Global Reinsurance co-editor, Lee Coppack, hosted a lunch time discussion of issues affecting asset management and (re)insurance held at the London Underwriting Centre on 18 October. Guests were Mark Camp, sales manager, AIM Global Advisors Ltd.; Stavros Christofides, Bacon & Woodrow; Kathleen Corbet, Alliance Capital Management Corp.; David North, senior vice president, Scudder Investments (U.K.) Ltd; and Dick Press, senior vice president, Wellington Management Company.

Lee Coppack: I would like to start by asking each of you to introduce yourselves and say what you do.

Dick Press: I head up the insurance asset management area of Wellington Management. I have been involved in the investment business for 35 years. I spent 18 years in Scudder, and 12 at Stein Roe & Farnham, a Chicago firm, building an insurance group there and five at Wellington. I manage money, I market, I close, I do client service and I wash the windows and clean the ashtrays. That is a good background, I think.

Mark Camp: I am a sales manager with AIM Global Advisors, which is part of the Invesco Group. I have been there since 1996, and I am concerned with money market funds. I was head of corporal finance at Lloyd's. I was at Lloyd's for 10 years, where I was responsible for most of the what I call market finance area of Lloyd's, so I got involved in all sort of things, like investments, trust funds, settlement systems, that sort of thing. I had a tax background before that.”

David North: I work for Scudder Investments in the United Kingdom. I head up a group in London for this part of Scudder Insurance Asset Management, which is the group that Scudder set up about 20 years ago to specialise in the management of third-party insurance assets. In London we have a team of about five investment managers who are responsible for the Lloyd's market, European companies and for offshore captives. Personally, I am a money manager, marketing, sales, very much like the role that Dick described.

Kathleen Corbet: I am a newcomer to the London market. I have been here for a year now. I am chief executive of Alliance Capital's London based subsidiary, called Alliance Capital Ltd. I have spent 16 years of my career with Alliance Capital and Equitable Capital, which was a wholly-owned subsidiary of Equitable Life. I have spent most of my career managing money for insurance companies, although I am now also co-head of fixed income for Alliance Capital, which has about $115 billion in assets under management for insurance companies, pension funds, mutual funds and the like. In terms of our insurance presence, we have a team of eight professionals based in New York who are servicing essentially the US market and a team of five investment professionals servicing primarily the London market, Lloyd's market and European insurance companies.

Stavros Christofides: I joined Bacon & Woodrow, who are actuary consultants, 11 months back after 11 years or so with CU, which eventually became CGU, where I was group non-life technical manager, effectively a head office, actuarial type position. At Bacon & Woodrow, my main interest is in asset liability modelling and dynamic financial analysis , as well as risk evaluations, company evaluations and so on. Bacon & Woodrow has some 1000 staff in the UK and 10 offices. Worldwide, we are part of the Woodrow Milliman organisation. We do, obviously, have quite a substantial investment department. Something like 80% of the work done by the organisation is from the employee benefits pension side, so we do have a lot of investment advisers in the organisation.

Kathleen Corbet: Does Bacon & Woodrow actually manage money or just provide advice?

Stavros Christofides: No, we develop financial models, and we have recently published an index with Barclay's Global investments.

Dick Press: What type of index?

Stavros Christofides: It is a global index with a lot of different areas and lots of different companies. If you are interested, I have got a brochure!

Dick Press: I am happy to be marketed to.

Kathleen Corbet: It is a new index which is going to be broadly representative of global markets.

Lee Coppack: Could I ask how you see the investment market for insurers, reinsurers, Lloyd's syndicates developing in the current conditions of what are still comparatively low interest rates and the contraction of the supply of bonds from western governments?

Kathleen Corbet: Clearly, they are beginning to look at alternative investment classes, expanding outside of the traditional fixed income markets. We are starting to see an increase in terms of acceptance of more equity in their portfolios, moving outside of the traditional fixed income markets, more acceptance of high yield, emerging markets. These are trends that are we are seeing taking place. There is more interest in yield enhancement and how can they broaden their asset classes to achieve those objectives in terms of yield enhancement.

