering of 8.85 million of shares at $34.85 in March, while AXIS priced 20 million of its shares at $27.91.

An additional $940mn was sold in block trades or spot secondary offerings for Montpelier Re, Endurance and Platinum.

The deal with the highest profile was naturally Endurance’s block sale of 9.8 million shares belonging to co-founding investor Aon, coming as it did hot on the heels of the Spitzer investigation into broking practices that had spotlighted the close relationship between intermediaries and (re)insurers.

New York attorney general Eliot Spitzer testifying at a Congress sub-committee in November, had criticised the “huge transfer of insurance capital to Bermuda”.

“Many of these offshore entities are either owned in part or operated by the insurance brokers themselves. Marsh helped to create the Bermuda-based ACE Ltd, XL Capital Ltd, Mid Ocean Re and Axis, while Aon has sponsored LaSalle Re and Endurance. This sets the stage for conflicts of interest, steering and self-dealing in insurance and reinsurance markets that we are just beginning to understand,” he told Senators.

Marsh’s private equity arm MMC Capital, through the Trident funds, has backed (re)insurance start-ups ever since industry legends Bob Clements and Bob Newhouse set up ACE in 1985 following the US excess liability crunch.

The SEC has launched an investigation to determine whether Marsh’s directors, officers and large investors were benefiting from the funds inappropriately.

Is capital surplus?Writing in this publication in Autumn 2005, Benfield’s Chris Klein noted that returning capital

to shareholders must be based on the rationale that the capital is in fact surplus to requirements.“In an industry that does not know the ultimate price of its goods at the time of sale, and may not do so for many years, such assumptions can be fraught with danger,” he warned.

Highlighting Converium’s annus horribilis, Klein pointed to the continuing stream of shock reserve strengthening announcements, particularly for US casualty business written between 1997 and 2001.

According to Klein, this issue is particularly relevant to the post-9/11 start-ups who, unlike their post-Andrew predecessors, set up as multi-line businesses. With softening property catastrophe rates, 2003 and 2004 renewals saw increasing focus on casualty business, especially US risks, as management allocated capital to segments offering potentially higher returns.

While most acquisitive behaviour of the new Bermudian companies has centred on non-legacy renewal business, Klein warns “the immaturity of the (casualty) book has raised some questions about the wisdom of releasing capital so soon after assuming the risks”.

The power of the ratings agencies will continue to counterbalance the threat that too much capital be cut loose from the balance sheet for the sake of shareholder appeasement.

At Standard & Poor’s annual conference last June, analyst Mark Puccia said in principle the agency was not against companies returning capital to shareholders, as long as the capital management plan was well thought out and accompanied by a sound business plan. Puccia cited Montpelier Re as an example of how to achieve this.

AM Best, however, has suggested that reinsurers will hit the downturn in the market “with less redundant capital while facing more pressure from investors for risk-adjusted returns on the capital they do hold”.

As Klein commented: “It will be interesting to watch whether the rating agencies adjust their

capital adequacy models to accommodate cyclical variations in the quality of premiums written. It is a long-standing irony that in a hard market when volumes increase, but exposure per dollar is falling, the capital models seem to penalise good quality growth and vice versa.”

And in IBNR, Dowling wrote: “Unfortunately, we worry (that) the rating agencies that matter (S&P/AM Best) will hinder the proper allocation of capital (read: its return) through overly conservative capital requirements. We expect the Bermuda class of 2001 to feel the full brunt of the rating agencies’ stringent capital approach (where actual requirements > modelled requirements).”

During an earnings call, Jim Bryce, CEO of property cat reinsurer IPC Re (one of the 1992 entrants), was asked how much flexibility his rating agencies allowed him to return capital “a bit more aggressively”.

Bryce answered by saying that it was down to the board of directors to decide, adding: “We don’t work for the rating agencies. We pay them a fee. They analyse us.”

Of course, the other option open to players in a softening market is consolidation – but views are mixed as to whether such moves are likely, or indeed desirable.

Vinay Saqi, insurance equity analyst at Morgan Stanley, thinks consolidation is likely in the marketplace. Indeed, as he points out, this was the eventual destiny of no less than five of the start-ups from the class of 1992 – when capital flooded the island in the wake of the then record Hurricane Andrew losses and consequential property cat capacity crunch.

“Preventing this consolidation trend outright from happening seems to be the same reasons we have heard before: concern about legacy reserves, rating agency constraints about use of capital, and a lack of strategic fit… Eventually someone will take the plunge and others are likely to follow, fearing the consequences of being left behind.”

But research from Standard & Poor’s suggests that, across

the sector, post acquisition performance of merged entities has been poor, with few exceptions (see Autumn 2004 issue of IQ, The Cost of Consolidation).

Dowling suggests that M&A opportunities are more limited for Bermudian class of 2001 reinsurers than other areas of the market.

“The natural desire to preserve the tax advantages on the island limits the group to either (a) combine with an existing Bermuda (re)insurer (which, we would suggest, has more to do with the ultimate ownership structure and management than any logic or 'shareholder value') or certain European buyers; or (b) to effect a 'reverse merger' to facilitate the movement of a profitable US specialty insurer offshore (or possibly a UK vehicle),” he suggests, noting that Bermudian shareholders must have greater than 50 percent of the combined company in order to maintain tax advantages.

For Dowling, the natural choice for the class of 2001 is to continue repurchasing shares – not least to dispel any question of a conflict of interest in the management of the company.

“We are mindful of the influence of founding shareholders on some Boards of Directors and would also suggest there is a conflict of interest if these shareholders remain on the Board and also sell shares. In today’s environment you shouldn’t do both.”

“Looking ahead we believe founding shareholders and remaining shareholders will both benefit by the repurchase of founders’ shares (at the appropriate discount to market price). It’s a delicate balance but a win/win opportunity,” he concludes.

And with estimates that, including warrants of $1.3bn, the current value of class of 2001 founder shares is around $8bn, buybacks and increased dividends – at least in the short term – are likely to remain the strategy of choice.

CAPITAL MANAGEMENT

Ca$hbackWill (re)insurers hand back surplus capital?

I Q S P R I N G 2 0 0 5 2 1

The run-off industry came of age a number of years ago but what is striking now is the consistency with which the industry is coming up with innovative solutions to achieve finality for both policyholders and for owners of dormant (re)insurance companies.

The continuing rise in the popularity of schemes of arrangement is well documented – in this IQ run-off report we hear from several of the pioneers of the schemes – but they are only one of a number of methods of bringing closure to run-off books. As Steve Mathews of actuarial consulting firm EMB describes on page 20, there are a number of options available from organic run-off to the sale of the entire portfolio to a specialist third-party.

Indeed, this is exactly what ACE Ltd did with the run-off investment group Randall & Quilter Investment Holdings Ltd over the Bermudian giant’s asbestos reinsurance exposures – a deal which, if regulatory approval is gained later this year, will demonstrate the industry’s ability to bring closure to even the most complicated and volatile of exposures.

ACE shareholders welcomed the company’s announcement on 6 January that it has agreed – subject to regulatory approval - to sell ACE American Reinsurance Co, Brandywine Reinsurance Co (UK) Ltd and Brandywine Reinsurance Co SA, to London-

based Randall & Quilter, removing 17 percent or $1bn of run-off liabilities from the company’s balance sheet. It was undoubtedly the most significant transfer in the run-off industry since the sale of CNA Re’s International arm to Tawa in October 2002.

But why would Randall & Quilter want to purchase asbestos debt? “We have taken a billion dollars in liabilities and we’re going to end up with $1.1bn in assets,” the former Lloyd’s regulator and company founder Ken Randall told IQ, adding that they have agreed with ACE to pay back a proportion of residue capital if it is able to manage down the liabilities successfully. “We also have the benefit of ACE’s work with Tillinghast in the US and Milliman’s in the UK, we are pretty comfortable with the numbers,” he added.

Randall & Quilter chose the reinsurance book because it is easier to do commercial settlements with insurance companies than with direct policyholders, but Randall would not even rule out the possibility of buying more of ACE’s run-off exposures (Brandywine has been causing ACE a headache ever since it was inherited from the 1999 acquisition of CIGNA’s property & casualty business). “We have done deals with direct portfolios and would do them again, but the reinsurance was a good place to start,” he explained.

It is a powerful statement of intent from Randall, one of the pioneers of the nascent run-off industry in the 1990s when he formed the Lloyd’s focused Eastgate Group Ltd, later sold to the outsourcing company Capita Group plc. Since then, however, more investors have cottoned on to the potential of the run-off industry leading Randall to criticise some of the “naïve” capital which, he suggests, has poured into the sector looking to buy run-off books.

“Investing capital into buying insurance companies in run-off is a long-term venture, you have to be able to take a 10-year plus view, rather than simply think you can be in and out within three years,” he explains, before adding that Randall & Quilter’s New Jersey based private-equity backers GSC Partners have exactly that long-term mindset.

The rise of the scheme Ironically, however, it has been the industry’s ability to innovate that has allowed people to dream of quick exits. As we note later in this section, schemes of arrangement have become increasingly popular in bringing finality to portfolios that might otherwise take years to close.

Of course, they are far from universally popular. Indeed, in the US – where cynicism is at its highest – they are often tagged “scams of arrangement”. These naysayers point to the speed at which policyholders must approve often highly complicated arrangements and even suggest that they legitimise a scorched earth policy (an accusation which is still levelled at some run-off managers in the industry).

Among the most vocal critics are, naturally enough, the legal industry. Robert Hammesfahr, a lawyer with US attorneys Cozen O’Connor, probably epitomised the views of these critics when he commented: “If run-off reinsurers are insolvent or otherwise unable to cover their obligations, the recourse should be liquidation with court supervision, and not an investment profit for a financial speculator.”

“Reinsurance performance should not – and cannot be – a tortured process of obstacles, intractable questions, land mines, water hazards, fallen bridges and false promises,” he continued

But these views are changing and there is no denying that many policyholders have been happy to enter into schemes of arrangement. Thus far, as Ruxley’s John Winter points out, 32 different initiatives have come to the market involving 44 solvent schemes. A host of others are also in the pipeline for later this year, many of which involve Dan Schwarzmann’s team at PricewaterhouseCoopers LLP.

The challenge for the run-off industry, however, is to see whether it can continue to be innovative and entrepreneurial, not least in demonstrating that schemes can be applied to complicated transactions. As Winter remarks: “The key question now… is that of how solvent schemes need to continue to evolve if they are to provide a viable mechanism by which to tackle very large and complex books of discontinued business within hundreds of millions, rather than tens, of millions of liabilities.”

There are other signs of progress. In the US, for instance, the creation of the Association of Insurance and Reinsurance Run-off Companies (AIRROC) in October 2004 promises to provide a platform for the industry’s development in the US. The momentum for tort reform may also see meaningful progress at a federal level on asbestos exposures.

Against this backdrop, however, the run-off industry continues to expand. KPMG, for instance, estimates that the total liabilities of the UK non-life run-off market, including business written at Lloyd’s, now stands at £41.1bn ($77bn) – around 25 percent of the UK non-life market as a whole. Extrapolate that figure globally and estimates rise to between $220bn-$400bn for total liabilities. The need for innovation and creativity is here to stay.

As the run-off industry matures, it is bringing ever-greater innovation and creativity to owners of discontinued businesses

Running with innovation

I Q S P R I N G 2 0 0 52 0

RUN-OFF

Exit strategies, their timing, their scope and the tools employed to execute them are among the most important judgements that insurance and reinsurance companies ever make. The difference between a well ordered run-off – be it a whole company or just a line of business – is usually worth many millions of dollars.

In the past two years there has been a sea-change in attitude towards run-off, which is no longer automatically seen as an admission of defeat. Of course, insurers and reinsurers are sometimes forced to stop writing business after getting it hopelessly wrong. Equally, run-off can simply be an acknowledgement that all products, in any industry, have a life cycle. There is now a growing recognition that a well-timed, well-ordered exit strategy is a sign of a professionally managed (re)insurer.

Yet the stigma remains, along with the temptation to allow emotion and pride get the better of you. The two most important decisions about any run-off are taken very early in the process. Getting the timing right and then choosing the most appropriate strategy are critical to the success of any run-off. Companies that stick with outdated strategies until the inevitable catches up with them quickly lose control of the process. Executive egos can then prove very expensive.

Your choice of run-off strategy (see box-out) will depend on individual circumstances, such as whether or not the company continues to write business, the reliance on reinsurance, the size of run-off, the priorities of shareholders, attitude to risk and financial robustness.

The overriding factor may well be the inherent uncertainty about the ultimate liability of the portfolio. In any accelerated exit strategy this uncertainty will be translated into a risk load, which is a premium you pay to mitigate the risk of the portfolio deteriorating further. This can sometimes be so expensive that the only viable option is solvent

run-off, assisted by an assertive approach to commutation.

Indeed, whatever your chosen route, it is essential to reduce this uncertainty to a minimum. A good, detailed understanding of your portfolio and all the possible scenarios will reduce your risk premium and facilitate both the choice and execution of your strategy. The demands of shareholders, and now the FSA, are such that it is no longer sufficient to blindly use aggregate claims projection techniques – assuming the future development will mirror the past. You should use the underlying policy and claims information to understand how the account and the exposures have changed over time and assess the effect this will have on future claims development.

The graph below represents the underwriting volumes by year of a troubled reinsurer, created after a detailed examination of the portfolio. The thin black lines with little boxes indicate policy length. The diagram shows not only that underwriters turned up the volume just as the market was at its softest, but they also wrote contracts averaging between 1.5 and 2

years in duration. This knowledge has severe implications for reserving that would not become apparent during a standard aggregation exercise.

This illustrates the benefit of understanding your commitments at individual contract level. This will enable you to get the best possible result from each contract and to maximise the value of our own reinsurance. The old approach of using averages to negotiate your portfolio is, by contrast, wasteful and inefficient.

