The Global Reinsurance 1998 Bermuda roundtable lunch was held at the Waterloo Inn in Hamilton. Global Reinsurance co-editor Lee Coppack was in conversation with Bruce Abrams, director of captive operations, American International Company; David Brown, chief financial officer, Centre Solutions (Bermuda); Michael Butt, president and ceo of Mid Ocean Re; Don Kramer, president and ceo of Tempest Re; and Graham Pewter, president and ceo of Commercial Risk Partners.

Lee Coppack: Today some people suggest that reinsurance will eventually be completely squeezed between larger and larger insurers who only want high level cat reinsurance and the capital markets. How likely do you think that is?

David Brown: I think some of that is true. If you look at the growth and consolidation of insurance companies and their capital bases, one of the biggest ways for them to grow their premium volume is to retain more of what they write. So, generally, there is a move among the insurance companies to retain more, cede less. At the same time, obviously, as reinsurers' capital bases grow, that tends to drive their pricing down. In terms of percentage of risk ceded to reinsurance markets, that potentially will decline over time.

Capital markets, I think, access reinsurance in two ways. One is to completely disintermediate reinsurers, which is potentially the idea that you could supplant a traditional cat cover or other form of insurance or reinsurance with a direct bond through to the market. Some of the problems with them have obviously been, though, that they are hard for investors to understand; they do not always absolutely match the liabilities of the insurance company.

Second, I think there is a large role for sophisticated reinsurers to write reinsurance on a traditional basis, which is an indemnity, so that in the event that a loss does happen, there will be a payment. There is no basis risk between the loss and the recovery, and sophisticated reinsurers will be the people that then lay off that risk in the market. They effectively take a basis risk, so I can envision a large cat company writing lots and lots of traditional cat covers and they being the ones to lay off that risk into the capital markets, being the intermediary and handling the basis risk.

Graham Pewter: Which is the first deal that was done on an ultimate net loss basis? There was one transaction done where the basis risk was not left with the buyer. Was it the St. Paul transaction?

David Brown: Yes. Ours are not index based either. We just did a transaction that was not index based.

Graham Pewter: The feeling was that if non-reinsurance investors could get comfortable with the frequency of a Hurricane Andrew type event without needing to see reams of data, they would be able to understand what drives the ultimate net loss of a given ceding company. I agree with what David is saying but if the capital markets show a greater willingness to play without leaving the basis risk in the hands of the buyer, then it could take off in a different direction.

Michael Butt: But there is not too much evidence of that.

Graham Pewter: Not too much evidence of that, no.

David Brown: It is hard to do because that means in every single instance the capital markets look - and these guys do not want to spend weeks underwriting, they have got to understand a different company, different in their writing philosophy. As we all know, reinsurance is a professional business. Clients' needs change weekly or daily and it is not unusual for a client to come midway through a contract with a change. They have acquired another company and their business has changed; their exposure has changed in a certain area. You can handle that as a professional reinsurer. Very hard to go to the capital markets and say: "Can we change the deal?" That is not how the capital markets work. They want to do it and forget it for a year, and see the outcome at the end of the year.

Don Kramer: Cancel and renewal.

David Brown: It is very hard to do multi-year contracts in the capital markets, because again there isn't the ability to know in advance what all the changes are likely to be and include the power of negotiation in it.

Michael Butt: It is like a Lloyd's syndicate with Names. It is very difficult to do multi-year contracts.

David Brown: Yes.

Michael Butt: I agree with what David has said, which isn't surprising. The transformer role is what the reinsurers will play on these type of products. But the other reservation which a lot of us have is what is going to happen to those markets, not after the first loss but after the second and third loss. If you just overlay the loss experience of, let us say, the late 1980s and early 1990s, which could easily happen in the late 1990s and early 2000s you wonder about the staying power of those markets under that type of stress. That is the business we are in. I am not saying they will not have it, but one has to ask the question, and certainly I think a lot of the buyers would ask that question.

Lee Coppack: Do you think that if the capital market investors get more involved they could then make more use of the derivatives market? It has been suggested that having the CBOT futures before there was a major primary market based on the price of the risk as opposed to an index based on historic claims was a bit back to front.

Michael Butt: It is possible. The evidence to date is that the volumes are so small and the appetite so small that it is going to take a long, long time to come into play. Secondly, one of the great problems of that market is there is very little differentiation by client. What the people sitting around this table do is look at a client's exposures and tailor very much and, indeed, increasingly differentiate one client from another. Marketplaces, once you start to syndicate, by definition do not differentiate. I think that is going to be a serious handicap in the development of those areas where clients want positive differentiation. You cannot tailor make securitisation. They are inconsistent statements.