Lee Coppack: Underwriting losses are emerging and rates are still not hardening significantly. If that is happening at a time when, perhaps, insurers are taking on more risks on the asset side of the balance sheet, is there any increase in overall risk?

Kathleen Corbet: They are clearly taking on more risk by dipping down into alternative asset classes. You just have to be more nimble in terms of the asset-liability equation, and you have to take more responsibility in terms of managing that balance. But yes, they are clearly taking on more risk on the asset management side.

David North: What we have seen develop is a concept of what I would describe as total risk, where both sides of the balance sheet are managed. An insurance company would look at the risk they are taking on their underwriting, the liability side, look at the risks they are taking on the asset management side and using a concept such as dynamic financial analysis, assess the level of enterprise risk. They then take a conscious decision, looking at the market, to see where the opportunity arises to make the most profit, whether it extends from over-weight in the risk on the asset side and minimising, through the use of reinsurance, the risk that they taking on the liability side or vice-versa. With certain lines being soft you are seeing insurance managers dipping down to take more risk on the asset management side. Sadly, if you did that in 1999 with bond markets and, to a certain extent equity markets now, that might not have been a win-win strategy. I guess if you take such a view, you are doing it for the long term and, therefore, dipping your toe into the high yield or into equities etc. will ultimately raise the level of return to an insurance company. So you are seeing an holistic approach now being adopted by insurance companies. Rather than separate the insurance side and the investment side, they are now looking at the whole thing as one package and managing everything in terms of enterprise.

Dick Press: But, David, I wonder whether talking about enterprise risk or total risk is more intellectual than real? What comes out of this? The reason that we have seen insurance companies moving out on the spectrum of taking risks, which Kathleen eluded to, is that their underwriting side is under such pressure, the ferocious pricing of the reinsurance industry has decimated bottom lines. So at just the time where underwriting has gone out on a limb to take on, perhaps, the marginal risk to keep gross premiums written up, they are also going out on a limb and reaching for high yield and other alternatives.

David North: Oh, sure.

Stavros Christofides: I wonder how much of this is actually happening with regard to UK based insurers or whether you have seen that from the continental US insurers.

Kathleen Corbet: We see both.

Stavros Christofides: I looked at the annual accounts of two of the largest UK groups, CGU and Royal & Sun Alliance (RSA), for the end of 1998 - looking especially for comments on low interest rates and what impact they may have, especially the property/casualty side. Bob Scott of CGU did make a statement that because of reductions in interest rates, they are concentrating much more on underwriting profits. There is no such comment from the (RSA), who thought they had done pretty well. There was a slight comment with regard to the pension and life side and longer term, but nothing on the P/C side.

Mark Camp: There are two approaches, I think you can take. One is obviously what I call a top down approach, which is what I think we have been talking about here. Equally important, especially for the smaller insurance companies and Lloyd's, which would be largely comprised of small insurance companies, is the bottom up approach. There is a lot of extra yield you can get out looking down more at your housekeeping end. Certainly, I am interested in cash. Also from my previous life, I would say it is actually doing things like making sure you get value for your reinsurances by collecting them on time. There are lots of other, what I call, housekeeping elements on the asset side that you can actually take that add up and they can make really quite a big difference. So, yes, look at your overall asset allocation, your asset-liability matching and all the rest of it. Also, make sure you are doing a proper job down at the housekeeping end.

David North: Certainly, there has been a revolution in Lloyd's in the last several years. That is a classic case in point where insurance entities have taken on more risks. Go back five or even 10 years. Lloyd's investment management was pretty much cash management. Today, virtually all managing agencies have adopted a benchmark that is beyond that of cash, and in some cases, you might find that Lloyd's syndicates are operating more aggressive policies than insurance companies who have permanent capital, particularly in the London market. This revolution comes about as a result of Reconstruction & Renewal (R&R), the introduction of corporate capital and the fact that the annual venture is becoming less and less relevant in making decisions. Looking at liabilities, looking at the level of risk that is appropriate to take based on the liabilities, is becoming more pertinent in setting an investment policy.

Kathleen Corbet: Can we also add the acquisitions in Lloyd's by, say, US insurance companies? A lot of the practices of US insurance companies are being exported over to Lloyd's.