A second, even more important factor is that good practice and the FSA’s Financial Condition Assessment and Internal Capital Assessment make it crucial that you can predict the full range of likely outcomes and in the process demonstrate robustness under extreme duress. It is possible, using the latest software, to create stochastic models that test your operation under any number of possible scenarios. Any shortcomings can then be rectified in line with regulatory requirements and the company’s own risk appetite.

The exit strategy flow chart above maps out the main routes. The best way to compare the different strategies is to create stochastic

models, which take into account all possible scenarios. These will show the range of profits/losses and relative chances of solvency with each different route.

These illustrations give just a flavour of how analysis of your liabilities and assets (including reinsurance contracts) can be translated into financial benefits. The process also makes it cheaper to exercise whichever option you adopt since people are more likely to accept your liabilities – and to do so at a lower risk loading (hence a lower price) – if they know what they are taking on.

Whilst this more technical and sophisticated approach to run-off is welcome, and is saving many millions of dollars every year, it points to a supreme irony. Many insurers and reinsurers only submit their portfolios and reserving to such rigorous scrutiny after they have gone into run-off. If only they had done so while they were going concerns, they might still be in business and their shareholders considerably better off. But that is another subject for another day.

Steve Mathews is a senior consultant at non-life actuarial consultancy EMB.

Making good your escape

Policy term by Underwriting Year

Deciding when and how to go into run-off can make a big difference to the financial outcome. Yet it is often approached in a haphazard manner, says Steve Mathews of EMB

I Q S P R I N G 2 0 0 5 2 1

Solvent run-offSolvent run-off is a continuation of the old operation without the underwriting. It takes the guesswork out of assessing your liabilities by enabling you to wait for them to crystallise. Solvent run-off can, however, encourage an ad hoc mentality, leading to ineffective use of capital. Of all the options, it takes longest to establish finality and can, therefore, be the most expensive to administer.

CommutationsThe great advantage of commutation is that it provides true finality, but it can be time-consuming, as Equitas has experienced. It requires deals to be made on an individual basis and, of course, both sides must be willing to compromise.

Reinsurers must also agree to set aside their right to avoid claims on case reserves and settled IBNR. Getting their agreement can involve intense negotiations, sometimes amounting to a game of bluff and counter-bluff. The number of reinsurers involved may be so large that it is just not practical to approach them prior to the commutation.

Solvent schemes ofarrangementThis relatively new approach, recently applied by ING in exiting some of its run-off operations, is gaining acceptance. Provided you have the consent of at least 50 percent of claimants, amounting to at least 75 percent by value, you can commute your entire portfolio. You thereby gain finality without having to approach every single one of your creditors.

You have the same potential problems with outward reinsurers as with commutations, however, and policyholders will require compensation for the risk you are passing back to them.

Portfolio transferA particularly powerful tool, which binds reinsurers as well as policyholders. The disposing company pays a sum to cover the expected liabilities on a portfolio plus administration costs in return for finality. CNA’s disposal of CNA Re to run-off specialist Tawa (now CXRE) was a high profile example.

Negotiation can, however, be complex as the entity taking on your liabilities needs to be confident of making a profit. It can also be expensive, as you must satisfy the FSA and an actuary or other insurance expert that policyholders will not be disadvantaged.

Stop Loss Stop Loss policies involve purchasing reinsurance. This device was used by CGNU to withdraw from marine underwriting at Lloyd’s via the Marlborough syndicate. Quick and simple to construct, it has a creditable track record. Your reinsurer, though, will want a sizeable profit margin. You will still be liable if you exhaust your reinsurance layer or your reinsurer defaults, and you may still need to administer claims.

Choosing your exit strategy - the main run-off options

Solvent Portfolio

Commutation

Solvent Scheme

Portfolio Transfer

Limited Stop Loss

Run-off

Solvent Scheme

Portfolio Transfer

Limited Stop Loss

Commutation

Solvent Scheme

Portfolio Transfer

Limited Stop Loss

Solvent Scheme

Portfolio Transfer

Limited Stop Loss

RUN-OFF

I Q S P R I N G 2 0 0 52 2

In search of closureRecent developments suggest that (re)insurers are becoming increasingly sophisticated in their use of commutations agreements. IQ talked to Jeremy Fall, managing director, and Andrew Smith, assistant director, of industry consultants Chiltington to discuss the changing landscape

Over the past 15 years commutations have risen from near obscurity to become a booming, multi-million-dollar business used internationally by (re)insurers small and large. And in that time it has become clear that there is a growing appetite from cedants and reinsurers to use commutations to crystallise losses and avoid disputes.

For both parties the drivers of commutation activity have not changed substantially.

For cedants, there are three main benefi ts of commutation agreements: they can remove the potential for bad debts caused by the insolvency of a reinsurer; they can provide immediate cash fl ow, (an important consideration for cedants which themselves are experiencing fi nancial diffi culties) and they are an alternative to the costly and time-consuming process of litigation or arbitration.

For reinsurers the benefi ts are also clear: they provide the opportunity for underwriting losses to be crystallised and for administration costs to be reduced. And, in common with insurers, they are also often keen to fi nd an alternative to litigation and arbitration.

But according to Andrew Smith, assistant director of industry consultants Chiltington, there have been a number of changes in recent years, most signifi cantly in the sophistication of both cedants and reinsurers when using commutations. This is especially the case in the London Market, which has traditionally been viewed as being at the heart of commutations innovation.

One indication of this has been the extensive adoption of actuarial techniques on the larger portfolios – bringing better-supported commutation values and an edge on the negotiating table as a result. Another indication has been the willingness of larger UK companies such as R&SA and AXA to set up their own in-house commutations teams.

In the words of Jeremy Fall, Chiltington's managing director: “They’ve gone through a phase of using companies like ours, and now they’re more able to do it themselves. It’s very much an educational thing.”

But less positively, there is also evidence to suggest that this rise in clients’ understanding of the commutations process can be a double-edged sword, with the now more savvy players increasingly willing to stand their ground and use arbitration as a means of settling disputes.

For companies such as Chiltington this means bringing a different approach to the negotiating table. Says Fall: “Ten years ago we would do an inspection of records, we’d fi nd some issues that were of concern, and we’d discuss them with a cedant. Ninety nine times out of a hundred the issue would then be resolved with a commutation.

“Nowadays people are more aware of whether a technical issue has validity or not – and so are far more willing to challenge any issues raised. This means your negotiating skills are more important than ever and this is where we add value to our client’s own resources. It has also changed what services we offer. Where arbitration and litigation is concerned, we’re being used as factual or expert witnesses to support our clients’ case. Litigation can make it hugely expensive – but it’s part of people becoming more professional and more willing to stand their ground when they feel they’re right.”

Outside of the UK and Europe, however, such a confrontational stance on commutations has yet to take fi rm root and, indeed, commutations in general may have some way to go to gain full currency as an acceptable means of achieving fi nality. In the US, this is partly down to a difference in cedants’ appetite for risk: and partly due to fears that long-tail exposures could come back to haunt cedants once they have brought them

back onto their books.

Says Fall: “Where people in the UK or in Europe will try to aggressively close down their portfolios, in the US they are far more cautious.”

Yet even here there is evidence of some cultural change. For instance, the sale of Sierra Health Services property and casualty operations to Folksamerica indicates that US companies are increasingly willing to transfer risk in this manner – a development that observers suggest could accelerate a willingness to use commutations in the future.

Likewise, the increase in the size and frequency of Equitas settlements over the past year (witness for instance the $118mn agreement with EnPro Industries and the $245mn deal with Travelers in 2004) has also focused attention on the opportunities presented by commutations. In the words of Smith: “Five years ago, if you’d heard of someone doing a $100mn commutation you’d have been surprised; these days you’d hardly think twice. It all helps bridge the cultural divide and change mindsets.”

With increasingly sophisticated players and the spread of commutations activity to hitherto untapped markets, the question now is whether service providers will need to adopt completely new methods of doing business.

But, says Smith, regardless of how many innovations take place, the core skills needed for creating successful commutations will remain the same. “For the most part, success or failure depends on the individuals and personalities involved in negotiations,” he says. “It mostly comes down to how well people know the book of business, how competent they are in answering technical questions and how well they understand the exposure from an actuarial point of view. Those requirements will never change.”

Done deal: commutations are on the rise

RUN-OFF

Please contact us at:

Phone: +46 8 5884 3375

E-mail: run-off@lansforsakringar.se

Postal address: Wasa Insurance Run-Off Co Ltd

SE-106 50 STOCKHOLM, Sweden

www.wasarunoff.se

Wasa InsuranceRun-Off Co Ltd for all your run-offportfolio needs

10 years of proactive run-off

Cost efficient

Proven track record

I Q S P R I N G 2 0 0 52 4

Solvent schemes have fast become an accepted part of the insurance and reinsurance landscape. But more important, they are increasingly receiving board level attention as one of the few viable tools by which risk carriers can achieve finality for legacy problems.

To date, however, they have largely been used as a device to tidy up relatively straightforward books of discontinued business, although new ground has been broken with such initiatives as City General (where Ruxley delivered finality to an APH book in just one year) and Ruxley’s Aviation & General (A&G) project which is using a combination of acquisition, business transfers and a solvent scheme to bring finality to an underwriting pool.

The key question now, therefore, is that of how solvent schemes need to continue to evolve if they are to provide a viable mechanism by which to tackle very large and complex books of discontinued business with hundreds of millions, rather than tens of millions of liabilities.

Perhaps the most obvious answer is that ever-greater skill will need to be brought to the process of early contact with policyholders. It goes without saying that the focus which policyholders are likely to bring to bear on unresolved liabilities worth tens of millions of dollars is likely to be very different from that which is applied to a process which is tidying up an outstanding sum of, say, $5mn.

Similarly, where large companies decide to propose schemes for some of their smaller subsidiaries, if the parent holds lines on the same risks or in other subsidiaries within the same group it may prove difficult to ring-fence policyholder negotiations to simply focus on the business within the books to be schemed. As such, policyholders may well ask for identical settlement terms in respect of all the lines within the group, even though some of those lines are not included in the schemed liabilities.

One way in which to circumvent such problems is, of course, to sell the discontinued book to a third party so, in effect, creating

the necessary ring-fence by removing the run-off portfolio from its original corporate home.

Granted, the sale or transfer of discontinued business may have an immediate cost in terms of goodwill and investment write-offs – but with record profits still working their way through the system it can be argued that now is the time when risk carriers can afford to take such hits.

And, on the flip side, such disposals potentially have both an immediate positive impact in terms of release of funds previously tied up due to rating agency loadings for discontinued business and a reduction in ongoing expense ratios.

However, the issue of policyholder negotiations and the ability to ring-fence is only one of the issues of scale. Just as important, if not more so, is the question of speed.

Achieving finality in an appropriately timely manner is fundamental to the success of a solvent scheme as this brings the benefits of:• delivering considerable

savings in terms of legal and administrative expenses, so directly benefiting policyholders by releasing monies to fund payment in full of claims; and

• providing a prompt release of any surplus to vendors of legacy portfolios, so they can make better use of their capital.

While all this may seem extremely obvious, in practice, swift delivery of schemes requires high levels of specialist expertise – and the critical importance of that expertise is likely to grow in direct proportion to the size of the scheme being undertaken.

At its most basic, a solvent scheme of arrangement provides the legal and regulatory framework within which such projects take place. The real work is carried out in the engine rooms that power such initiatives.

A wide range of activities create the platform from which it becomes possible to deliver the core objective – that of an appropriate scheme structure underpinned by fair and transparent process which together deliver swift finality

on the liabilities in question.

For a start, absolutely fundamental to the whole process is having not just the will, but also the ability and experience, to dissect existing and usually inadequate data so that policyholders can be tracked down to the specific individual responsible within each organisation.

In other words, one of the most important issues relating to schemes – that of the amount of work that has to go into ensuring policyholder addresses and details are correct – is one that does not even appear in scheme documents.

With A&G, for instance, Ruxley had to identify some 1,250 addresses and had to spend the time equivalent of one person working full time for nine months in tracking down missing policyholder details. Similarly with City General some 25 percent of policyholders had missing details that had to be identified.

And that is only the start. Widespread policyholder consultation and communication is another fundamental of delivering any scheme and happens through almost every form: advertising, letters, recorded delivery mail, phone, emails and face-to-face meetings. The A&G project, for example, involved some 10,500 plus mailings and over 200 face-to-face meetings.

Another key part of the process is that high levels of information need to be assessed by the engine room behind the scheme, so again requiring well developed processes for the transfer, analysis and management of claims information.

Again while this may sound obvious, in practice it is a far from straightforward process as sense needs to be made of huge quantities of, often paper, files where typical complications include policyholders being listed under as many as five different variations of their names.

Overall, Ruxley estimates the process of bringing finality to the A&G portfolio will have taken over 17,000 man-hours, and that was using highly experienced Ruxley staff who are very time efficient.

As a result, it will be interesting to see how, with ever bigger run off portfolios seeking finality, the industry steps up to the challenge of making sure tomorrow’s solvent schemes are appropriately comprehensive and yet still sufficiently swift to deliver their benefits.

When properly executed, solvent schemes offer a genuine solution to the legacy problems that have been a running sore for the sector, damaging the general perception of competence and viability of the industry as a whole.

What is more, given ever more stringent investor demand for sustainable and meaningful returns on capital, the cost of managing discontinued business, not to mention the capital cost in terms of rating agency loadings, are pressures that live businesses could well do without, especially when the market is softening.

However, senior management need to think very hard about how to execute initiatives to remove dead business from risk carrier balance sheets, especially if they are planning to tie up considerable internal resource to do so. That solvent schemes for such large books can be delivered, there is no doubt. But to do so effectively will require a level, depth and focus of expertise this is still relatively rare in the run-off world.