David Brown: The capital markets look for risks which are homogeneous in size and type and which are masses of consistent data. As Michael points out, every single client we deal with is different and the reason they seek out a professional insurer or reinsurer is because of that difference. Otherwise they would all get charged a price multiplied by the size of capacity that they wish. That is the essence of the capital markets.

Graham Pewter: We would all be trading over screen as opposed to entering into detailed negotiations with an individual client. Quite aside from expertise, it is the price at which the risk can be distributed to whomever the buyer is. What we have seen in transactions that seek to blend insurance risk with financial risks - this is moving a little bit away from distributing catastrophe risk - is that a decision has to be made whether the insurer is going to simply hedge through the financial risk to an investment institution or run it net.

I think until such time that the market, the reinsurance market, comes to a view that it can run those risks net, then capacity is going to be an issue and price is going to be inefficient. Something that we are grappling with at the moment, particularly on contracts that involve multiple triggers for which we are seeing more and more demand, is getting pricing of a combined probability to the point where the buyer will say: "Yes, I'll buy." That is a big problem that we see in the fusion of insurance risks and financial risks. It is a bit of a diversion away from capital markets and securitisation, but I think we are all pretty much in agreement as to where that is going to lead.

Michael Butt: If what these people are saying around this table is correct, then that leads to you to seeing effectively a merger of skills from the investment banking world increasingly into the reinsurance world as transformers and innovators and inventors of the multiple use of the various capital markets, be it derivatives, cat bonds or the whole series of structures that are going to evolve.

Lee Coppack: Bruce, from your point of view talking to, perhaps, energy companies who are major buyers of the original product, do they have any feelings about these developments?

Bruce Abrams: It is not raised in our discussions with the energy majors. They are quite happy with the structures that they have at the moment.

Graham Pewter: Cheap, cheap, cheap traditional prices, that is what they have got.

Bruce Abrams: Well, yes, we are in the fourth year of 20 point plus reductions on the oil rig side, so this would not be the time now . . . I did hear some interesting comments that some of the buyers felt that it was imperative for them to structure their programmes now for a coming of the hard market, for a change in the market, which indicated to us that they felt they may have reached a trough.

Michael Butt: That is the best piece of news I have had in two years!

Bruce Abrams: It was surprising to me to hear it, but the first time I heard it I discounted it, but the second and third time . . .

Graham Pewter: The biggest impediment to us doing more interesting things or more business with European based companies, for example, is simply that even while we can convince them that taking a different view of managing the bottom end of their programmes as opposed to the top end, perhaps on a multi-year, multi-line basis which they understand intellectually makes great sense, they can buy cheap, guaranteed cost capacity for less than the burning cost. They can arbitrage the position, buy it down low, and say: "I'll come back and see you in five years, thanks." That is one of the big obstacles that I think is holding back the evolution of, say, the large corporate buyer going into more progressive types of risk financing strategies. Would you agree with that?

Bruce Abrams: Yes.

Don Kramer: The other thing is that the absolute level of interest rates is so low that you cannot get a big arbitrage that is spread in basis points when you are at 5% and you have got a flat yield curve. You cannot do much by arbitraging time or maturity or quality or anything else. The difference between a single A and a triple A, the difference between a 3-year and the 10-year is almost non-existent. We need a combination of what you have described, and recognition of the fact that at 16%-17% interest rates or 13% interest rates and wild inflation, there were always opportunities. It is much more difficult with narrow spreads.

Michael Butt: Going back to the point that David started off with, the increased retentions by the ceding companies which certainly is a noticeable trend in the last two years in the developed world, I think, Lee, you can go back and get somebody to check for you, but there is a definite pattern that ceding company retentions always go up just before the major losses!

Lee Coppack: That ought to be a good leading indicator.

David Brown: Some of the comments that were made here about the difficulties of the capital markets getting involved in the reinsurance business I think are true. Nevertheless, I think that we will all see them getting more and more involved over the next few years. They will overcome the difficulties; they will find the appropriate way to access insurance and reinsurance risk, both directly and as a way of providing assistance to existing insurance and reinsurance companies.

We have already seen in the half-dozen to dozen cat bonds that have been issued, for instance, a rapid progression in terms of the sophistication of the bonds, the way they are set up, and the fact that now, the one we have just issued will be book entry, which is a relatively simple thing to think about, but it means that you can trade it. It is theoretically tradable; it is not a physical piece of paper that you have to hold. But small steps like that, such as creating a secondary market, I think, are going to lead to the speeding up of the growth of those instruments.

Lee Coppack: How will reinsurers respond to that?

David Brown: I think they will take advantage of the market.

Don Kramer: They will be buyers and sellers.

Michael Butt: They will be the transformers.

Don Kramer: We want a buying cat market actually. We bought the Tokio Marine bond. I think a lot of us did and it was oversubscribed.