David North: Yes, you suddenly start getting asked questions about an amortised cost and book yield, but...

Kathleen Corbet: ...and on the NAIC codes - no relevance.

David North: Absolutely. Perhaps there is no relevance directly in the London market, but if you are consolidating your financials back into the US, they are very familiar concepts. Ultimately, if you allow accountancy to be the tail that wags the dog, you can end up with that driving your investment policy.

Dick Press: It is a confluence of what you both say. It is US and Bermuda corporate ownership, both of which are used to GAAP accounting, and the US statutory approach replacing individuals who had to true up every year and settle up for every three years. A corporation like ACE or some of the others that are in the market are in it for much more than a one year or three year time period. The key to this is their time horizons are different.

Lee Coppack: Would you expect to see insurers having or wanting to be more transparent about their investment performance? I tried to find out from analysts how much attention they paid to how well insurers handled their assets, and it does not seem that on the whole you can get enough information from the report and accounts and the balance sheets to make comparisons.

David North: When you look at reports written by the rating agencies when they are assessing the ability of a insurer being able to pay, you see that the investment policy is assessed and they require transparency. That is translated down to our level when you are acting as client service to an insurer, the level of information you are required to provide now, the questions, the duty of care that is placed on an investment committee is much, much higher. Harkening back to the old days, life is a lot harder now. You need to provide more reporting and more accurate reporting and customers require explanations, much better explanations. That changes the quality of the investment institutions who are now servicing the insurance market. If you look around this table, you are dealing with absolutely high quality, very large organisations who have the resources to be able to meet the need. A few years ago the market was dominated by boutiques who did not have those resources and they have now become, to a certain extent, dinosaurs in this business.

Dick Press: I do not think 20 years ago a company would identify itself the way Markel or Warren Buffet's firm have done, as really being principally investors. The insurance industry was an industry that was in business to insure, and the portfolio was something that fell out of it. Now there are companies, Markel is a wonderful example, that are basically saying: We are in it to accumulate assets and to run those assets with an extremely long time horizon, with the total return approach. We are certainly going to stand and be judged by the build-up of shareholder value based on our investment expertise, not primarily on our insurance operating expertise.There is almost a dichotomy building up of those companies which are not only willing but anxious to report their investment results, as opposed to those who say: No, no, look at us. We are an operating company. Look at our bottom line. Their bottom line is primarily investment income, and they are just arriving at it in a very different way.Stavros Christofides: Are we suggesting that active management is sufficient to create value for insurance shareholders? The reality is that while insurance generates investment income from policyholder funds, the underwriting losses often exceed this income. In a lot of cases, shareholders would have been better off without taking on this underwriting risk. We need to be careful not to infer that the gearing of assets and active management of these assets are a sufficient combination that guarantees value creation for these shareholders.

David North: The active versus passive management divide is probably alien to the insurance industry, given the cash flow demands of an insurer. To adopt a passive investment policy, an index matching policy, is very hard when you have daily sell dates and cash flows to meet claims, so active management and understanding of the business and tailoring an investment policy for a specific insurer's need, even for a small or medium size insurer, can make a significant difference in the their overall operating result.Kathleen Corbet: Are you aware of many insurers who have chosen passive investment strategies?

David North: Some. There is a lot of interest in the press in passive investment styles.

Kathleen Corbet: I do not see it happening.

David North: It depends on the board. If you look at the captive insurance industry, you present certain results. The results are similar to an index. It is not an unfamiliar knee jerk reaction for the board to say: Why don't we just index this? Why are we paying the fee for you to be an active manager, if all you have done is meet the result? You say: Hang on a minute. You do realise you have daily flows here putting money in and out.

Lee Coppack: Mark, cash is your area.

Mark Camp: I think it is an area which is beginning to become very active. At AIM Global we have put a lot of effort in, not just in the insurance sector but also on the pension side, to differentiate cash and treat it as a separate asset class. Such an approach can conflict with existing practice, because traditionally each asset manger manages cash within their speciality mandate, and the cash has not been managed overall. In other words, an institution might have four or five investment managers with different mandates. They have each got cash, and there is actually no co-ordination between how that cash is managed. In addition, you often have day to day operating cash with a cashier, in the bank or wherever.