The scheming solution By John Winterchief executive, Ruxley Ventures

A numbers game: Larger schemes can become more difficult to handle

RUN-OFF

I Q S P R I N G 2 0 0 5 2 5

Solvent schemes: A process of evolutionSolvent schemes have come a relatively long way in just under a decade. An evolution from the schemes that were originally developed in the early 1990s to cope with insolvent run offs, the first solvent schemes started to appear in the mid 1990s.

Since then some 32 different initiatives have come to the market (ie those where schemes have actually been issued) involving 44 solvent schemes.

During this time solvent schemes in themselves have also evolved significantly.

While the initial schemes were mainly relatively small “tidy up” exercises within much larger established companies, various of the subsequent ones have been more complex in terms of structure, content or scope.

Analysis of the various scheme structures to date shows that wide variations

now exist on key factors such as time bars, discounting and so forth.

For instance, while seven of the schemes state that the time value of money will be taken into account when settling claims, some 29 explicitly state it will not. Similarly while seven state that the time period from the scheme becoming effective to the claims been timed barred is in excess of 90 days, nine provide for less than 90 days to bar date and 25 specify 90 days exactly.

Separately, 27 include a provision, so far unused, under which the scheme would revert to run off if for some reason liabilities significantly fail to develop as expected and some 10 of the 44 enable advisers to be remunerated on a contingent fees basis.

Such variations in structure largely reflect the fact that that one of the advantages of schemes is the ability to tailor the proposal to recognise specific issues that exist in

respect of a particular book of business. For instance, the 29 schemes that state they will not discount for the time value of money are all dealing with short tail accounts.

By the same token, however, this flexibility means high levels of expertise are required when drafting such mechanisms in order to ensure the proposed terms are appropriate to the policyholder community affected.

The scope of solvent schemes is also developing. More recent initiatives, such as City General and National Insurance & Guarantee Corp, have dealt with the closure of APH books while others, such as Aviation & General, have used transfers of business to tackle the vexed issue of underwriting pools.

As such, the next stage in the evolution of solvent schemes may well be one of scale – ie dealing with discontinued books with gross liabilities of hundreds, rather than tens of millions.

Closed schemes (as at 1 February 2005)Name Issue date Effective Bar Closure Time span Scope

date date date (issue to closure)

Hopewell International May-95 Jun-95 Jun-99 Tidy up **

Scottish & Commonwealth Nov-97 Feb-98 Mar-98 Jul-02 56 months Tidy up *

HIR (UK) Dec-97 - - - Tidy up **

Osiris Oct-98 Nov-98 Feb-99 Mar-00 17 months Tidy up

Mutual of Omaha Dec-98 Feb-99 May-99 Dec-99 12 months Tidy up

Trent May-99 Nov-99 Feb-00 Dec-00 19 months Tidy up

Crombie (UK) Jun-99 Oct-99 Jan-00 Nov-00 17 months Tidy up

Ramus Feb-01 Apr-01 Jul-01 Oct-01 8 months Tidy up

Transcon Jul-01 Sep-01 Nov-01 Sep-02 14 months Tidy up

Hassneh Feb-02 Apr-02 Jul-02 Aug-02 6 months Tidy up

City General May-02 Oct-02 Jan-03 Jun-03 13 months APH account

Dunedin Pool (4 identical schemes) Aug-02 Jan-03 Apr-03 Jan-04 17 months Tidy up

ING ( 5 identical schemes) Oct-02 Dec-02 Mar-03 Dec-04 24 months Tidy up

La Metropole Feb-03 Jul-03 Oct-03 Jun-04 16 months Tidy up

Marlon May-03 Aug-03 Nov-03 Dec-04 19 months Tidy up

National Insurance & Guarantee Corp May-03 Aug-03 Nov-03 Dec-04 19 months APH account

Riverstone May-03 Aug-03 Nov-03 Dec-04 19 months Tidy up

Arig (UK) Aug-03 Sep-03 Dec-03 Sep-04 13 months Facultative account

FIGRE Dec-03 Mar-04 Jun-04 Sep-04 9 months Tidy up

Blackfriars May-04 Jul-04 Oct-04 Dec-04 7 months Tidy up

* = All claims were agreed within 7 months

** = Dates of closure not known Source: Ruxley Ventures

Schemes not yet concluded (as at 1 February 2005)

Name Issue date Effective Bar Closure # Time span Scope date date date Nichido Fire & Marine of Japan Nov-01 Jan-02 Mar-02 tbc tbc Tidy upTrident pool ( 2 identical schemes) Oct-03 Dec-03 Apr-04 Apr-05 18 months Tidy upLudgate Feb-04 Apr-04 Jul-04 Apr-05 14 months Tidy upLakewood Mar-04 Jun-04 Feb-05 May-05 14 months Tidy upTanker Apr-04 Jul-04 Oct-04 Feb-05 10 months Tidy upSt Helens Trust ( 5 identical schemes) May-04 Jul-04 Oct-04 Jun-05 13 months Tidy up Aviation & General May-04 Aug-04 Nov-04 Mar-05 10 months APH businessQuincy Mutual assume May 04 Jul-04 Dec-04 tbc tbc Tidy upSeven Continents Jul-04 Oct-04 Nov-04 tbc tbc Tidy upKorean Aug-04 Oct-04 Jan-05 tbc tbc Tidy upMoorgate Oct-04 Dec-04 Mar-05 tbc tbc Tidy upPan Financial Oct-04 Dec-04 Mar-05 tbc tbc Tidy up

tbc = to be confirmed# = Anticipated date of closure. ## = Time span included three business transfers. Source: Ruxley Ventures

RUN-OFF

Big in the US “What goes around comes around.” This quote is probably attributable to a very smart person who most likely worked in the fledgling insurance and/or reinsurance industry back in 1638 when Cuthbert Heath wrote the first reinsurance contract in a coffee shop run by a guy named Edward Lloyd in the City of London.

In our industry, this phrase has never been more appropriate. The following is a synopsis of the runoff industry in the United States:

In the mid-1980s, when the concept of discontinued business was in its early stages and first seen as something that was possibly tangible, the trend was to in-source the discontinued business by setting up a unit to maintain the business until it went away.

In the late 1980s and mid-1990s, there was a market contraction in staff, created in part by the automation that had been promised for two decades along with the realisation that long-tail business meant more than three years. This contributed to the formation of third-party runoff managers along with a crowd of consultants offering bundled and unbundled services to the industry.

The mid-1990s through the early 2000s saw financial reinsurance and portfolio assumptions becoming tools used by third-party entities to build their runoff portfolios. Buzzwords of the day were “good bank – bad bank” and “are they providing for finality?” (In most cases “they” were not!) Activity during this period was fostered by fears of Y2K and the perceived breakdown of old legacy systems. In-house runoff units started getting a bit more sophisticated, but still would look to outsource consulting-related

services such as inspections and reinsurance collections. Specialised consulting is available from all sizes of entities ranging from large accounting firms to solo service providers.

Today, we find the runoff industry in an era which offers a hybrid of potential services. “Horses for courses”, is a phrase I’ve heard used for years in the UK that seems to be a useful analogy. By this I mean that the menu available to insurers and reinsurers is full of appetisers, entrees, desserts and prix-fixe options. Basically, you buy what you need.

Some companies use third-party runoff administrators to take on processing and business mitigation functions rather than have to worry about maintaining a staff for which they have dwindling needs. Others seek exit strategies which may or may not include sale of the liabilities or reinsurance protection. Runoff managers seek to partner with capital sources to provide the processing and “value added solutions” to third parties that house the liabilities. And finally, many companies are keeping their runoff “in-house” and purchasing unbundled services when needed. In many ways, we have returned to where we started 25 years ago. Today, there are more options available to an insurer or reinsurer than there are menu choices at a restaurant.

What’s missing is a forum where insurers and reinsurers can meet with other insurers and reinsurers who share the common bond of runoff liability in their portfolios. While there are many articles written on the subject of runoff and many more new conferences focusing on runoff issues, there is no place where the companies can work among themselves to improve the runoff industry.

In the UK, there is the Association of Run-off Companies (ARC) which was formed in 1998 as an informal arena for like-minded entities to look at business issues germane to the London Market. ARC offers a variety of membership options and has attracted over 200 members from a field including insurers, reinsurers, brokers, service providers and law firms. Membership is open to all as long as the service type firms provide services to a member company. (For more information visit their website at www.arcrunoff.com.)

During 2004, a group of insurers and reinsurers started exploring the possibility of forming a trade group in the United States that could address the issues of runoff companies. This new group is known as the Association of Insurance and Reinsurance Runoff Companies, Inc. (AIRROC); a New York-based non-profit corporation.

AIRROC’s mission statement is simple and clear:

“… to promote and represent the common business interests of insurance and reinsurance companies in runoff. The Association’s objectives will include improving professional and managerial standards and practices, and enhancing knowledge and communications within and outside of the run-off industry through educational activities.”

Currently, AIRROC has in excess of 30 members, including international insurance and reinsurance companies, several receiverships and liquidations, all of which have given the organisation access to some of the best runoff talent and experience in the industry.

Membership in AIRROC is open to all risk-bearing entities that have runoff in their portfolio.

Third-party providers can act as representatives of member companies, but membership and voting privileges are limited to risk-bearing entities.

AIRROC has created 11 committees designed to evaluate current runoff practices and procedures, set appropriate benchmarks and matrices to measure performance and explore various methods and strategies to ensure success:

Benchmarking Research Committee: study production metrics, evaluate runoff companies’ compensation plans and set standards for personal and professional development;

Early Closure Committee: study closure strategies, claims estimation and cut-throughs;

Intermediary Services Committee: research and monitor solutions to industry trends, intermediary performance issues and the impact of privacy issues on the development of a common database;

IT Committee: research solutions for various IT platforms needed to produce effective runoff reports;

Reinsurance Committee: work with runoff companies, insurers and receivers to set minimum criteria for common document requirements and streamline the reinsurance collections process;

Commutation Event Committee: organise annual commutation event by partnering with other event sponsors;

Education Committee: provide a forum to distribute information on the receivership process, regulators’ and reinsurers’ concerns, and effective strategies to resolve runoff issues;

Legislative/Amicus Committee: monitor legislative efforts to change the insolvency and

Run-off in the United States finally gets its own representative body AIRROC - and not before time, argues Arthur P Coleman

I Q S P R I N G 2 0 0 52 6

RUN-OFF

One small step: The US finally gets its own run-off

association

I Q S P R I N G 2 0 0 5 2 7

Big in the US runoff industry, liaise and share information and recommendations with the RAA, and work with the NAIC on relevant issues including progress of the Model Receivership Act; Marketing Committee: promote AIRROC membership, industry awareness of the Association’s efforts and accomplishments, and AIRROC website advertising;

Publications Committee: create AIRROC publication, determine and solicit applicable articles or papers, liaise with other related publications and create news releases for AIRROC website;

Website Committee: construct and oversee maintenance of AIRROC website.

AIRROC is also planning an Educational Conference and Commutation/Networking Forum which will be held in the fall of 2005. The event will gather insurers and reinsurers from all over the world in an educational and networking environment. Other educational events are planned for 2006.

More information regarding AIRROC can be found at its website www.airroc.org.

Hosting the bulk of the worldwide runoff market, the formation of AIRROC symbolises the maturation of the discontinued business industry in the United States. In parallel with this development, we have also

witnessed in recent years a metamorphosis within major US carriers in their approach to the subject. The establishment of specific business units within major carriers is now the norm, not the exception. There is now recognition of the value of employing specialist staff to focus on managing liabilities divorced from ongoing underwriting operations. As the value of discontinued business has skyrocketed in recent years, so has the attention of senior management on the subject.

Notwithstanding the insurance and reinsurance industry’s historical address of latent liabilities, the discontinued

business sector shows signs of continued expansion. Merger and acquisition activity will drive further discontinued business as much as retrenchment and the expulsion of weaker risk bearers from the market. State and federal regulatory oversight will also obviously play a part.

For an estimated $94bn industry in the United States, AIRROC comes not a moment too soon.

Arthur P. Coleman is executive vice-president, Global Resources Managers Inc and vice chairman, Association of Insurance and Reinsurance Run-off Companies, Inc (“AIRROC”).

I t ’s c lear from our perspect ive. . .

In a global industry our independence and international network of offices enables us to provide expertise locally to

serve our clients’ needs.

Just some of the services we are able to offer our clients include:

Consultants to the insurance and reinsurance industry

Chiltington International Ltd8-10 St Saviours Wharf, 23-25 Mill Street

London SE1 2BETel: +44 (0)20 7252 0316

www.chiltington.comARGENTINA • AUSTRALIA • CHILE

ENGLAND • GERMANY • PERU • USA

Inspection of records Due diligenceCoverholder reviews Underwriting compliance auditRun-off Commutation negotiationsDebt Collections

RUN-OFF

I Q S P R I N G 2 0 0 52 8

Few experienced practitioners in the insurance and reinsurance markets would doubt that the run-off segment of the market is huge, global and growing rapidly. This reflects a continuing trend of industry consolidation, a relentless pursuit of costs reduction and increased awareness of, and sensitivity to, the risk of significant deterioration in loss reserves. As a result there has been an increasing willingness to discontinue unprofitable or unattractive lines of business, which has been further encouraged by greater scrutiny of the deployment and management of scarce capital resources and the focus on return on capital, particularly by external rating agencies.

Discontinuing business is only the beginning of the endLong term run-off is rarely a cost-effective or capital efficient course of action given the long term drain of run-off expenses, the inevitable management distraction of run-off and the long term risk of diminution of the value of reinsurance protections. Hence, various exit strategies or options should be considered. These will possibly include an active commutations strategy, reinsurance solutions, or the sale or disposal of the portfolio of business concerned. Alternatively, depending on the circumstances, a solvent scheme of arrangement may provide the optimum route to finality and closure.