David Brown: It is a good way for them to access risk, but also I think the smart companies are going to be the ones that are the biggest users in the next few years of cat bonds. They are the very, very largest companies in the world. Most smaller companies want to have a policy that they can guarantee that when they have a loss, the reinsurer will pay. They do not want to be concerned as to whether the index is up or down that day, whether they have a loss that is reflected in the portfolio or not. They want to know they are going to get the cheque, and they will let the professional reinsurer take the risk to manage that risk in the backend.

Lee Coppack: To what extent do you think traditional reinsurance type contracts will continue, particularly say quota share? One could make an argument, could you not, that it would be easier to package home owners' and motor into an asset backed security than cat risk?

Michael Butt: Much, much more logical, because you have got a mathematical base to do it from, of course.

David Brown: The attraction of cat bonds has been, I think, that despite the recent rate reductions, it is probably the most attractive risk-reward business in insurance today.

Don Kramer: That is the cat business itself.

David Brown: Which is why I think it has attracted the capital markets. I wonder whether, if they had started this process right after Andrew when the cat companies were formed, they would not have been much more successful than they have been today.

Michael Butt: Yes.

David Brown: They have been trying to do it in a declining market. The other lines of business, as Michael points out, seem to be more attractive to the market mathematically but the margins on them are small. They are very thin, there is a lot of competition, and there isn't really that benefit of accessing the capital markets in terms of the risk - reward you can look for.

Don Kramer: Actually there is no supply side right now. There is a huge demand side with no supply. This is like many years ago when they had these mutual funds that were split, one group got the capital appreciation, and the other group got the income. What invariably happened was everybody wanted one side or the other, and you never could get enough together so it actually worked. You either had it oversubscribed on the income side, everybody wanted them and you did not have enough of the equity, or vice versa.

In the cat bonds it is the same thing. Right now the capital markets want them and you can see they are oversubscribed. There is a huge demand; they are easy to place. But it is not so often that many of us want to cede them or create them because we do not want to give up the income for the risk. It is the most remunerative part of the industry.

Just for a second look at the motivation on the buy side. Money managers now all have to meet or beat some index, some benchmark that they are trading against which forces them to actually simulate the index. If they go out on their own and decide to just invest away from the benchmark, if the benchmark goes up and they have missed, then they lose the account, and they are gone. If they meet the benchmark, spot on, then everybody says: "Hey, why I am I bothering to hire a money manager and pay a fee. Why don't I just index the whole thing?"

So the money manager basically buys the index for 90% of the portfolio and if he can find 10% non-correlated, it gives him an enhanced return which is exactly what these guys do. Even with an enhanced risk, he does not materially change his risk profile, because of the way these things are rated. He continues to stay within his quality parameters and he can then say: "The Shearson and Lehman index was up 3.2%. I was up 3.4%, and, therefore, I outperformed the index." He keeps the account in perpetuity. And once in 20 years, or 10 years, or whenever the event occurs, he gets clobbered. And he says: "I have been beating the index every year all these years. One day I was out of step. I just missed one. You can understand that." Hopefully he does not get put on probation and watched or bounced off the account for one bad year. That creates the demand side.

Lee Coppack: Do you think that at the moment there is unsatisfied demand for reinsurance? It is said that there is the potential for a $25 trillion event and the reinsurance capacity of the world cannot get anywhere near it.

Michael Butt: If you take the recent Sigma studies on the adequacy of protection in various markets, you can see there are obviously views that demand is not being purchased. It took hurricanes Hugo and Andrew to remind people of the limits of aggregation that they needed to protect against and arguably, therefore, there are exposures that are currently seriously under-reinsured. Personally, I am convinced that the world is substantially under-reinsured at the moment, but we will have to have a whole series of events for that to come through and then we will have a new shortage of supply. But that is not tomorrow.

Don Kramer: I really have tried to refresh my memory as to when the cycle turned between 1980 and 1986, because 1986 was the greatest year in the history of the insurance business and 1980 was probably the worst year. Talk about the bottom of the cycle. If you had less than 500% loss rates coming out of 1980, you were probably lying about your reserves. That said, what happened? What was the seminal event? I looked back at my records, I looked back at history, I tried to scratch about . . . I really could not find it other than the fact the only thing that happened was there were losses. It was not a single event; it was not a catastrophe; it was not anything else. But the reinsurer started losing his shirt. Combined ratios went to 116, 115, 120, 128.

There were guys that did not know. You had the Mentor and the famous naive capacity. It was just the fact that the reinsurers took risks they did not understand. I remember the satellite business which we are all making so much money on now. I remember the New York Insurance Exchange. Our underwriter took on a satellite programme. He immediately agreed to insure four satellites. The first one went off into space somewhere, blew up. We were in a huge net loss position and had three more launches to worry about, with no premium due. It was horrible! But in this cycle, I do not know what will turn it unless we have . . .