It is very easy, I think, for an asset manager to explain under-performance using this cash element as an excuse because he is saying: I always have all these flows in and out. How do you expect me to meet that benchmark? What you do is take away this cash element, and give him a much more stable base of assets and a much more rigorous benchmark. Then you actually deal with the cash in a different way. Possibly, if you are a very large organisation, you can deal with cash by running your own desk or you can out-source it and specify proper cash related benchmarks.

Even more important, you have got all sorts of problems, I think, in terms of managing your exposures with counter-parties. We had one case where a company had five different asset managers. I asked the question and they found that all the different asset managers were using the same bank. You have blown all the carefully constructed counter-party limits to pieces, because nobody had actually asked the question before. If you can tighten up and organise your cash investment economically, then that allows you more time to go and talk about the bigger picture, say, looking at equities or more sophisticated asset management options.

Dick Press: If your focus is on short-term money management, then I understand what you are saying. But it seems to me that it was 20 years ago that companies talked about cash being the passive fallout after you have done your long-term fixed income and your equity investing. The type of clients we have, and I would think both of you have, cash is an asset class to be managed, to be utilised, to squeeze basis points out of. I have not thought about it as a residual that is left idle for a long time.

Kathleen Corbet: Mark is talking about here in the UK. They are about 10 or 15 years behind.

Stavros Christofides: The problem becomes more acute, as we get into low interest returns because the earnings that are coming out net of expenses are dwindling fast and expenses are beginning to look very high.

Mark Camp: To give you a good example of this situation, we have got a euro fund that we are now marketing very hard to the Lloyd's market. The amount of euro premium received so far has been relatively small and one of the reasons is that many agency systems cannot handle the euro at present, so they use Lloyd's central system to exchange euro into sterling, which is then received through Lloyd's central accounting. The other half of the market is receiving euro direct. In my experience, syndicate euro bank accounts are not that large, maybe eight, nine or ten million euros, and it is not worthwhile appointing an investment adviser for these small amounts. What have syndicates done? They have opened bank accounts and the best interest rate I have heard yet is 1.5%, and they have been down as low as 0.25%. Then a money market fund comes along offering up to 3%, and all of a sudden you are picking up an extra 150 plus basis points. All right, it may be a relatively small additional yield in absolute terms, but it is achievable at no cost and for little effort.

Lee Coppack: Is the continuing low inflation of significance as far as you are concerned?

David North: If it remains low, it will keep a floor or put a cap on asset prices. Certainly, at the moment what you are experiencing around the world is a pick up in growth, a pick up in inflation, which results in a pressure on conventional fixed income markets. That partly explains why this year is so grim for fixed income investors.

You are seeing a shift also in government funding to the use of inflation-protected securities, index linked. A significant part of their investment approach now is assessing a value of these inflation-protected securities over a period of time. Certainly, the US Treasury has put a lot of time and effort into developing a market. You have seen that commitment replicated around the world now in the issuance of inflation-protected securities. We include that in our investable universe. At the moment, for example, for very short term accounts, by that I mean sort of one and a half, two year duration, we think TIPS are very cheap, and we have been using them as an alternative to conventional interest rate exposure by selling coupon bonds to buy inflation-protected securities, because based on our assumptions, even with inflation not rising, they out-perform.

Stavros Christofides: I can see a potential here for a reduction in the availability of long term bonds, because some of the government bonds have been replaced by corporate and some of the corporate bonds are now inflation indexed. They tend to be on a shorter term than the government issues.

David North: Even more if you observe the price movement. It is not a just the term; the observed or the empirical duration of the bonds is far shorter. For example, a five year US government inflation-protected security presently exhibits the volatility of a one-year security. You might have a longer term, but its price performance or its investment performance, at present levels of volatility, is very much shorter than the term.

Lee Coppack: Do you see any risks in the way that certain reinsurers and insurers are themselves becoming much bigger in third-party asset management?