The concept of using a scheme of arrangement for solvent insurance companies in run-off was introduced many years ago. However, in recent years its application to such companies as a means of effecting a planned exit from the market has increased as schemes have evolved. Increasingly, high profile companies are using solvent schemes as a viable means of achieving finality and recent schemes have dealt with tens of millions of liabilities, including long tail liabilities emanating from North American policyholders.

Indeed, it is strikingly evident from the table below that solvent schemes have become

increasingly popular for discontinued insurance business, but what is the attraction…? The answer is simple. In seeking to balance the interests of policyholders, shareholders and all other stakeholders, the objective is finality and a solvent scheme usually provides the flexibility to tailor an appropriate solution.

What is a scheme?In the UK, a scheme of arrangement under section 425 of the Companies Act 1985 is a compromise or arrangement between a company and its creditors or any class of them. It becomes legally binding on all creditors or any class of creditors if the necessary majority vote in favour of the

scheme and it is approved by the High Court. It is similar to a US plan of reorganisation.

Why is a solvent scheme proposed ?Where insurance policies have been written on an occurrence basis, claims could arise indefinitely. As a result, it is very difficult to finalise the run-off of a company that has written long tail business. A solvent scheme can introduce a wholesale estimation (or valuation) of all present and future claims by a set date, thereby, in essence, effecting a commutation (or cut-off) with all policyholders and allowing a final

distribution to be made. Usually, cedants and policyholders are required to submit claims by a certain date and the company is required to agree them or submit them to independent adjudication.

Such a scheme is usually proposed as part of a strategy to finalise the run-off while the company is solvent in order to achieve certainty, finality and the possible release of capital otherwise tied-up that could be better employed elsewhere.

The advantages of solvent schemesThe attractiveness of a solvent scheme is its ability to provide a solution that balances the needs of all the company’s

stakeholders. This is essential for a solvent scheme to be accepted in the market and hence meet the objective of finality. The various stakeholders could include, amongst others, policyholders/cedants, claimants, reinsurers, brokers and the Financial Services Authority (FSA).

A solvent scheme seeks to present a deal that balances the needs of each of the key stakeholders and it is therefore important that, during the promotion and implementation of a solvent scheme, all perspectives are considered.

Dan Schwarzmann (above) is a partner and Gary Bray (below) is a

senior manager in the Solutions for Discontinued Insurance Business

team at PricewaterhouseCoopers.

Website: www.pwc.com/discontinuedinsurance

Email: discontinuedinsurance@uk.pwc.com

Scheming the futureDan Schwarzmann and Gary Bray of PWC look at the growth of discontinued insurance business and the increasing popularity of solvent schemes of arrangement

RUN-OFF

I Q S P R I N G 2 0 0 5 2 9

The main advantages usually arising from solvent schemes are:

• Certainty and finality – any doubt a cedant or policyholder might have over the solvency of the company and whether its insurance protection will perform can be removed by a solvent scheme.

• Flexibility – a solvent scheme can be designed to deal with the specific circumstances of each case and the particular needs of the stakeholders in a cost effective and efficient commercial manner, for example, it can deal with a book of business or all of a company’s business.

• Early payment – a solvent scheme will provide a mechanism for estimating and agreeing all present and future claims allowing policyholders to receive payment earlier than would be likely in a run-off in the normal course.

• Run-off costs – some of these, which may be incurred in the normal course for many years, can be avoided by a solvent scheme and such savings may in turn provide financial benefits to stakeholders.

• Shareholder equity – residual value, if any, can be realised at the earliest opportunity through a solvent scheme.

• Solvent schemes can be designed to include “safety-valves” so that there is limited risk to companies entering a solvent scheme.

Solvent schemes for poolsThe first solvent schemes were for non-complex books of business. This methodology has now, however, been developed and applied for the first time to UK pools. In a recent case, the members of an underwriting pool each effected a solvent scheme for their participation in a pool. From a legal perspective, policyholders needed to approve each company’s solvent scheme, and this was achieved through having separate votes for each pool company at the same creditors’ meeting. From a practical perspective only one

scheme document was required and once the solvent scheme became effective only one “pool-level” claim was needed to be submitted by creditors.

The solvent scheme was able to simplify the complex arrangements and relationships commonly observed in pools, and formalise the sharing arrangement for the pool liabilities enabling the liabilities to all be dealt with on a consistent basis.

Solvent Schemes - not just a UK solutionSolvent schemes have now been developed for a number of UK branches of overseas companies and also companies deemed to have “sufficient connection” to the UK, for example because of their policyholder makeup. There have also been solvent schemes for companies domiciled in countries (typically commonwealth jurisdictions such as Bermuda and Singapore) where section 425 Companies Act-type provisions are available.

An example of the application of solvent schemes for foreign companies was that for various subsidiaries of the ING Group. The schemes covered the international discontinued reinsurance business of four Dutch and one Australian company. All five schemes were presented in one scheme document enabling the shareholder to adopt a parallel approach in developing, promoting and gaining the requisite support from policyholders.

It is also worth noting that an opportunity is now available for a solvent scheme solution in the US. In 2002, Rhode Island became the first state to enact a statute that allows a solvent company in run-off to reach a court supervised agreement with all of its creditors to accelerate the completion of the run-off.

Whilst for either legal, technical or commercial reasons solvent schemes may not be suitable for all types of business, their flexibility means that they are continuing to grow in popularity for the very real and proven benefits they deliver to all stakeholders.

Locking out uncertainty: Schemes offer the closure companies crave

RUN-OFF

I Q S P R I N G 2 0 0 53 0

The London Market can justifiably claim to be the run-off capital of the world, although whether this is something to be proud of is more debatable.

Certainly the international nature of the London Market has left it exposed to most of the significant global events that have affected insurers, not least US asbestos and pollution. This has led to very significant property and casualty liabilities in run-off in London and these are growing.

The sheer scale of the problem and the impact upon the balance sheet of so many entitles coupled with the entrepreneurial spirit that exists in London has seen it lead the world in formulating solutions to address the problems of discontinued business. This has been underpinned by having, within a tight geographical area, a full range of professional support services. This creates real competition which itself engenders innovation and creative thought. The UK also benefits from having a regulator who encourages the market, in an open and transparent way to find real solutions to the ever-increasing burdens of the past.

This significant volume of run-off has been managed both internally and by specialist outsource providers.

Whilst the larger part of the discontinued liabilities remain within the original entities, including dedicated run-off vehicles such as Equitas, outsourcing to professional organisations has become an increasingly favoured option.

London Market OutsourcingThe last decade has seen a market typified by a handful of large players offering a full service run-off and generating a turnover in excess of £10mn

per annum for third party work, alongside numerous smaller entities offering a limited number of professional services such as inspections and debt collection. Whilst the fortunes of the individual participants have fluctuated over the years the basic balance has remained fairly constant. Personally I believe this will change.

So who will be the ‘New School’?Will the ‘small boys’ join the ‘big boys’ and will the larger players grow, contract or die? Indeed, is there a future for the third party management of discontinued portfolios?

Firstly I cannot foresee the ‘small’ becoming ‘big’. Many of the smaller players operate quite profitably within their niche and have little motivation to seek substantial growth. Also it is a matter of economics.

The larger run-off companies are significant businesses – PRO employs 300 staff in the UK. We and our peers have the critical mass to invest significant sums in staff development and training, in systems, in strong controls and corporate governance procedures and compliance, and in business development. At PRO we are fortunate that we have the resources, the desire and a supportive shareholder which allow us to invest in the future in a way that the smaller entities cannot.

I believe that the biggest single factor however is the changing nature of the market. This will prevent the smaller entities being able to experience substantial growth, will lead to the demise of some of the bigger players and see the growth of new entrants.

London does lead the world in formulating real solutions

to the problems of the past. The explosion in the number of solvent Schemes of Arrangement over the last two years, with an increasing number announced each month, coupled with the growth in entities willing to purchase discontinued operations, are the most striking examples of these. Part VII transfers are another. As a result there is significantly reduced motivation for an insurer to outsource its business in run-off when it can potentially obtain finality. This, coupled with the decline in insolvencies in recent years has significantly reduced the amount of business that is outsourced in the company market. Lloyd’s has seen some activity but even this is relatively little compared to the amount of liabilities in run-off for the 1993 and subsequent years of account.

Run-off managers will have to evolve or die. Some will use the skills they have developed in run-off to migrate to other areas such as back office support or outsourcing generally. Others may seek to compete directly with the established purchasers and/or seek to expand overseas.

I expect that each of the large run-off managers can proclaim its expertise in solvent Schemes of Arrangement, and either directly or indirectly facilitate the purchase of discontinued business. It is of course an exaggeration, but perhaps not much of one, to say that London is currently awash with funds looking to buy companies in run-off. There is a big difference between intent and delivery and it will be interesting to see who such capital really supports, who they believe can truly effectively manage down the purchased portfolio to finality and deliver the returns they demand.

I believe that private equity will in part drive a rationalisation of

the outsourcing run-off market in London. Some of the larger players have or are currently going through an MBO process, supported by a business plan as to how these companies will be developed. Whether reality or not there is an expectation from private equity that, freed from the burden of a bigger group, there can be a benefit to the bottom line in terms of reduced costs. Beyond that in a highly competitive environment where a crude yardstick of success is how effectively and quickly one descales an operation it will be interesting to see whether in the medium term expectations can be met. Whether the freedom to operate outside the constraints of a large group outweighs the benefits of having the backing of a strong and reputable parent company remains to be seen.

Private equity will want to exit in the medium term and one way of doing so may be to force consolidation even if this is not envisaged by the current management.

In conclusion I believe that alongside an array of smaller niche entities there will be a small number of significant players who purchase discontinued operations and manage the run-off themselves together with a reduced number of professional outsource providers. These outsource providers will be increasing and highly skilled and offer a much wider range of services, products and solutions including purchase, and will operate internationally. The ones that survive and prosper will be those that have the drive, imagination and desire to succeed and the ability to select relevant products and services from the range they offer to deliver tailored solutions to individual clients.

The Future Management of London Market Run-off?By Lee Brandon, chief executive of PRO Insurance SolutionsThe New School

Flocking to run-off: but what course will smaller players set as the market matures?

RUN-OFF

QCQUANTUM CONSULTING, INC. IS A LEADER IN HELPING CREDITORS

AND LIQUIDATORS REALIZE CURRENT CASH VALUE FROM

NON-LIQUID ASSETS.

Joseph F. ScognamiglioTelephone: (718) 802-9423 Facsimile: (718)-802-9701

Email: joescog@bigplanet.com

Marcia RuskinTelephone: (212) 369-5432 Facsimile: (212)-369-7794

Email: mruskin@bigplanet.com

■ We acquire your insurance or reinsurance claims against insolvent estates in exchange for cash or a joint venture structure if preferred;

■ We absorb the collection risk of insurance receivables;

■ We increase your firm’s bottom line by purchasing assets you have probably written off;

■ We relieve you of the administrative burden of monitoring and pursuing difficult collections;

■ In addition to our factoring services, we perform contingency collection services and provide insurance industry consulting and advisory services.

We look forward to hearing from you. For further details please contact:

Wasa have moved portfolios between different jurisdictions to stay on track

By Johan Lagerwall, EVP of Wasa Run-off

Portfolio transfer An effective run-off tool?

3 3I Q S P R I N G 2 0 0 5I Q S P R I N G 2 0 0 53 2

As many (re)insurers will testify, managing run-off businesses can be a drain on both management time and company resources – and these difficulties can multiply when the units are overseas.

This was the problem faced by the newly merged Scandinavian insurance group Länsförsäkringar Wasa group when, in 1998, it consolidated its various run-off operations into Wasa Insurance Run-Off Co Ltd. Wasa Run-Off owned four individual reinsurance companies and also managed seven run-off portfolios for other members of the group. Two of these reinsurance companies, Wasa International (UK) and Stockholm Re (UK), were domiciled in the UK.

Wasa’s solution was genuinely pioneering: it became the first company to transfer business using the then new UK regulations under the Financial Services Act 2000 to repatriate the Wasa International UK portfolio to Sweden. In itself, this was innovative but Wasa is now examining whether it would be appropriate to bring the business back to the UK to wind up via a scheme of arrangement. In this

article we examine why

it was sensible to transfer the business to Sweden and what logic there might now be to bring it back to the UK.

The journey to SwedenA comparison of the levels of cost in the UK and in Sweden showed that it would be far more cost efficient to run the UK businesses in Sweden. Not only were the office and staff costs far higher in London, but so were the professional advisory fees. Sweden’s strong IT knowledge and infrastructures were also attractive and, to cap it off, Wasa’s Swedish staff were more experienced in pursuing aggressive commutation strategies.

There were a number of options available, including the continued run-off in the UK, a solvent scheme of arrangement, selling the companies or portfolios to a third party, transferring the administration to Sweden but retaining the business legally in the UK or transferring the portfolios to Sweden.

The latter, however, proved to be the most attractive. It enabled the group to benefit from the economies of scale of having all the run-off entities

together, together with the lower cost base of Sweden and Wasa’s experienced staff.

Wasa Run-off set up a project team with a clear imperative: to transfer the Wasa International UK (WIUK) portfolio to Sweden and to liquidate WIUK and its holding company. The legal sub project was responsible for the transfer, the de-authorizations and the

liquidations of the companies, while other sub projects were responsible for incorporating the WIUK business into the daily run-off work of the Swedish staff, set up commutation goals and to see to it that the data was transferred correctly and that the IT systems worked efficiently.