Michael Butt: Ultimately it is the financial discipline of shareholders. Unfortunately in our business, being a long-term business, the ability to defer the visibility of the pain is considerable.

Lee Coppack: Bruce, would you say that the quality of the underlying risks has improved? Perhaps as a result of risk management?

Bruce Abrams: As far as the clients that I work with directly who are either creating in new markets or are enhancing their existing retention programmes, I think that, absolutely, yes. Some of the more interesting things that I have seen recently are that some captives have actually used investment portfolios to increase loss prevention activities in their own organisations, which we think is very encouraging. But from what we understand, certainly the loss record would bear that out, it does seem that clients are much more prepared to take much heavier risk, and they continue to have improved confidence in the underlying risks.

Lee Coppack: How does that eventually feed through to the reinsurer? Does that simply mean that everyone is more cat related and, therefore, results are likely to be more volatile?

Graham Pewter: That is an opening for companies like Centre Re and us, who would then say, if risk retention is inevitably going to increase, that is going to pull more volatility on to the balance sheet. At some point there is a trade-off between what is retained pure net, and what can be passed into the insurance market through long-term contractual relationships. So managing retentions of whatever sort, baskets of retentions, over a long period of time, which provides chronological stabilisation in results, is one of the key reasons that our products are going to be in demand. I think the two things are happening at the same time.

The qualitative side of risk management is improving significantly - the holistic approach to risk management, which I hate to say because it is such a cliché, but that is the expression. The standard of financial analysis that is available has never been greater, whether you are seeking that from major broking houses or from insurance and reinsurance. And in the soft market, one way insurers can differentiate themselves is through service, through better use of technology.

Bruce Abrams: I try to keep up as much as I can on the developments going on in the market for alternative risk products and holistic risk management. Yet travelling into less sophisticated markets around the world, you find that those terms are not even understood and they certainly are not on anyone's radar screen. I recently spent a bit of time in Turkey. You go in and talk to a major company in that market, a large brewer with a tremendous sized motor fleet, serious exposures. Never even considered the idea of things like driver safety programmes or any of this kind of thing. When you begin to talk with them about how to improve their risk and have that flow through to the balance sheet, they are tremendously interested. No one has talked to them about it, or few, few companies.

David Brown: It seems to me that generally companies around the world, particularly in the Western world but increasingly in other parts of the world, are becoming more sophisticated in their financial management overall and addressing risk of all sorts within the financial management process. Certainly in the business that Graham and I are in, there is much more happening these days. Clients come to you with a discussion of many risks, some of which would be traditionally protected in insurance, but many of which are not. The challenge is to try and help them manage all of their risks, regardless of the fact that some of them you wouldn't normally consider to be insured or insurable risks.

Michael Butt: I agree with that entirely. That is why innovation is coming in today.

Don Kramer: I think you guys together, actually wrote a rogue trader's risk, recently. It just makes sense, that financial institutions insure against the possibility of a rogue trader getting loose on a derivatives contract and blowing the bank out of the water.

Bruce Abrams: It's a life-threatening exposure . . .

Don Kramer: I know. A perfect example is that NatWest had a trader that left. He was not a rogue trader actually; he just mis-priced some trades which were not discovered until after he had moved on. The bank had to announce that it was setting aside £77 million to cover the loss. Of course, that sent the stock down.

If they had bought one of the structured contracts, you know, a non-designated loss contract or a variety of things they could literally designate to trigger, they could have said: "We are going to have a £77 million loss . . . and by the way we are insured." Those kinds of things people understand.

Lee Coppack: Is that one of the advantages to conventional insurance and reinsurance, that you can say to the stock market, to the investors: "We are insured."

Don Kramer: It is very difficult to structure a price for that, because it is such an uncertain risk, and you have got to work it out in a way that the guy does not feel the premium is going to be greater than a loss or that there is no probability of loss. Most of these things are unforeseen.

Michael Butt: These are areas where partnership is increasingly important, and you are finding that companies sitting around this table are increasingly developing relationships with their client base where it is long-term partnership, across a whole series of areas. Then there is the confidence to take the kind of thing that Don is talking about. If there is fear of short-term trading advantage, and that you are just trying to buy a product as a one-off, you cannot do those type of deals. It is being that close and really viewing your relationship as business partners long term that enables you to develop those types of contracts and relations.