Mark Camp: I would say: What are you doing? Are you an insurer or are you an investment manager? At the end of the day, you are probably going to be better off having a specialist, sticking to him and making sure you do that well, rather than getting involved in an area perhaps which is not your major area of interest and your major expertise, but you think you can do well.

It would not surprise me if in four or five years time an awful lot of the asset management divisions of companies , if they are built up, will have all spun off into effectively separate asset management companies, which might or might not survive out there in the big world. Inveco's point of view is that we do investment management and investment management and investment management, and we do not get hooked on anything else.

Kathleen Corbet: I think, Lee, it is all about how much they are integrated into the insurance company, be it reinsurance companies, life or P/C, and if they are pretty separate and distinct. Equitable and AXA now have very much kept an arm's-length relationship between the asset management side and the insurance side. When I go to, say an AXA entity, and I bid for the business, be it fixed income or equity, I very much do it not because I am a cousin of theirs, but because we think we can add value. We compete with other asset managers on a level playing field.

So I think that insurance companies or larger financial services institutions can have ownership stakes in asset management companies, if they are free to develop that business separate and distinct from what is driving the insurance side of the balance sheet. There are success stories.

If you are developing from scratch an asset management firm, you have to make sure you are going to be able to retain your people. How you are going to incentivise them? How they are going to be able to attract other institutions' assets under management? I think the more independence you give a subsidiary or an investment department if you will, the better chance they have of developing.

David North: Our experience of being associated with the Zurich group and being an active insurance asset manager is very much reflective of the experience you described with Equitable and Alliance. It is a strength in the sense that in this day and age, it seems to be the big companies, those who are secure financially, who are the more successful managers, who are able to commit the resources. Being associated with the larger financial services entity is a benefit, but you need to keep a separate distinct identity.

Insurance is a competitive business, asset management is a competitive business and you do not want your association with an insurer to prevent your competitive edge. You read in the paper major insurers say: Hey, look, we have got an in-house investment department. Why don't we just expand that to do other forms of asset management? Let us take other customers' money in-house.

You think: Hang on a minute. Where is the commitment? Where is your history of third-party management, your track record, your client service people? How do I know as a client that you are going to do the right thing by me, when you have got this gorilla in the corner with many billions who actually pays your salary?

Dick Press: I think there are three distinct approaches. One relates to an in-house investment operation where an insurance company says: Here is a profit centre. Let us optimise it. At the other extreme is a large insurance company taken over by or involved with a very large asset management firm, where each keeps its identity. Then there is the possibility that I see, which has become very common, where the reinsurance company takes over, for strategic reasons, a small money management firm and says: Maybe, we will get business if we can provide money management to small insurance companies or reinsureds. There is really no commitment to making the asset manager an excellent money manager; it is a commitment to a insurance marketing strategy. We have seen numerous examples of that which, I think, all of us could name. It strikes me as a dangerous game for the company doing it, both on the insurance side and on the money management side.

David North: The client is smart. Someone knocks on their door and says: I come from X. We have been running our in-house money for 150 years with a fabulous record. Hire us. They are going to say: I want to see the proof. Show me your track record. I want to see you do somebody's else money for three to five years and then maybe I will consider it.

Lee Coppack: Getting back to the point about transparency, insurers and reinsurers are not at all transparent about their own investment management results.

Stavros Christofides: That is a key, because the risks have not been understood - the risks of selling their services and having to perform. Measures were never developed to measure the performance.

David North: From an IMRO or regulatory perspective, you have to be entirely transparent. If you are going to sell your track record, you have got to be entirely open about what the sample size is, the fees that were charged and all the usual health warnings. And if you cannot do that, no one is going to hire you.

Kathleen Corbet: Another driver is also trying to keep the people that you currently have. If you have an investment management arm and they are any good, people in other asset management firms are going to come after them. A carrot to get them to stay is to say: Look, we will develop an asset management business you can run. Many of them believe that they can, and that is an incentive to stay and make a go of it. It is not necessarily the right reason to develop an asset management business, but it is the last “gasp” of those insurance companies trying to keep good people.