The first objective was reached on the 23 October 2002 when the UK High Court approved the plan to repatriate WIUK to Sweden, the first time a company had transferred business using the new UK regulations (Financial Services Act 2000).

Yet more progress was made on the 22 March 2004, when the High Court approved the transfer of Stockholm Re (UK)’s portfolio to Wasa International Insurance Co Ltd in Sweden and made an order for the dissolution of Stockholm Re (UK).

Wasa Run-Off has always focused on an active run-off through commutations, in order to minimize liabilities as efficiently as possible. The Swedish reinsurance company Wasa International is a good example: It went into run-off in 1993 and, ten years later, less than 2 percent of the reserve is remaining.

If you pursue a successful commutations strategy there will come a time, however,

when it is no longer viable to run the business off because the investment income has diminished so far that it will not cover expenses. Unfortunately, under Swedish law solvent schemes of arrangement – a highly efficient method of closing run-off businesses – are not possible.

Journey back to the UK?One alternative, of course, is to merge the portfolio into a larger in-house entity to obtain economies of scale. But a more intriguing possibility could be to transfer a mature portfolio (back) to the UK and then put it into a solvent scheme.

This means that a business could be taken to a jurisdiction such as Sweden and the liabilities managed down before returning to the UK for finality.

There should be no conflict between a portfolio transfer and a scheme; on the contrary the benefit would probably be maximised if these two tools were combined. The advantage of the low cost for administration in Sweden and the finality through scheme in the UK is efficient in terms of resources and time.

Run-off is a growing business and it will continue to do so because (re)insurance is a constantly changing business. Catastrophic and unpredictable events such as the WTC attacks, the US hurricanes and the Indian Ocean tsunami mean companies will need to respond and often restructure; these changes in strategy will often result in books of business in run-off. Wasa is demonstrating that it is possible to transfer these portfolios to different jurisdictions in order to obtain the most efficient results.

Wasa have moved portfolios between different jurisdictions to stay on track

By Johan Lagerwall, EVP of Wasa Run-off

Portfolio transfer An effective run-off tool?

As many (re)insurers will testify,

article we examine why

it was sensible to transfer the business to Sweden and

together, together with the lower cost base of Sweden and Wasa’s experienced staff.

Wasa Run-off set up a project

while other sub projects were responsible for incorporating the WIUK business into the daily run-off work of the Swedish staff,

RUN-OFF

3 3I Q S P R I N G 2 0 0 5I Q S P R I N G 2 0 0 53 2

The continuing consolidation and ongoing emphasis on reducing expenses is causing more insurers and reinsurers to discontinue unprofitable lines of business, and in many instances close offices and subsidiaries.

Whilst insurers no longer writing these more spicy risks may breath a sigh of relief, the related risk lives on and in many cases for 10 years or more in the form of long-tail liability exposures. Historically, insurers were prepared to manage these discontinued businesses to conclusion in a somewhat laissez faire approach. Those more relaxing days are gone and most insurers are looking for closure and a clean exit from this arena at the earliest opportunity, thus preventing an impact on their financial and market credibility.

So what’s the solution? In response, many large companies no longer write certain lines or locations, opting to sell the renewal rights to existing business but retain the obligation to service and pay claims emanating from long-tail

casualty business. Insurers make the decision to run-off business because they want to concentrate on what they do well and eliminate smaller, less profitable business segments. Whatever the reason, the result is the same: run-off business from these defunct or lines of business must be cared for even after the business is gone.

In many instances insurers segregate run-off business from their ongoing, core business and administer internally. Difficulties arise when a business discovers that claim run-off can be a burdensome task, involving years of administrative costs and an ongoing responsibility to a line of business that it no longer writes. Servicing run-off business detracts from a company’s core strengths. The final irony is that as revenues from the eliminated line shrink, the administrative costs of handling run-off often continue to grow. For example: if an insurer changes its lines of business from, say, commercial to personal lines, they must maintain staff that are able to respond to the challenges emanating from a line that the company no longer writes. In reality, the energy and resource required to do this actually defeats the businesses initial purpose in creating the run-off. The logical progression is that more insurers and re-insurers are turning to specialist service companies to handle their run-off business and in particular the claims handling and administrative element.

The benefits of utilising a specialist company are:

• By utilising a bespoke run-off claims operation it enables a company to concentrate on its core business without the distraction of managing an historical book of work

• In addition to the removal of the burden of handling the run-off claims, an outsourced service can demonstrate cost savings on a retained, in-house operation

• Because the specialist claims handling company is concentrating on the run-off as

a live contract, it is not seen as a distraction to an insurer’s current business strategy

• A stringent suite of service level agreements and key performance indicators can be put in place, enabling all involved to ensure that the service company is performing - thus maximising the benefits without having to manage the claims themselves. The result of this focus is that a different approach can be taken to expedite the conclusion of the claim, which is not always the case when the run-off is managed in-house

Insurers in the market for outsourcing their run-off claims handling operation should not be looking for a one-size fits all approach. Ideally, they will source a dynamic and flexible solution that not only brings finality but also provides a cost saving over an in-house alternative, together with the enhancement of their reputation. The service company should be able to provide a tailored claims handling solution, including a single 24/7 focal point for the receipt of claims and notifications, the application of the correct level of investigation, whether via specialist adjusters or desk handlers, and the engagement of outside experts where appropriate.

The more imaginative claims handling offerings are able to provide this level of service all wrapped up in a bureau operation, which manages the supply chain, financial reporting and all encompassing management information and tracking.

The run-off claims industry will continue to grow, as the need for finality in discontinued unprofitable lines of business becomes a driver. The businesses that are considering the alternative to an in-house strategy, or shedding the administration burden and utilising a specialist operation, are looking for a cost-effective option to their existing capabilities. Insurers require imaginative and flexible solutions, which are bespoke to their needs but at the same time wrapped up in a single offering.

The claim to run-offSean Ball of Cunningham Lindsey examines the relationship between efficient claims management and successful run-off

Sean Ball is business development director at

Cunningham Lindsey UK

The claims function is a vital cog in a smooth run-off process

RUN-OFF

EXECUTIVE FORUM

This question must be seen in context of the high number of catastrophes that occurred last year, and it is clear that these events prevented any excessive reduction in rates. On the whole, the market demonstrated good discipline in the early stages of the renewal process, and this was the prevailing opinion at the major reinsurance conferences last Autumn. However, the last two weeks of the renewal season saw some price softening. This would appear to be for two reasons; the phenomenon of localised underwriting and very focused underwriting on behalf of reinsurers looking to fill their aggregates within certain territories.

While there has been some softening it has not been followed by an easing in terms and conditions as the market has maintained discipline in this area.

Pricing has risen in those territories directly affected by the catastrophes in the third quarter of 2004, such as Caribbean companies whereas European programmes saw fairly consistent and modest price concessions. For Japanese ceding companies and regional carriers in Florida whose programmes renew in April and July 2005 it remains to be seen what price increases the market will seek.

For some of the specialist lines, such as marine and worldwide retrocession, rates held firm and in some cases increased on the back of significant losses. Conversely, aerospace has seen rates under pressure this season due to the continued lack of losses recorded in this sector.

On the casualty front, we have seen a good level of professionalism this season. Reinsurers showed more firmness than had generally been expected, to the point where some customers were surprised by inflexibility over technical conditions in contexts where this may not always have been fully relevant.

There is no getting away from the fact that the 2005 renewal season was tough. Indeed no one ever thought it would be easy, coming as it did after a spate of record natural catastrophes.

Despite an exceptional year of natural disasters -a record typhoon season in Japan, and an unprecedented string of hurricanes in US which resulted in substantial insured losses, and then the Asian Tsunami which had a devastating impact on the countries affected, companies are still planning to make a profit, albeit slightly smaller than expected, in 2004. As a result the capital base of the global insurance industry emerged relatively unscathed while earnings were effected.

That’s not to say that the hurricanes did not have a significant impact on rates, particularly on Floridian and other cat exposed regional programmes and national US catastrophes programmes affected by the hurricanes where rates either stabilised or increased.

Overall the reinsurance market has exhibited more discipline than the direct market, which is encouraging, but there are still warning signs. Recent industry reports highlight that renewals have been tough in many sectors. Clients and brokers have been seeking premium reductions following sharp rises since 2002 in a number of classes particularly aviation. It is important not to generalise and remember that although rates remained relatively stable we have seen signs of softening in terms and conditions. However, it is equally important not to be complacent. The industry may have weathered the storm in 2004 but there are testing times ahead.

Barring any major catastrophes in 2005 we expect further pressure on the reinsurance market due to increased competition throughout the industry as reinsurers still believe there is a significant margin in the business. The only way to counter this pressure is for the reinsurance market to remain disciplined and restrained.

I continue to believe wholeheartedly that good cycle management is the key to our future success and underwriters must have in place the tools to adequately price business relative to exposure. This remains the only way for reinsurers to resist the temptation to create more euphemisms to justify the need to support softening rates, terms and conditions.

Rolf TolleFranchise Performance Director of Lloyd’s

Overall the reinsurance market has exhibited more discipline than the direct market, which is encouraging, but there are still warning signs. Recent industry reports highlight that renewals have been tough in many sectors. Clients and brokers have been seeking premium reductions following sharp rises since 2002 in a number of classes particularly aviation. It is important not to generalise and remember that although rates remained relatively stable we have seen signs of softening in terms and conditions. However, it is equally important not to be complacent. The industry may have weathered the storm in 2004 but there are testing

Barring any major catastrophes in 2005 we expect further pressure on the reinsurance market due to increased competition throughout the industry as reinsurers still believe there is a significant margin in the business. The only way to counter this pressure is for the reinsurance market to remain Rolf Tolle

Franchise Performance Director of Lloyd’s

Grahame MillwaterChairman and CEO of Willis Re

This question must be seen in context of the high number of catastrophes that occurred last year, and it is clear that these events prevented any excessive reduction in rates. On the whole, the market demonstrated good discipline in the early stages of the renewal process, and this was the prevailing opinion at the major reinsurance conferences last Autumn. However, the last two weeks of the renewal season saw some price softening. This would appear to be for two reasons; the phenomenon of localised underwriting and very focused underwriting on behalf of reinsurers looking to fill their aggregates within certain territories.

While there has been some softening it has not been followed by an easing in terms and conditions as the market has maintained discipline in this area.

Pricing has risen in those territories directly affected by the catastrophes in the third quarter of 2004, such as Caribbean companies whereas European programmes saw fairly consistent and modest price concessions. For Japanese ceding companies and regional carriers in Florida whose programmes renew in April and July 2005 it remains to be seen what price increases the market will seek.

For some of the specialist lines, such as marine and worldwide retrocession, rates held firm and in some cases increased on the back of significant losses. Conversely, aerospace has seen rates under pressure this season due to the continued lack of losses recorded in this sector.

On the casualty front, we have seen a good level of professionalism this season. Reinsurers showed more firmness than had generally been expected, to the point where some customers were surprised by inflexibility over technical conditions in contexts where this may not always have been fully relevant.

Grahame MillwaterChairman and CEO of Willis Re

IQ asks a series of senior market f igures: “How satisf ied are you with the discipline displayed by the reinsurance industry at renewal?”

3 5I Q S P R I N G 2 0 0 5I Q S P R I N G 2 0 0 53 4

EXECUTIVE FORUM

Generally, I would characterise the global insurance and reinsurance marketplace as unsystematic during this latest renewal season. In some instances, the market seems to be impulsive and, in others, economically rational. With respect to the reinsurance marketplace, in particular, this behaviour is not inconsistent with my belief that the peaks and valleys of the current “cycle” will be dampened relative to “cycles” of the past. The market is experiencing some differentiating softening, but I am not anticipating anything like the extreme market behaviour of past cycles. We remain satisfied with the overall behavior and technical approach of the reinsurance marketplace.

The unprecedented claims burden from natural catastrophes this year has heightened risk awareness and appreciation for protection against losses from natural perils, particularly in the US. While property reinsurance premium rates are softening, any declines remain orderly – in the region of 5 –10 percent for loss-free accounts. Rate rises of up to 20 percent have been achieved for some loss-affected accounts. Outside the US, renewals were flat to down 10 percent on average. There were few coverage issues and the market competed on price not by broadening policy wordings.

The casualty reinsurance marketplace has proven even more resistant to rating pressures in most areas. Reinsurance terms tended to be flat with some minor variations in both directions. In general, initially, there appeared to be more pressure on pricing for professional liability than general casualty, although this moderated later in the year. Despite this, ultimate profitability is expected to remain attractive due to primary pricing coupled with tighter conditions outplaying loss trends. In general, primary pricing has flattened and, for some lines, has started to decline. These conditions appear to be changing at different paces both by segment and by line of business. Inevitably, circumstances of extreme change were demonstrated by weak, less technically able markets.

Many primary companies substantially increased their retentions, particularly for non-cat exposed lines of business, in response to relatively tight reinsurance terms, their evaluation of the profitability of the original business and their need to drive revenue for cash flow. Driving this may be a belief that balance sheets appear to have strengthened and, therefore, capital is available for increased retentions. However, history has clearly shown that this view has its limitations as the industry continues to drip-feed the never-ending legacy reserve and reinsurance recoverable issues. All that glistens, in our view, is not gold. As we navigate the markets in 2005 and 2006, it will be important for reinsurers to keep pressure on primary companies’ margins. Due to the limited number of quality reinsurance counterparties, I am optimistic that this might happen.

There was a feeling in the market that this renewal season would have a significant impact on the development of the insurance cycle as a whole. If we could maintain discipline in reinsurance markets then perhaps the precipitate slide on direct pricing would be halted and insurers might continue to write for an underwriting profit.

Maybe that is why there have been so many people with opinions; the question almost seems to have become “half full or half empty” – each of us taking a view that reflects our own personal experience and perception.