Graham Pewter: I was going to say, it isn't a one-off Band-Aid. That would send absolutely the wrong signal, that these programmes are some attempt to deflect attention from the economic realities. But as part of a closely based long-term trading relationship, all sorts of things can be done. Everything we have said in this last segment is about moving toward a skill based competition. Having lots of capital is the price of admission into the game; this has been said by a number of observers. If you want to survive into the future, you have got to have people and you have got to compete on skills. To me, one of the great things about Bermuda is that a risk manager can come here with a problem, and he can see five companies. This happened 4-6 weeks ago. A Fortune Thousand risk manager was here with his broker. He had a specific problem. He saw four companies. He got four proposals, all completely different, all in an attempt to solve a problem that was a significant financial one to him. We were the last that he saw. I said to him: "How has your week been?" He said: "It has been amazing. Everyone has had a lot to say, but everyone has attacked this problem from a different angle, and they are all interesting." He could not have gone anywhere else, I don't think, and got the same sort of lateral thinking about his business problem set in a proper context in any other market.

Michael Butt: Supported by the right type of capital.

Graham Pewter: Supported by triple A capital.

Don Kramer: And that is what absolutely makes a market - diversity of opinion. If everybody says the same thing . . .

Lee Coppack: What areas in non-traditional risk do you find people are interested?

Graham Pewter: I think risk managers are intrigued by ways of being able to manage loss costs over time. They are trying to somehow reconcile in their own minds their internal power struggle with the treasurer and the cfo, because there are all sorts of non-economic reasons why deals do not get done. I keep coming back to this issue that the intellectual interest is there, but a lot of buyers are not going to be pushed over the top until the price is right. There is a lot of patience needed to prevail, particularly with companies whose mind sets are more traditionally moulded. But when I went into insurance there were certain risks that could be insured, and speculative risks were uninsurable. That was Elements of Insurance, page 1. Now, suddenly the rule book has gone. We are now apparently able to cover this whole spectrum of risks, whether it is taking away risk of a client's cost of their raw base materials. . .

Michael Butt: Jet fuel . . .

Don Kramer: There isn't an instrument that we are using today that I studied about when I went to graduate school. I studied fixed income! You know, I studied bonds and had a great professor on it, and some of the really great theorists in credit theory. And none of these instruments existed. They did not exist 10 years ago.

Graham Pewter: How far can you push this? It is like BP saying: "I am willing to pay someone a ton of money for a contract with no exclusions. The triggers I want will stop our aggregated losses at a billion pounds a year. Now, someone tell me what that is going to cost." That really happened, but I do not think they ever bought anything. We are pushing the boundaries. Maybe not spending too much time thinking about where lines should be drawn if they need to be drawn.

Michael Butt: There is going to be a merger of skills without a doubt.

David Brown: There seem to be pressures coming from both sides. To me, the customer base is no longer willing to accept just looking at an array of products and saying: "From these products can I meet my needs?"

Bruce Abrams: Saying: "I will have that one. . ."

David Brown: Yes. "I will take that one and that one, and that is kind of near enough, but there does not appear to be a product to cover this, so I will not do anything." They are realising that is very short-sighted, that really risk is risk and you have to try and manage it in an overall sense. So when they find risks that are not covered by the current product market, or where they find the array of products does not quite meet their needs or does not meet them efficiently, they want something different. They demand something different, and they demand that of all of us.

On the other side, I think insurance companies have woken up to the fact of the same thing, risk is risk. If you look at the cat companies as one very clear example, when they started, it was looking at natural perils, earthquakes, windstorms, which are very high severity, very low frequency events. They are all running around trying to find un-correlated books of risk. All of them realise that there are other forms of high severity, low frequency risk which are not correlated like satellites, for instance, and it is entirely logical to add those risks to an existing book of property cat. They fit the same risk profile. That is happening throughout the industry; it is just more complicated in other areas. Insurers are realising that, within the risk profile of their business, they can add all sorts of other risks, and still manage that risk on a portfolio basis.

Bruce Abrams: I think a very good example of that is credit, particularly export and trade credit, where the exposure is potentially catastrophic to the company if its sales are concentrated. Yet, the conventional, traditional insurance markets have always been focused more internally on: "What kind of buyer limits and what kind of territorial aggregations can I withstand?"

There is an example of the traditional market putting a product out on the shelf, and then sort of daring the customer to either take it or not take it, as distinct from sitting down and trying to understand what the catastrophic elements are for the company. I have seen a lot of interest over the last two to three years in bringing trade credit in. It is not quite as foreign to the risk manager as interest rate or underlying commodity prices might be, and it is getting more attention.

Don Kramer: Actually in that market, availability created demand rather than the other way round. It was supply that created demand. The demand could have been there but people did not know it was available yet.

Bruce Abrams: That is absolutely right, in that it has always been a retained exposure considered as part of the cost of doing business.