Dick Press: But then they run into the flip side of the problem. It is this: once you take that path, you then have a group of individuals who have a pay scale which is so totally removed from the rest of your operation that it is hard to rationalise. You see it over and over again. Lee, you also asked one other question relative to outside management. That is the question of risk. We, here, probably all have the same bias, but when you hire a third-party which is objective - and I would have one other premise, which is key - where the manager understands the implications of operating an insurance company, then I think an insurance company reduces its risk by hiring an outside manager. That way there is this third-party looking at you and saying: I understand what you are doing. I understand how you price your product. I understand how you market it. This is the way we see the implications of what you are doing on your balance sheet and your income statement. Here is where regulations come into effect and your A.M. Best rating. Here is where we think the investment part of the equation fits. If you do it in-house, you do not have somebody saying the emperor is not wearing clothes.

Lee Coppack: Would the interest of insurers and reinsurers in convergence products come into that equation as well?

David North: It depends. You see a lot of crossover sales of products, so-called catastrophe bonds or whatever. The difficulty is that those are very much a transaction, whereas investment management is a relationship, so an investment manager is hopefully there for the cycle to produce value, whereas going off and selling a catastrophe bond is a three-month event.

Stavros Christofides: I see catastrophe bonds - and I have looked at catastrophe bonds for some time- really as a manifestation almost of junk bonds. Here is a bond that is going to give you a big return. You are not quite sure what the characteristics of the bonds are, but you just hope that within a year it is not going to come home, and it has got a 1% chance of coming home. But it is a 500 basis point bond. It is not proper at this stage, because industry has not done a particularly good job at justifying the risk profile that goes with this bond. If you justify the risk profile and prove it to everybody, then I think there will be a huge prospect for using these bonds in a way they that should be used. That is to use them to equalise catastrophe type risk.

Mark Camp: We talked about inflation in terms of assets. We did not talk about inflation in terms of liabilities. If you think inflation on your liabilities is out of sync with your assets for whatever reason, like the American courts are going to carry on paying increasing amounts of damages without regard to the RPI or any other form of indexation, you have got a problem. How do you protect yourself at that end when you cannot possibly get an asset to match that?

Stavros Christofides: There is a difference between the securitisation of catastrophe exposures, which are random and where there is a market, especially at the top end where even the big, global insurers are not able to diversify geographically, to the securitisation of, say, a motor portfolio. Here, much of the volatility of results is price driven, which would make it a very unattractive package for securitisation.David North: Why would you securitise that? There is no need.

Stavros Christofides: No, that is the point. There is no economic sense for the investor taking that on, especially as he could invest directly in the insurer and avoid the additional costs of securitisation.

David North: What you had seen originally when cat bonds came about, was that they were sold as stand-alone transactions where you could acquire an uncorrelated risk within your investment portfolio. It was not interest rate related, but it paid a junk bond type return. It moved you to the top left corner of the risk reward scenario. As the market has broadened, you have seen insurance companies set up virtual reinsurance companies by buying a portfolio of cat bonds - some earthquake exposure from Japan, California exposure and some East Coast windstorm exposure. Providing the insured event does not happen, cat bonds have provided very good returns and so far they have worked.

Stavros Christofides: They are going to work. These exposures are both uncorrelated with asset returns and are currently priced by the reinsurance market at many times expected cost.

David North: I think cat bonds do have a future. An investment manager has a very important role in the development of that market, whether it is in the form of a stand alone cat bond fund or it is as part of a diversified portfolio. It makes sense, providing you work in alliance with your customer. We looked at a windstorm cat bond. We said: We can analyse this completely from an investor perspective. We can look at the a. tranche, the b. tranche. We can look at the risk-reward, and it makes sense to us, but we do not understand the insurance risk. So we went to a customer and said: For this particular reinsurer, what do you think? This is what we are being paid for this layer. They said: To be honest, that is actually more than we are being paid for taking it from the reinsurance market; therefore, we are going to exit it out of our cover. You buy us that bond, and we will do it. It worked out. I would never say: Hey, I am an underwriter of insurance for goodness sake.

Stavros Christofides: To my mind, for the catastrophe bonds, they have been priced very much like traditional insurance with prices for the risk of not being able to diversify. If you look at, say, the USAA bond which was biggest and probably so far continues to be the dominant feature of a market, that bond was massively over-priced as a bond, because it has the characteristics of a double B, and it is now about 450 basis points; it came in at 565. What is a one year double B: 125, 150?