My belief is that, by and large, reinsurance markets have kept their discipline. There are some exceptions to this: On the property cat side one or two markets continue to underwrite irresponsibly, but these are the exceptions; by and large price reductions have been kept to a minimum and any softening of terms and conditions has been resisted. On the marine side, I had thought that reinsurers would have been able to take a stronger position after the Q4 losses but given the continued pressure on the direct side perhaps it is not wholly surprising that marine reinsurance rates have not hardened.

All in all, I believe that reinsurance markets have performed well and have managed to “keep their shape”. We were probably naïve however to think that this would be enough to keep the cycle under control. Rating pressure on the direct side continues to be acute and, over time this will put pressure on terms and conditions as well as deductibles.

Reinsurers kept their discipline at 1/1 but I believe that the pressure will continue. Although that cup looks half full at the moment I fear that it may be looking half empty by the end of the year!

Martin ReithCEO of Ascot Underwriting Ltd

be impulsive and, in others, economically rational. With respect to the reinsurance

appeared to be more pressure on pricing for professional liability than general casualty, although this moderated later in the year. Despite this, ultimate profitability is expected to remain attractive due to primary pricing coupled with tighter conditions outplaying loss trends. In general, primary pricing has flattened and, for some lines, has started to decline. These conditions appear to be changing at different paces both by segment and by line of business. Inevitably, circumstances of extreme change were demonstrated by weak,

Many primary companies substantially increased their retentions, particularly for non-cat exposed lines of business, in response to relatively tight reinsurance terms, their evaluation of the profitability of the original business and their need to drive revenue for cash flow. Driving this may be a belief that balance sheets appear to have strengthened and, therefore, capital is available for increased retentions. However, history has clearly shown that this view has its limitations as the industry continues to drip-feed the never-ending legacy reserve and reinsurance recoverable issues. All that glistens, in our view, is not gold. As we navigate the markets in 2005 and 2006, it will be important for reinsurers to keep pressure on primary companies’ margins. Due to the limited number of quality

There was a feeling in the market that this renewal season would have a significant impact on the development of the insurance cycle as a whole. If we could maintain discipline in reinsurance markets then perhaps the precipitate slide on direct pricing would be halted and insurers might continue to write for an underwriting profit.

Maybe that is why there have been so many people with opinions; the question almost seems to have become “half full or half empty” – each of us taking a view that reflects our own personal experience and perception.

My belief is that, by and large, reinsurance markets have kept their discipline. There are some exceptions to this: On the property cat side one or two markets continue to underwrite irresponsibly, but these are the exceptions; by and large price reductions have been kept to a minimum and any softening of terms and conditions has been resisted. On the marine side, I had thought that reinsurers would have been able to take a stronger position after the Q4 losses but given the continued pressure on the direct side perhaps it is not wholly surprising that marine reinsurance rates have not hardened.

All in all, I believe that reinsurance markets have performed well and have managed to “keep their shape”. We were probably naïve however to think that this would be enough to keep the cycle under control. Rating pressure on the direct side continues to be acute and, over time this will put pressure on terms and conditions as well as deductibles.

Reinsurers kept their discipline at 1/1 but I believe that the pressure will continue. Although that cup looks half full at the moment I fear that it may be looking half empty by the end of the year!

Martin ReithCEO of Ascot Underwriting Ltd

Michael A. ButtChairman of Axis Capital

3 5I Q S P R I N G 2 0 0 5I Q S P R I N G 2 0 0 53 4

3 6 I Q S P R I N G 2 0 0 5

Based upon the experience of GE Insurance Solutions and from what I see in the press, I would characterise the recent reinsurance renewal season as fairly stable. In terms of reinsurance and original primary pricing, which was presented to us for consideration, we would have hoped for more. Terms and conditions were also fairly stable, which is good.

But “stable” property pricing isn’t necessarily a rational response to the events of 2004. If you reflect on the number of significant hurricanes, typhoons and the devastating tsunami, I would have thought that we would have seen much stronger and broader property pricing. Despite the fact that property is truly a global product, the response to these events appears to us at GE Insurance Solutions to have been very localised. A reinsurer with exposures in Florida saw rate increases. Other insurers didn’t; their rates were probably flat-to-down. Reinsurers with exposures within the affected Caribbean islands saw rate increases, while those with exposures on the neighboring islands saw their rates probably only modestly adjusted. This localised reaction is understandable if the models used are accurately contemplated and risks were priced for these types of events. However, the experience of last year would seem to say otherwise, and many portfolios experienced losses that were a multiple of their modelled predictions.

On the casualty side, our indications are that there was fairly stable pricing with a few exceptions on the toughest exposures. However, industry capacity was entirely sufficient to complete most, if not all reinsurance programmes. The concern of anyone who has seen the escalating losses of certain casualty lines in the past several years is whether we are covering loss cost trends on the long-tail and excess casualty lines. It’s obviously critical that we get that right.

So, macroeconomics is at play in our industry. Plenty of capacity with moderate demand. Many of us are not troubled by a “stable” renewal season if we’re confident that we are getting a fair return for the risks we are taking. If we’re not getting a fair return then of course “stable” is anything but fine.

Ken BrandtPresident, North America and Asia Reinsurance division of GE Insurance Solutions

types of events. However, the experience of last year would seem to say otherwise, and many portfolios experienced losses that were a multiple of their

On the casualty side, our indications are that there was fairly stable pricing with a few exceptions on the toughest exposures. However, industry capacity was entirely sufficient to complete most, if not all reinsurance programmes. The concern of anyone who has seen the escalating losses of certain casualty lines in the past several years is whether we are covering loss cost trends on the long-tail

So, macroeconomics is at play in our industry. Plenty of capacity with moderate demand. Many of us are not troubled by a “stable” renewal season if we’re confident that we are getting a fair return for the risks we are taking. If we’re not

Much has been written concerning the state of the reinsurance market throughout this renewal season by various industry pundits, brokers and rating agencies so some of my comments below may seem repetitive. I am concerned with some areas of the market as we enter 2005, although the overall market behaved about as well as could be expected.

In summary, property rates were stable to down a bit; loss hit areas were flat to up 10 percent, while loss free covers obtained small decreases. Many underwriters posit that rates continue to be “technically adequate”. Casualty is beginning to soften with buyers able to obtain small improvements in coverage while rates remain unchanged. One area where reinsurers held firm is the D&O arena leading one significant primary writer to go without cover. One just has to wonder what will happen in the public D&O arena – severity is up, frequency may be as well, and primary pricing is falling.

What concerns us? I’d hoped that the trend of the last few years' tightening of market terms whereby many “finite” features (loss ratio caps, premium warranties, sub-limits by class, etc.) became more mainstream would continue. I think we’re seeing the first signs of slippage here (concurrently with large European markets commenting that they intend to impose limits on all business). Secondly, the potential large inflow of capacity, predominantly property, backed by investment vehicles (in lieu of “reinsurance capital”) could prove to be a dampening force on pricing. This remains to be seen, particularly as experienced underwriters are being recruited for these new entrants.

So how did the reinsurance market do over this last renewal season? In short… “Not bad”. We’ll soon have to stop using the phrase “technically adequate”.

Dave BrinningEVP, Client and Marketing Services of Max Re

EXECUTIVE FORUM

Much has been written concerning the state of the reinsurance market throughout this renewal season by various industry pundits, brokers and rating agencies so some of my comments below may seem repetitive. I am concerned with some areas of the market as we enter 2005, although the overall market behaved about as well as could be expected.

In summary, property rates were stable to down a bit; loss hit areas were flat to up 10 percent, while loss free covers obtained small decreases. Many underwriters posit that rates continue to be “technically adequate”. Casualty is beginning to soften with buyers able to obtain small improvements in coverage while rates remain unchanged. One area where reinsurers held firm is the D&O arena leading one significant primary writer to go without cover. One just has to wonder what will happen in the public D&O arena – severity is up, frequency may be as well, and primary pricing is falling.

What concerns us? I’d hoped that the trend of the last few years' tightening of market terms whereby many “finite” features (loss ratio caps, premium warranties, sub-limits by class, etc.) became more mainstream would continue. I think we’re seeing the first signs of slippage here (concurrently with large European markets commenting that they intend to impose limits on all business). Secondly, the potential large inflow of capacity, predominantly property, backed by investment vehicles (in lieu of “reinsurance capital”) could prove to be a dampening force on pricing. This remains to be seen, particularly as experienced underwriters are being recruited for these new entrants.

So how did the reinsurance market do over this last renewal season? In short… “Not bad”. We’ll soon have to stop using the phrase “technically adequate”.

Dave BrinningEVP, Client and Marketing Services of Max Re

3 7I Q S P R I N G 2 0 0 5

3 8 I Q S P R I N G 2 0 0 5

G L A C I E R R E

A cool proposition

European reinsurers have been through the mill in recent years. Since 2001, Munich Re, Swiss Re and SCOR to name but the obvious candidates have all endured the ignominy of multiple downgrades at the hands of rating agencies concerned about their long-term profitability record and prospects.

In September 2004, their concerns came to a head when Swiss reinsurer Converium admitted under-reserving to the tune of $598mn primarily on its US casualty business – an action that caused Standard & Poor’s to issue a devastating downgrade of Converium AG to a mere “BBB”, and its UK and German subsidiaries to “BBB-“. The result was the closure of Converium’s US operation, a $420mn rights issue and the near collapse of the company.

Less than two months after S&P’s action, start-up Glacier Re took to the water as the newest addition to the European reinsurance landscape – leading some sceptics to suggest that the timing of the launch was a ploy to snatch at Converium’s business.

But speaking in the days following 1/1 renewals, Robbie Klaus, CEO

of the Switzerland based start-up, told IQ that Glacier’s strategy was to avoid head-to-head competition with established players – and that the timing of the launch had more to do with a desire to satisfy demand in niche areas of the market that were crying out for fresh capacity.

“I was pushing for a pre-1/1 start,” he says. “I knew that some customers – especially in France – would like it if we were up and running before the end of 2004 and there was a lot of business out there which could use our capacity.”

The push for an early launch met with some success. On 22 December 2004, the reinsurer was granted a financial strength rating of “A-” (Excellent) and an issuer credit rating of “a-” from AM Best, which commented approvingly on the company’s “well-diversified book of business” based on the “strong relationships of the management team with broker distribution channels”.

On the same day it received its licence to write reinsurance business from the Swiss Federal Department of Finance. But this left just six days in the UK

and nine days in Switzerland to write business ahead of the crucial 1/1 renewals.

“The deadline for getting the capital providers together and getting everyone lined up was short,” says Klaus. “But we went through the approval process with all major brokers extremely fast and made it onto the renewal panels of all major insurers.”

Nonetheless he admits that the company will now have to make the most of the renewals deadlines that fall through the remainder of 2005.

“We may have been a bit late for some lines of business at 1/1 but there are a lot of people still out there who can use what we bring to the table. We expect our business will come out of aviation, marine, property cat, and Bermudian renewals through the rest of 2005.”

Klaus comes to his new home after 18 years in GE Frankona, most recently as chief of the global specialty division. And it was while at the reinsurer, he says, that he had the idea for Glacier Re. “I worked at GE Frankona from 1986 onwards and we were very strong in the aviation, property and marine portfolios. But some of the business mix I was underwriting just didn’t fit. There were limitations around what I wanted and was able to do.”

Thus fell the first flurry of a snowfall that was set to become a glacier. Says Klaus: “I thought: wouldn’t it be nice to start from scratch. It was an idea I’d been nursing for a long time. I wanted to build on what I had learned from the past 25 years and get into the market as soon as possible.”

Accordingly, after hearing positive noises from Benfield CEO Graham Chilton (the broker has a 10 percent, $30mn investment in Glacier through Benfield Investment Holdings), Klaus handed in his notice at GE in May 2004.

A meeting with Benfield Advisory, the corporate consulting arm

of the reinsurance broker, was then followed by an introduction to Dallas based hedge fund HBK Investments.

Crucially, this led in turn to an introduction to Soros Fund Management, the fund run by investment legend George Soros. Although Klaus says he has never met Soros, his backing of Glacier has been crucial in generating a buzz around the launch of the start-up and has been cited numerous times as evidence of hedge funds’ increasing desire to invest in the reinsurance arena.

Observes Klaus: “Our investors liked the business plan; the people involved; the management style and the set up of the company. It wasn’t just one thing they liked about it; they liked the whole package. That included the long-term nature of the plan, the fact that it wasn’t just mono-line and the remuneration structure. which aligns the interests of management and shareholders.”

And he insists that, despite concerns over the staying power of hedge funds, HBK and Soros are not looking for a quick exit. He points out that between them, Soros and HBK have shown the courage of their convictions by taking roughly a 90 percent investment in the business, adding: “Obviously they have goals for a return but they are long term.”

The involvement of Benfield has also raised a number of other issues, which Glacier has been at pains to downplay.

In December 2004, the US Securities and Exchange Commission (SEC) sent a subpoena to brokers Marsh requesting information about its private equity arm, MMC Capital and its managed Trident investment funds, which has stakes in a number of start-ups including Axis Specialty.

The subpoena threw a spotlight on concerns that (re)insurance brokers with too strong a financial interest in (re)insurance companies could be faced with conflicts of interest.

Multiple downgrades, reserve strengthening, cash calls and falling rates: by any measure the past few years have been torrid ones for European reinsurers. Enter Glacier Re, the Swiss reinsurer backed by legendary investor George Soros. Robbie Klaus, the start-up’s CEO, tells IQ why the time is ripe for a new entrant

Robbie Klaus CEO of Glacier Re

3 9I Q S P R I N G 2 0 0 5

In the same month as the Sec subpoena was issued, Benfield’s head of investor relations Julianne Jessup admitted that the broker had thought twice about taking a stake in Glacier Re.