Don Kramer: In principle, insurers who were always very small in this area, got sold out of their aggregates by country limits. All you had to do is bring the new player in and suddenly in all of those A countries that you wanted to be in, you can expand by another $50-$100 million. That is true of trade credit; it is true of political risk.

David Brown: One thing that we see despite the soft market is that there is still a great deal of inefficiency in the way that insurance is bought and sold. Many times buying on a one year at a time and risk by risk basis, even at incredibly efficient prices, is an inefficient way to buy and sell risk. The person that buys risk on a year by year basis, line by line, is giving away the fact those risks are probably to some degree uncorrelated and, therefore, there is a portfolio effect which mitigates the overall risk. By combining them, particularly over a number of years, you can actually reduce the cost of buying the same cover.

Somebody recently approached us who had interest in aircraft around the world, lots of them, and they had political risk cover on their interest in every single aircraft. The theory was that at any one time these aircraft could be taken by some country and they would be out lots and lots of money. If you think about it, of the hundreds of aircraft subjects, they are effectively buying cover that it could happen to all of them. Is it realistic that they are all parked in Tripoli the day that Gaddafi decides to wipe them out all at once? It isn't going to happen, so really they are buying way too much insurance for every plane. They need a programme covering their entire portfolio with a limit that says - we cover you for two or three aircraft, or maybe one or two; that is really all you need. There is zero risk that all of their aircraft will be expropriated. Admittedly, we do not know which one it is going to be, but they really need to think about it on a different basis.

Graham Pewter: And the traditional market never would have suggested that, obviously. It just took a different point of view.

Michael Butt: I wonder if that is fair. I would have thought that a traditional aviation war risk insurer would have quoted it on the basis of just the point that you have made and, therefore, the rate, the line would reflect that - the real exposure as opposed to the 100%.

Bruce Abrams: A good broker would have pointed it out.

Don Kramer: I have got another point not to be lost. In designing these kinds of products, one of the unique advantages that Bermuda has, besides the fact that it has the depth of capital to build these programmes, is it has the regulatory flexibility to design them. In many jurisdictions, policy forms are required which are very complicated. In Bermuda, we have a great deal of flexibility. The governing agent is really the rating agencies, and as long as you do not do anything that is unsound, as long as you are not bad credit, as long as you give them good security, beyond that it isn't a problem.

David Brown: If you look at the last five years even, in the way that products, or solutions are bought on the market, it has been radical. We noticed in our business, when Centre Re was started 10 years ago, what it was selling was very odd. People were very interested in it, but found it a very strange approach to business. In the last five years, there has been a lot of competition in our business. Paradoxically, it has been very good for us, because now when we go to see a potential customer, what we are proposing is no longer entirely radical. Lots of people offer multi-year policies with multi-lines, so we are not talking about something that is entirely radical in the business.

Michael Butt: Two other factors that are very interesting, playing on this, sort of forcing innovation through at the moment. One is the stepping back of governments, which began with Reagan and Thatcher, from being the security blanket to everybody. That changed people's attitudes towards risk. People became a lot more aware of it and moved towards seeking to protect themselves much more. That forced innovation into the market. The second was the globalisation of capital movement. Capital will go to its most efficient location, and all the consequences of that have again forced through innovation. The power of Wall Street thinking in terms of companies having to deliver financial results, which is spreading through even continental Europe, is one of the major forces that is making the insurance industry become innovative.

Bruce Abrams: I do not think it is as much a regulatory issue why these were slow to develop as much as it might be internal structures of the companies themselves.

Michael Butt: It is the rigidities.

Lee Coppack: If you are creating products like multi-year basket aggregates on a direct level, what then happens if you want to reinsure them?

Bruce Abrams: A lot of complications. A lot of difficulties. I have just come out of Palm Springs at the IAS symposium. One of the questions from the audience was: "Can anyone think of an example of a multi-year basket aggregate programme that required excessive loss reinsurance that was actually placed on the market?" No one in the audience could think of an example where that was done.

Michael Butt: Let us put it around the other way. David, I think, is organising his shop whereby the centres of expertise can come out into the market either through insurance or reinsurance, and what you are doing is creating the think-tanks that then inject into wherever the need comes from. If I understand correctly, Centre Solutions is that. That seems to me a model again that people are going to have to follow. Because the skill is as applicable in insurance or reinsurance.

David Brown: That is exactly right. As you know we started as a reinsurance company. The change of our name recently reflects the fact that less than half our business is now reinsurance. If you were to look at the way we analyse a transaction, and we deleted the name of the potential customer, you would not know the difference. The analysis of a large complicated insurance risk and a reinsurance risk are identical. Large quantums of risk . . .

Michael Butt: And, indeed, so they should be.