David North: But it was only the principle and it was one a one-year.

Stavros Christofides: Yes.

David North: The principle comes back to you, but it is only eventually, so if the event occurs, you could have a bond that extends on you for five or 10 years. You price that out; that is a big risk. You are writing a big zero coupon option or an option against a zero coupon, in fact, and you need to be compensated for it.

Lee Coppack: What is the risk of picking up the same exposure one way or another on both sides of your balance sheet?

David North: That is why you need to talk to your client.

Kathleen Corbet: You would not just ordinarily go out and buy one of these securities without talking to your client about it.

Dick Press: You should not.

Stavros Christofides: But the amounts are very, very small in relation to the amount that is floating around in investment markets. The USAA bond, you are looking at $1/2 billion worth. It is nothing, It is not even going to be noticed by the time it is spread, by the time you have divided it into what is covered and protected and what is not.

David North: It very interesting where those bonds have been sold. Initially, they were aimed at your classic market attracted to high yield, private bank or whatever. Then it was aimed at a professional investor as a non-correlated, diversified risk, and today I would argue that the majority of buyers of cat bonds are actually insurance entities.

Kathleen Corbet: Through investment managers or directly?

David North: Directly. I am very happy to sit down and enjoy having a good discussion with the structurers but ..Dick Press: If we could review several hundred of them and put several hundred in a portfolio, then you might have a diversified risk, but a cat bond by definition is an on/off switch.

David North: It is a one year term, and why are you going to bother to put the effort in if it is only going to be around for a year?

Stavros Christofides: I think they could be renewed. They could be made into longer term. They could be expanded into other areas which have other exposures, but the problem is that the information flow is not there to give people who manage the assets enough information to see the characteristics. If I came to you and said I have UK exposure to weather or flood, and you ask for information to establish the probability of these things happening, I go back and say: Well, in the last 250 years I cannot really show you much, so give me a very good rate. You may be reluctant to take what effectively is a gamble, when in your ordinary business you have information by the minute and you have huge amounts of information.

David North: That is why it is very important that it is non-correlated. An investment manager buying an asset that you can put into a portfolio and a small percentage that is not correlated with the other risks he is taking, it can be an enormous benefit.

Dick Press: It can be an enormous risk.

David North: It can be an enormous risk, but it depends on how much you buy and how you do it.

Mark Camp: One of the other areas where insurance companies have difficulty is how to handle the interface between the broker and investment management. This interface is now beginning to blur, and traditionally this is an area where there have been few crossovers.

Dick Press: You mean in insurance broking?

Mark Camp: Yes. I am talking about insurance brokers. You have got Aon, which is beginning to do this in a big way, and Marsh as well. If you are talking about cat bonds or others forms of ART, there is a huge crossover between these type of programmes, and what I call the traditional long-term asset management side. To manage both properly, you do all need to be talking together and sharing views. Traditionally, on the insurance broking side there has been a chasm between asset management and reinsurance programmes as the last person you spoke to was anybody who was a professional asset or investment manager, and vice versa.

Now we are seeing a coming together of insurance liability management, tax and asset management approaches to work out an optimum risk strategy and best asset mix for each insurance concern. This involves captives, protective cells and other innovative vehicles which are well outside the experience of the average asset manager.

Stavros Christofides: There is a real issue here. I remember spending two years trying to develop a common language with the asset management side, so that we could feed them with information on the liability side that would be useful to them in managing the assets. As I said, it took us two to three years to understand that when they talked about liabilities, they purely looked at balance sheet, i.e. claim reserve, what they could understand. When we looked at liabilities from the insurance side, we were not really concerned too much about volatility of the reserves. We were much more concerned with volatility coming through new business. We were concerned about totally different issues, and it took some time, as I said, to understand what language they used, the issues they had and what we were dealing with on the insurance side.

It has probably to some extent eased, as we have progressed to modelling these things. But they are really there in terms of the language that people are brought up to use on the asset and liability side of the balance sheet in running complex organisations.