This was despite Benfield’s previous extremely successful investment in an reinsurance start-up: namely Bermudian Montpelier Re, which it capitalised to the tune of $25mn in 2001, later recouping $27.7mn from the sale of shares and $54mn from the sale of warrants.

But according to Klaus, worries about overly strong links between reinsurance brokers and reinsurers have been overcooked: “If you were to speak to brokers outside of Benfield you would find that they don’t see any preferential treatment given to Glacier Re. And that’s because there is no preferential treatment to see. I would use Benfield if the price was right but equally I would use Aon, Guy Carpenter and others.”

He continues: “Our relationship with Benfield is an arm’s length one. It was arm’s length before and it is arm’s length now. Nothing has changed. Benfield made the investment because they liked me; they liked the idea and they liked the team. I had a strong relationship with Benfield in my previous company but I also had a strong relationship with Aon and other brokers.”

Business mix Another concern mooted at the end of 2004 was whether the company’s launch, coinciding with the tail-end of a hard market would increase pressure on other reinsurers to lower rates.

But here also, Klaus is robust in his defence of Glacier’s strategy. He points out that with a relatively small capitalisation – its initial capital comes to a modest SF347.4mn ($300mn) – Glacier offers no real threat to established players.

He notes: “At renewals we didn’t quote against existing leaders. We made it clear to our customers that we wouldn’t do that.

“It helps that we’re a small. We only have to find only a few hundred million dollars of business. There’s enough room for us to be writing a 5-10 percent share.”

And contrary to statements at the launch of the company, he suggests that an earlier 2005 premium target of $300mn has now been scaled back.

“I don’t think we’ll go that high,” he says. “It really depends on the quality of what comes to us. We’ll have to see what Asia and the US will bring. I don’t have the pressure to have to reach $300mn. This isn’t a volume driven business; it’s about returning value to shareholders.”

This also means turning away business that does not fit: “If we’re shown business in the wrong area, or for the wrong price, or if the attachment points are too low, we won’t accept it,” he says. “We can’t write everything: we need to get a good balance. Maybe people will say it’s good business but if it doesn’t fit right now we won’t write it.”

There is a downside to being small, however, and the question cedants may ask is whether $300mn represents sufficient security. But on the issue of whether Glacier will need to raise extra capital to address these concerns, Klaus is non-committal. “If the market went in the right direction and the opportunities were there for growing the business profitably we might look at increasing our capital base,” he says.

In its assessment of Glacier Re’s business model AM Best noted that it anticipates weakening in the market for many of the company’s key business lines in 2005 and 2006.

More positively, it pointed to the company’s position “as a relatively small niche reinsurer in a market where several continental reinsurers have substantially reduced business volumes”. This, it said “is likely to ensure that the company can develop a profitable account of business”.

Despite the fact that rate reductions are clearly hotting-up in 2005, Klaus is bullish on Glacier’s ability to thrive in this warmer climate.

“We did extremely well in renewals and the reception we got from our customers has been fantastic. We’ve got a clean balance sheet, we’ve had a great start, and we’ll build on those strengths for the coming year.”

G L A C I E R R E

Glacier Re is moving into specialist reinsurance markets

4 0 I Q S P R I N G 2 0 0 5

Second Pender collapse strains telecoms marketCollapse of second Cable &Wireless-backed telecoms insurer in two yearsUp to $65bn of telecoms assets may have to be placed on the open market following the collapse in November 2004 of Pender Mutual Insurance Company (PMIC), the Isle of Man based insurer set up to provide cover for Cable & Wireless and other large telecoms companies.

As reported in the Autumn 2004 edition of IQ, PMIC was set up in April 2003 after its predecessor, Pender Ltd – which was established as a captive insurer to Cable & Wireless (C&W) – went into run-off under the weight of disputed claims, alleged fraud and litigation.

At the time, PMIC was touted as a clean-sheet alternative to Pender Ltd, offering some of the world’s largest telecoms firms – C&W and Singapore Telecommunications among them – mutual cover for a wide range of risks.

The Pender Mutual website describes PMIC’s offering as

“a blend of finite, facultative and treaty reinsurance to allow the members to aggregate buying power, share risk, and jointly benefit from a non-profit making enterprise”.

It adds that the facility is “designed to provide a long-term cost effective and stable alternative to the conventional insurance market”.

However, IQ understands that in November 2004, after it was unable to recruit a sufficient number of new members, a circular was sent by PMIC to the facility’s insureds offering them two options: either to pay extra premiums to shore up the scheme, or to place it into controlled run-off.

The insureds chose the latter option, with the result that PMIC has now stopped accepting new risks. Although contracts run up to 31 March 2006 and some capacity will be maintained on

selected risks – it is understood that the scheme will be wound down well before that, with a number of former members already working with brokers Aon to find DIC cover for their risks.

Before its collapse, the facility (fronted by AIG and reinsured by Swiss Re, Munich Re and ZFS) insured 48 C&W associates, subsidiaries and rival telecoms firms – with assets estimated in the region of $65bn.

Of the 48 companies insured by PMIC, C&W, Singapore Telecommunications (Singtel), Australian telecoms monolith Optus (a Singtel subsidiary), Pacific Century CyberWorks (PCCW) and US firm Wiltel were by far the largest and provided the majority of the risks to the cover.

And it was partly in this bias towards the larger insureds on the cover that the genesis of the Mutual’s collapse may be found.

As explained on the PMIC

company website (www.pendertfl.com), the mutual had a two-tier governance structure.

On one side there was the Pender Telecommunications Facility Members’ Association (PTFMA), whose members were provided by employees of the insured telecoms companies. This management board was obliged to represent “at least 50 percent of the total insurance contributions into the scheme”, while “any Member representing more than 10 percent of those contributions” was “entitled to have a representative on the Board”.

In addition, the Board was obliged to be “representative of both the business mix and geographic profile of the Members”. The website adds: “A Member’s votes are determined according to its insured amount and contributions but no Member may have votes representing more than 15 percent of total voting power.”

PENDER

Comment from Pender MutualFollowing publication of the above article in January 2005’s edition of IQ’s sister publication The Insurance Insider, Pender Mutual released the following statement.

”There has been considerable comment in relation to actions brought by and relating to Pender Insurance Ltd. It is important to differentiate between Pender Insurance, which is a Cable & Wireless (C&W) subsidiary and Pender Mutual, which is an industry based mutual, which has been in operation since 1 April 2003.

”The circumstances, which led to C&W’s actions against certain individuals and companies, and the implications of those actions, did require the Mutual to seek alternative security support for certain of its reinsurance arrangements. However, the majority of the Mutual’s reinsurance arrangements were not affected by these actions.

”During 2004 a series of meetings and roadshows were undertaken with Members and advisors to canvass members’ views on a number of alternative actions. After extensive consideration the members have elected to support a controlled runoff of the facility at 31 March 2005. Certain covers have, with the knowledge and acceptance of the membership, been altered or withdrawn.

”A small team has been put together to manage the Mutual through the runoff process. The Isle of Man Insurance Regulator has been kept up to date on all major developments and the Mutual continues to meet its Isle of Man Regulatory requirements including its solvency.

”The Pender Mutual proposition was well received and, notwithstanding the impact of the events referred to above on Pender Mutual itself, the proposition provides a viable alternative to the traditional markets. Whether some form of arrangement can be put together to replace Pender Mutual based on the experiences of the last few years will be down to the participants in the mutual, and other members of the telecom industry, to decide.”

E l b o r n e M i t c h e l lthe market specialists

www.elbornes.com

PENDER

Despite these rules governing the make-up and structure of the PTFMA, the larger of its members - C&W, Sintel, PCCW, Optus – are understood to have received the majority of voting rights, creating disagreements over the balance of power in the mutual and contributing to its eventual collapse.

However, there may be a second reason for the failure of Pender Mutual. This was the make-up of the second tier of governance, the PMIC Board of Directors, which comprised three PTFMA members as well as “four independent directors” with a background in law, accounting and insurance.

It appears that after Pender Mutual was established in April 2003, a number of former directors of Pender Ltd were transplanted into the PMIC Board of Directors to fulfil the requirement for members with non-telecoms business expertise – this despite their appalling track record of successfully managing risks at the mutual’s predecessor. Although there is no suggestion that they were directly liable for Pender Ltd’s collapse, the transfer of these directors gave the lie to claims

that Pender Mutual represented a clean break from the past – and can only have contributed to the dissolution of the facility.

When contacted by IQ, a spokesman for C&W admitted that “changes” were planned at Pender Mutual, although he refused to comment on whether the telecoms firm would continue to insure its risks through the insurer.

Litigation abounds Meanwhile, legal disputes in relation to Pender Ltd continue to grind their way through London’s Royal Courts of Justice. As reported in the Summer 2004 edition of IQ, Pender’s travails have spawned a tangle of legal disputes ranging from allegations of fraud to non-paid claims.

In dollar terms, the most significant of the disputes involves an action for unpaid insurance claims of $92.5mn brought by telecoms firm Australia-Japan Cable.

In a complaint filed in the UK Royal Courts of Justice on 10 June, 2004, the firm states that Pender provided insurance for the laying of an undersea cable link between Japan and Australia in

2000 and 2001. It adds that the policy provided £200mn cover for various risks as well as cover on delay-related loss of earnings.

When bad weather damaged cabling and resulted in a four-month hiatus in construction, the company duly called on Pender to honour its agreement. Pender, however, denied the claim, saying the policy wordings did not cover financial losses before the project was completed.

Proceedings are still at an early stage, but at a case management conference on 14 January, presiding judge Mr Justice Cooke confirmed C&W as defendants in the case – a move that could have profound consequences for the telecoms firm if it is found to be responsible in any way for Pender’s Ltd’s collapse.

At the conference, Australia-Japan Cable also confirmed that it had made an application to join brokers Aon as defendants in the case – a development that could have similarly profound consequences.

Australia-Japan Cable’s case rests on the exact construction of its insurance contract with Pender, but it is also expected to present as evidence what was said by

C&W deputy risk manager Phillip Wright at a meeting on 17 May, 2000, at which representatives from Aon, ABN Amro and Pender negotiated the terms of the insurance contract.

A second dispute centres on allegations of fraud involving five of C&W’s former employees at Pender as well as at the company’s brokers, Willis Captive Management.

Here, C&W alleges that its former risk manager, Christopher Valentine, and others at Pender, as well as Peter Foulger, the Willis captive manager, were responsible for defrauding the telecoms giant of some £25mn while running Pender Ltd. It says the defendants set up an elaborate reinsurance fronting arrangement whereby Guardian Insurance, AXA General Insurance and QBE International Insurance provided reinsurance cover while fronting for Guernsey based Messenger PCC without C&W’s knowledge.

The owner of Messenger, Michael Koster, is also named in the writ in relation to another of his companies, MKS Ltd, which was paid to supply operational risk reviews to C&W.

IQ comment: Telecoms back on the menu?The collapse of Pender Mutual has important ramifications for the telecoms (re)insurance market. The obvious question is what will happen to the $65bn of assets covered by the insurer. Here, IQ has heard a number of mooted solutions.

One suggestion is that moves are afoot to create a non-mutual facility for some of the smaller members of PMIC. A second is that those close to PMIC want to create a “Son of Pender” that would only insure the risks of the larger companies on the facility, thus eliminating the power struggles between smaller and larger members that characterised PMIC’s short existence.

In both cases, the solution would have to be able to deal with issues such as patent infringement, media liabilities and the potential for EMF liability claims – areas that until now general insurers have at best been tentative in addressing.

A third, more intriguing possibility is that, absent of any long-term solution, the entirety of PMIC’s colossal insured assets would be allowed to flood onto the open market. The question then would be whether sufficient capacity existed to provide adequate cover.

4 2 I Q S P R I N G 2 0 0 5

Crisis of confidence? The Pender Mutual BoardIn March 2004 Pender Ltd was placed into run-off. Willis Captive Management, which had managed the insurer – allowing the assets it insured to balloon to a remarkable £60bn despite woefully inadequate reinsurance cover – was replaced by Thomas Miller. Subsequently, Peter Foulger, the Willis employee who had run the account was sacked, and was later named in the C&W fraud dispute against Pender Ltd’s former risk manager Christopher Valentine.

When Pender Mutual was established as a successor to Pender Ltd in April 2004 it was touted as a new start, unblemished by Pender Ltd’s less than outstanding track record.

Despite this, the board of Pender Mutual was packed with employees of Willis Captive Management – in other words, by the self same people who had been at the helm while Pender Ltd slipped into run-off.

Although there is no suggestion that these directors were directly liable for bringing Pender Ltd to its knees, the fact that they had been transferred to PMIC’s Board of Directors could have sent the wrong signals to the members of the mutual, possibly contributing to its collapse.

Second Pender collapse strains telecoms market (continued)According to C&W, however, these services were in fact provided by its employees named in the writ, all of whom - unknown to C&W – received a cut of the fees by reason of their “beneficial interest” in MKS’ parent company.

On this case, the latest news is that Willis Management (Isle of Man) Ltd and Willis UK Ltd have now been joined in the Valentine action, with the trial expected to run from October 2005.

As an interesting aside, it is understood that C&W have allotted as much as £10mn on the Valentine court case, apparently with the intention of making as public a statement as possible about corporate governance. A C&W spokesperson refused to comment on sums involved, although he said the firm was “keen to ensure that blame is allotted where it properly lies”.

The list of courtroom spats is far from at an end, however, for IQ now understands that a further dispute has been added to Pender’s already fraught legal landscape. This latest addition involves Pender Ltd’s reinsurance with Generali and CNA in relation to dotcom telecoms blow-out Global Crossing.

CNA’s case found its way to court after Global Crossing’s acrimonious 2002 collapse created a total loss on Pender’s £100mn D&O reinsurance policy.