David Brown: Yes, they are. You know many large corporations, in fact, have way more risk in terms of quantum and variety than many insurance companies.

Graham Pewter: With all the consolidation taking place in the market, whether they be insurers or reinsurers, there are net writers of large blocks of capacity. So the companies writing those multi-year, multi-line programmes do not need to go to the reinsurance or retrocessional markets to protect them.

Bruce Abrams: That was the conclusion last week.

Graham Pewter: That is the fundamental change: you do not try.

David Brown: Actually I do not entirely agree with that. I think for the most part it is true, but one of the benefits that Bermuda has been able to offer is the ability as a market to solve the very, very big problems. There are very few parts of the world that can do that. Berkshire Hathaway is known for solving very big problems; that is their specialty, but there are very few. Bermuda has been known to do that on a number of fairly public occasions in the last few years by the markets combining. A number of companies working together to take mega risks, in the half-billion, billion dollar range that no one of us would prudently take on behalf of our shareholders, but by working together either on a shared basis or on an excess basis, in fact, a structured basis, we manage to meet the needs of the customer.

In terms of the growth of Bermuda, in particular, that is a very big area. It is something we are now recognised for and increasingly we see opportunities to solve the very large risks, much in the way Lloyd's in its heyday really was seen as the place you went with a very big, unusual risk. You came to Lloyd's because there was a roomful of underwriters in one market that would all take a piece of the risk.

Bruce Abrams: Interesting metaphor, isn't it?

Don Kramer: It has become to a degree a syndicated market.

Graham Pewter: Now it is the Bermuda lead that people are looking for.

Michael Butt: Because of the muscle that goes with it. The capital.

David Brown: It is more than the Bermuda lead. You know you can walk upstairs or downstairs or across the street and you can find people preparing to put down hundreds of millions of capacity with you on a programme.

Don Kramer: We collectively assembled the $700 million aircraft lease programmes just recently. A bunch of us all contributed.

Michael Butt: I would like to take up the structural point for a second as I think that is also fundamental. It is incredibly difficult to innovate if you have a historically structured organisation that is in departments that do not talk to each other. One of the coincidences of the start-ups in Bermuda is, of course, they do not have that baggage. Therefore, the innovation is that much easier structurally. That is a very important part of what is happening on the island at the moment.

Lee Coppack: Do you see it happening in the rest of the reinsurance world as a result now?

Graham Pewter: We often talk about the financial baggage that comes with old-line companies having written liabilities in the past, but people forget the bureaucracy that does prevent open communication. So the cultures of the companies are completely different. Completely. It is far more collegiate; it is far more democratic.

Michael Butt: And it is very results oriented.

Graham Pewter: Very results oriented. Much flatter organisational structures. And they work extremely well.

Lee Coppack: It sounds as if insurance and reinsurance companies are developing other lines of business perhaps as a consequence of becoming involved in non-traditional risk.

Michael Butt: Of course we are going to. We are already doing it. We are recruiting derivatives specialists - that is not something we would have done 5-10 years ago. And we are all spreading out the skills that we have and need to package what we have been talking about. There are a whole bunch of different skills. Centre Re started with accountants, with lawyers, each specialised in various territories. Now they are all having to add other skills on top of those as they find different opportunities to package. So are we, so is ACE, we are all doing it - AIG in a big way.

Lee Coppack: Would you see yourselves perhaps getting involved in different businesses, perhaps taking equity participations as part of risk finance?

Michael Butt: Yes.

Bruce Abrams: I'll speak for AIG. We have a large share of the required talents already under the corporate umbrella. The question is how do you make those different pieces of the organisation work together. I think the same may be true in other companies as well. So our issue is a cross-cultural one, not so much requiring us to go out and acquire companies or boutiques.

Michael Butt: The thinking that Mid-Ocean has been doing in the last year, which has resulted in our merging with EXEL, is exactly what we are talking about here. This is the creation of units, like ACE, like Centre Re, where the skills, very expensive skills by the way, can be put together and then used across many lines to be innovative. That seems to be the model that is coming through most strongly.

Don Kramer: We also make strategic investments, where the opportunity permits. We invested in CGA. Commercial Guarantee Assurance company, a new credit enhancement company.

Michael Butt: EXEL has invested in annuity life.

Lee Coppack: Would you see yourself basically still as insurers and reinsurers or eventually becoming more venture capitalists? Perhaps taking equity stakes, or doing something which would involve a conversion into an equity.

Michael Butt: There are some who have taken that route - Risk Capital Re had that as a declared strategy when it started. Certainly AIG in Southeast Asia has said that is something that they would wish to do to support the development of local markets. So I think some of us will try, some of us will not, and you know there will be different attempts at finding solutions.