Kathleen Corbet: As the market becomes more global in its orientation, you do need to develop a common language of insurance concepts and money management concepts. That is probably the challenge of the future.

David North: Quite so, facilitated by the arrival of the European single currency with the whole scale import of US cutting edge investment management techniques that can now be implemented pan-Europe. Three years down the road, the European investment market will look very similar to the way the US looks today.

Lee Coppack: Could I just finish by asking how you would expect what you are doing now to change - to take a relatively short term view - over the next five years. Stavros, may I start with you?

Stavros Christofides: If I look at financial institutions, insurers, banks, investment houses and so on, I see that we will be converging with regard to the way we look at the regulatory requirements. I see some convergence there with banking RPC and insurance solvency and dynamic solvency testing or capital testing. This means that all sides would need to understand the other side much more than they do now to be able to satisfy the regulators, the analysts and all the others that are looking at us as financial institutions that have significant risks associated with us. In my view, this means that both the liability managers and the asset managers have to be almost state of the art. They have to understand the dynamics of both sides and understand them sufficiently well enough not to expose themselves to traumas. I see what you call an uplift in the technical work that is being done and the understanding of the key people who are going to be successful in a business.

Kathleen Corbet: In terms of no-change versus change, no-change will be performance. From an investment management perspective, the way you add value to your insurance company clients is to provide performance, and that is not going to change. Where it will change going forward, obviously, technology is going to play the big role in terms of communication to clients and providing additional services to clients. We are going to see, in terms of change, continued consolidation, I believe, on the investment management side.

We are going to see continued acceptance by insurance companies to utilise a broader array of investment products. Those are all change agents, and I think that you are going to see continued change toward out-sourcing. I do not mean that in a self-serving way, but just as the larger pension funds throughout the world are recognising that financial markets are so diverse, ever changing and dynamic that they need the expertise of investment managers, more and more insurance companies are going to embrace that, and in the next five years the trend will continue.

David North: I have to agree with the point about out-sourcing. I think that is going to be the big sea- change in Europe. I think it will be an enormous revolution in terms of small and medium size insurers in Europe that currently operate their own investment departments and decide, probably initially for niche mandates, specialist mandates, but then across the whole framework, to broader core mandates to out-source their investment management activities to specialist investment managers who can provide a low cost professional service using tools such as the internet to provide reporting. In effect, you can hire an investment department for a fraction of the cost of running one today and get the same policy service.

Mark Camp: I talk about cash and money market funds because that is what I am doing, but it is one where out-sourcing is increasingly happening. I think that on the investment front it is going to go two ways. It is going to go one to a commoditisation of products, and money market funds effectively are a commodity in the US now. It is a $1.4 trillion industry, and it is a commodity. Therefore, we will be having to price ourselves on that basis.

You will have commodity on one side, often driven with internet. Against that on the other side, you are going to have a more bespoke, complicated professional service at the top end where insurance and financial products are coming together. You are going to have products developed to try to tackle the very real difficulties with matching assets and liabilities, particularly on longer-term products.

Dick Press: I am not sure I can add much that has not been said. I would amplify, perhaps, two of the earlier points. I cannot speak from an European point of view, but even in the US, the number of money managers who have a sophisticated understanding of what makes an insurance company tick and, therefore, can relate the portfolio to the company is a very small universe. By the sound of it, it is even smaller here and I maybe sitting with a great deal of that universe itself.

Whether it is in the US or here, there will be more out-sourcing and perhaps in a self-serving way, I believe that no small part of that out-sourcing will go to firms which understand how to relate a portfolio to operations. In that regard, I go back to what Stavros eluded to but did not discuss which is dynamic financial analysis (DFA). I do not think that DFA is the be all and end all. It gives you a starting point to identify what is going on. It does not give you the solution - maybe in modelling it gives you some alternatives- but it identifies direction, past direction more than future direction. The firms that can put together an understanding in the industry, all of these exogenous variables that bear on the industry and can use a modelling system like DFA as roadmarks, landmarks, are going to be the ones that will gather the assets and gather them they will.

Lee Coppack is co-editor of Global Reinsurance. E-mail: lee.coppack@globalreinsurance.com.