The reinsurance cover, which was placed by brokers Marsh, allowed for a Pender claim of up to £100mn, in excess of £5mn, plus one free reinstatement.

Carriers such as QBE, AIG, Gulf, Chubb and CNA covered the first £50mn of the facility, with a second layer of Lloyd’s insurers, Faraday and Limit among them, involved in a second tier.

Following its 2002 collapse, Global Crossing was hit by 50 securities lawsuits, and 17 Erisa lawsuits, brought by former employees and investors against its executives. When the case was resolved in March, 2004, Pender footed the bill for £118mn of the $270mn insurance settlement – the other carriers being Chubb and AIG

– a sum Pender duly attempted to recover from its reinsurers.

However, despite the fact that all of Pender’s reinsurers, barring CNA, which accounted for 4-5 percent of the slip, paid on the D&O claim, only £99mn was recovered, leaving Pender with a £19mn hole in its accounts.

It now emerges that CNA, joined by co-claimants Generali, which also refused to pay its share of the Global Crossings claim, have taken the captive to court in search of a ruling that its reinsurance of Pender’s risks is limited. Sources close to the dispute suggest that a case management conference is scheduled for the second quarter of 2005 as a prelude to the case proper.

Since being placed into run-off in March 2004 Pender Ltd has been managed by Thomas Miller. A spokesperson for the company refused to discuss the details of any litigation but said there were a number of disputes currently in the public domain.

“There are cases ongoing and our legal advisors are working with us on those now,” he said. “As an insurance company we are always involved in addressing outstanding claims.”

He added that he was unable to comment on any developments at Pender Mutual, noting that a deliberate effort had been made to keep the management of the two companies separate.

Willis declined to comment on developments at Pender Mutual but confirmed that Willis Management (Isle of Man) Ltd and Willis UK Ltd were awaiting formal confirmation “of being joined as the 16th and 17th Defendants to the action brought by Pender Insurance Ltd and Cable & Wireless Plc against Christopher Valentine and Others”.

It added: “To Willis’ knowledge, no Willis company has been joined to any other proceedings relating to the management of Pender and PMIC.”

PENDER

I Q S P R I N G 2 0 0 5 4 3

Pender Mutual Insurance Company Board MembersCharles FargherFormer chairman of the Pender Ltd Board. Was required to provide weekly updates on the state of the captive to the Isle of Man Insurance and Pensions Authority over the course of nine months before it was placed into run-off. Currently chairman of PMIC Board of Directors.

Paul DoughertyWas a director of Pender Ltd. Currently a member of the PMIC Board of Directors.

Provided paid legal advice on setting up PMIC. Also a director on the boards of a significant number of other Willis captive clients.

Members of the Pender Telecommunications Facility Members’ Association (PTFMA)

Christopher Valentine, former C&W risk managerWas CEO of the PTFMA, the association representing insureds on Pender Mutual. Was sacked shortly after it emerged he was being sued for fraud by C&W.

Willis Captive Management

Peter Foulger, former captive manager of Pender LtdWas on the Board of Willis Captive Management but was sacked from Willis in April 2004 after being linked to Pender Ltd fraud allegations. Was also initially on the Pender Mutual Board before resigning on 1 April 2004.

For a short period he was subsequently employed at ZFS’s Isle of Man life business but his contract was terminated after news of his involvement in the Valentine fraud case reached ZFS management.

Angus AlexanderFormer secretary of Willis Captive Management Board.Resigned from Willis in October 2004 to become CEO of PMIC.Understood to be advising C&W on the possibility of setting up a successor to Pender Mutual.

PENDER

I Q S P R I N G 2 0 0 54 4

Best form of defence?During 2001 and 2002 there were a total of 554 terrorist attacks across the world and attacks in the last few years in Casablanca, Saudi Arabia, Mombassa & Bali demonstrate that terrorism is no longer limited to a few high profile targets…it is truly a global phenomenon.

Terrorism insurance is seen as difficult and expensive and the focus is usually only on the largest clients. But full bespoke facultative placements are not always appropriate or cost effective. The need for reasonably priced terrorism protection for small and medium sized businesses needs to be addressed.

Ascot is one of the leading writers of terrorism insurance in Lloyd’s; to address the problems faced by SME clients we have developed

ATAQ (Ascot Terrorism Automatic Quoting System). ATAQ, is an online terrorism quoting facility for real time quotes and cover for terrorism business around the world. ATAQ allows users, at the click of a button, to obtain real time quotes and cover for terrorism insurance through a straightforward mechanism whereby key information regarding industry sector; risk analysis; and location variables along with general risk information is submitted. Terms and conditions can either be bound immediately or remain valid for 14 days.

ATAQ can offer limits of $25mn of (re)insurance capacity per policy on either a full value or first loss basis and/or can accept part orders subject to terms and conditions.

The system is easy to use: the only information typically required to obtain a quote is:

Name of Insured

Total Value at Risk

Industry Sector

Limit of Liability required (up to $25mn)

% Order and Retention in respect of Reinsurance

We do require full location information, and retain the right on occasion to limit the risks being bound in certain areas, or review individual exposures for certain insureds. These parameters help us to ensure that the system remains highly competitive.

Partial solutions Certain national governments (like the USA with its TRIA legislation or the UK Pool Re scheme) have provided solutions to terrorism, which are invariably for those risks on their own doorstep. But TRIA and government schemes are often only partial solutions to buyers’-needs because they try and provide one solution for all - ATAQ is illustrative of our flexible approach. We have developed this system in-house specifically to address the needs of ordinary businesses trying to find terrorism cover. It offers an exceptionally adaptable and competitive solution for the local broker or insurer; and because of the streamlined administration we are able to offer pricing which is extremely competitive. Mid-market risks, in particular, are often poorly served.

To put this into context, the tragic events of 11 September 2001 in New York highlighted to the general public the very real risk of terrorist attack and public awareness has since remained high. The effect on the global industry has been a re-evaluation of their risk management strategies and insurance requirements in light of the levels of damage that could result from such an event, an issue again highlighted in the Madrid train bombings in 2004.

The situation in the UK is slightly different, British businesses had been conscious of the threat posed by terrorism since the IRA started their attack on mainland Britain in the late 1970’s. The response of the insurance market and the government at that time was a combination of private insurance policies covering terrorist attacks and latterly the establishment of the government backed Pool Re scheme.

Pool Re offered businesses with locations in the UK a facility to purchase terrorism insurance along with their property fire risk on a reinsurance basis for all locations. Depending on the location of the assets, the reinsurance rates are prescribed at the beginning of the year and premium is derived from the total insurable values. The stand alone market based in Lloyd’s also continued to exist providing an alternative price for bespoke policies often concentrating solely on key locations and first loss limits designed to meet assureds concerns rather than the broad brush of cover provided by the Pool, clearly these sorts of solutions were really only relevant to risk managed businesses or multi-national clients.

With the events of 9/11 in New York a full re-evaluation of the UK domestic terrorism market took place, within the context of the changes to the terrorism/ property market worldwide. Many of the insurance companies who had previously offered terrorism coverage outside of the Pool Re structure re-entered Pool Re because of the stability offered to their balance sheet. Since 2002 the non Pool Re terrorism market has been small, with limited capacity severely restricting the levels of coverage available.

Stand-alone capacity on the rise

However within the last three months there have been significant movements within the stand-alone terrorism market. One of the key changes has been the increase in capacity available for the product within the insurance industry, a significant amount being provided by Ascot.

Torquil McLusky of Ascot Underwriting talks IQ through ATAQ, the Lloyd’s insurer’s new approach to writing terror cover in the stand alone market

TERROR COVER

The risk of terrorism is real, but not all businesses have the same requirements

I Q S P R I N G 2 0 0 5 4 5

I Q S P R I N G 2 0 0 54 6

Ascot’s withdrawal from Pool Re at the beginning of 2005 means that capacity of approximately £80mn is now available.

The coverage offered by a stand-alone market is on the same basis as that used internationally for pure terrorism business, it can therefore be integrated with clients’ worldwide programmes, or used to offer UK located clients coverage outside the UK. This assimilation allows seamless insurance cover and can additionally include other coverage such as strikes, riots, and overseas war cover.

There are some differences between the usual terms on which London operates and the UK pool that clients need to be aware of. In particular, the standard wording in use in the London market, usually known as “T3”, excludes losses resulting from nuclear, biological or chemical (NBC) attack, which is provided by Pool Re. This may be an issue for some insureds but in reality NBC losses would be of such a catastrophic nature that it is difficult to imagine the UK government not needing to be implicated in some way.

Outside the Pool each policy can be designed for a specific business model and structured to fit the individual needs of the assured. In technical terms what this means is that underwriters are able to structure a policy using terrorism modelling technology rather than standard All Risks models. As a result, underwriters can create a cost-effective solution reflecting the specific needs of the client and allowing that client to benefit from first loss limits, reinstatement provisions and the like. Very few clients are “average”; therefore, a stand-alone policy tailored to the exact needs of a client will often be a more favourable product to purchase than the off-the-peg solution provided by Pool Re.

But the possibilities do not stop there… By using ATAQ, the client is able to benefit from some of the flexibility of a bespoke policy, including separate loss limits for different locations, while at the same time benefiting

from the cost-efficiencies of an automated processing platform and a standardised set of terms and conditions. ATAQ allows underwriters to make available stand-alone terrorism coverage to a range of businesses which have in the past not been catered for.

Put simply, where we are using ATAQ worldwide, it is a multi jurisdictional tool for brokers and reinsurance partners; when used in the UK, ATAQ allows us to offer cost-effective solutions to all businesses seeking coverage outside of the pool.

ATAQ is one example of insurers using IT to create new and innovative client solutions. Making effective use of technology will be an important challenge for all of us in the global insurance industry in 2005 particularly as the impact of the New York attorney general’s inquiry into broker remuneration is felt more fully. Certainly there will be pressure to reduce costs and simplify transactions wherever possible. The Lloyd’s market has always been typified by its ability to create tailor-made solution for clients and one of the major challenges will be finding ways to maintain these strengths while at the same time reducing frictional costs. A system like ATAQ offers a great deal of flexibility in the way in which it can be used and the options that it provides to brokers. We will feel the impact not just in costs: the global brokers are all under pressure to come up with a new business model – one that allows them to make use of their global networks without exposing themselves to the conflicts of different remuneration drivers for the wholesale and retail arms of their businesses. Here too ATAQ is well adapted because it allows the selling of the terrorism policy to be controlled close to the ultimate client, while still offering a cost-effective way to involve London.

Driving development The use of innovative technology such as ATAQ is also an important strategic development tool for us:

First, the deployment of innovative cutting edge technology solutions is a clear demonstration of our ability to “think outside the box”

and make use of new solutions that are available. This is a system that we have developed ourselves using in-house resources. It was an exciting project to work on which created advantages in terms of motivation. It is a clear demonstration of our determination to innovate and adopt new processes wherever appropriate.

Second, technology like this creates a bridgehead with new markets. ATAQ allows us to build trust and confidence in territories where we would otherwise struggle to establish critical mass: in other words by focussing on a niche specialty product we can establish recognition with a carrier in a new market that would otherwise take years. Two examples of this are in Chile and Romania; both are markets where we would like to do more. ATAQ has enabled us to establish relationships with a leading local broker in one case a leading domestic insurer in the other.

Third, ATAQ is a platform that we can look to develop and use as a basis for accessing other classes. Indeed, the basic system is extremely flexible and can be modified to cover other situations including Aviation war and Marine war.

Fourth and perhaps most importantly, ATAQ offers us the ability to see business that does not traditionally come into Lloyd’s. The Lloyd’s market is the natural home for specialty lines business but the frictional costs involved with accessing Lloyd’s mean that business tends to be polarised between either so called “big ticket” business that can be placed as a one off (e.g. the Olympics) or schemes where a number of small risks can be lumped together and dealt with as a portfolio. A system like ATAQ offers the possibility of writing smaller risks on a standard framework but using a range of options to “tweak” cover – at long last we have a system that allows a Lloyd’s business to write mainstream business offering a bespoke feel to a simple product.

Best form of defence?(continued)

TERROR COVER

At Max Re, we’ve made our name with innovative reinsurance solutions, like structured business with progressive asset management. Our new frontier: conventional insurance products. At a time when capacity is desperately lacking in many industries, we have assembled a talented underwriting team and focused on key products, like excess liability and professional lines. What we bring to every client is sophisticated risk control, deep understanding, and the willingness to solve problems one at a time. Max Re. Always in tune.

CHANGING THE FACE OF REINSURANCE

P R O P E R T Y / C A S U A L T Y I N S U R A N C E & R E I N S U R A N C E L I F E / A N N U I T Y

A.M. Best’s A - (Excellent) Fitch A (Strong)

New Tune

MAX RE CAPITAL LTD. MAX RE LTD. MAX RE HOUSE, 2 FRONT STREET, HAMILTON HM11, BERMUDA

T 441 296 8800 F 441 296 8811 E info@maxre.bm W www.maxre.bm

MAX RE EUROPE LIMITED THE HARCOURT BUILDING, HARCOURT STREET, DUBLIN 2, IRELANDT 353 1 416 1555 F 353 1 416 1599 E info@maxre.bm

MAX INSURANCE EUROPE LIMITED THE HARCOURT BUILDING, HARCOURT STREET, DUBLIN 2, IRELANDT 353 1 416 1500 F 353 1 416 1549 E info@maxre.bm

Max Insurance Europe Limited is regulated by the Irish Financial Services Regulatory Authority

Angelo Guagliano

Bernard (Buddy) Anckner

Mike Morgan

Jim Gray

Drew Dinsmore

Jonathan Evans

John Boylan

Joey O’Dea

Colin Shaw

I N S U R A N C E T E A M

DUBLIN BERMUDA