David Brown: I think there is a big synergy between insurance and reinsurance, which is one form of capital provision in many senses, and direct capital provision. Our company has a long history of being involved in the capital provision business; we had a large firm called Insurance Investors; we have got a new one called Insurance Partners that is specifically designed to invest in companies where we find opportunities that the right solution isn't insurance or reinsurance. The right solution may be straight investment, or it might be a combination of insurance, reinsurance and some form of equity investment.

That trend for us will continue, and hopefully continue in an actually bigger way in the near future. When you sit down with a potential client, and you are trying to help them address their problem, you would like to have as broad a range as possible of things to provide, including direct provision of capital if that is appropriate.

Lee Coppack: Would the rest of you see that approach becoming more common, or is it likely to remain quite a specialist area?

Graham Pewter: I think it has to be another weapon in the armoury. We are all trying to be very client oriented with a very broad sweep. If that is the best fit for that client's needs, then it should be one of the solutions that can be put forward.

Bruce Abrams: It is in our interest to be able to do that. It is in the interest of AIG to run billion dollar infrastructure investment funds. That works to our advantage in the long run and helps the local economy to develop, so it makes a lot sense. There is a lot of synergy there. Take central and eastern Europe. Those joint ventures have helped local governments understand and gain skills, and we have shown them how to be able to make money as well. It is good for our shareholders. It is not pure altruism.

David Brown: There are also hybrid products between investing and insurance. We did a couple last year which are contingent capital products where it looks a bit like an insurance contract in that it is triggered in the event of a loss, but in the event of a loss, you do not just write a cheque for a loss, you invest in the company.

It is somewhere between being an investor up front, and being an indemnifier as an insurance company. But the point is, it does it for a reason. It does it because that more closely meets exactly what the client needs.

Don Kramer: They called it CatEPuts.

Graham Pewter: Again it is the end result of a negotiation where you are not pushing the client to an end result. You are trying to extract as much information as you can, and wherever those negotiations take you is the best solution for him. It may be a pure equity play; it may be a combination of common equity and reinsurance capacity, and it may be on a contingent basis. Maybe none of them. The companies have the ability to deliver.

Bruce Abrams: It is probably the most extreme example of the partnership, isn't it, where you have got to stand by capital provision. That will make you partner pretty quickly.

David Brown: Compared to a traditional cat programme where I just write a cheque for $100 million and that is the end of it, at least now that $100 million has not disappeared. I have an investment, albeit in a company that has just been through a big loss, but that is probably better than having just written a cheque off for $100 million.

Lee Coppack: So you would really see reinsurance developing much more of a banking element?

Don Kramer: Reinsurance is capital, isn't it?

David Brown: If you read the very early reinsurance texts, a lot of it talks about the reasons that you buy reinsurance. When you read them with a financial view like mine, not a reinsurance specialist view, it is the same reason you might get capital. Which is to write more business. Well, you could raise more capital. So you get a quota share. Or to cap certain risks, well again, you could raise more capital. Always an alternative to capital, is really what reinsurance has been. Companies could buy less cat cover if they had twice the capital. They should buy less cat cover, for instance, but the trick is, is it cheaper to lay the risk off to a cat company, and have less capital, or raise more capital? Invariably the answer is lay the risk off.

Michael Butt: Pooling of pooling. It is just the mathematics of transferring.

Lee Coppack: Does anyone want to take a guess at what reinsurance will look like in 10 years?

Michael Butt: I suspect, broadly, similar to today. Reinsurance has, taking David's earlier point, stood the test of time as a need for the efficient use of capital in the marketplace. You get leverage out of the pooling of pooling, which a specialist reinsurer can do. I suspect we will have a broader product range and a very different mix of skills than we have today, as the new world demands those skills, with an understanding of the new industries around the world, etc. But I suspect the basic function will look very similar in 10 years time as it does today. Just a much broader base.

Graham Pewter: I think demand for financial strength will continue to grow. More consolidation for fewer players.

Michael Butt: I agree with all that, but it is a different question from the one Lee asked. Yes, certainly the flight to quality one would expect to continue. I think the winners are beginning to differentiate themselves from those who are not going to win. Certainly capital and skill base, the ability to manage a skill base, are going to be the two determining qualities.

David Brown: I think in the next 10 years you will see a reduction in the syndicated commodity product market, although you will still see a commodity based market on the high cat layers; it is natural for those kind of risks. But what you will see is people will replace that by having much more complicated and all-encompassing programmes so that the reinsurers today who write the commodity for a client will write a programme that covers multiple lines, maybe over multiple years. We have already seen that happen. I think you will also see the reinsurers be the main users over the next 10 years of the financial markets, as opposed to their clients.

Don Kramer: I think that is possible.

Michael Butt: I agree with that. Can't we find something to disagree about?