Thomas Blunck, Member of the Board of Management, Munich Reinsurance Company

Rupert Boswell, Partner, Reynolds Porter Chamberlain

Jeremy Brazil, Director of Reinsurance & Director of London Underwriting, Markel International

Matthew Grant, Managing Director, Risk Management Solutions

Peter Grove, Finance Director and Chief Underwriting Officer, QBE

David Priebe, President and CEO, Guy Carpenter Europe

Marcus Rivaldi, Senior Analyst, Standard & Poor’s

Helen Yates, Editor, Global Reinsurance

Helen Yates: If I could start by aiming this question at you David. Based on what your clients are telling you, what trends do you see emerging in the run up to this renewals?

David Priebe: We are continuing to feel the effects of Katrina, which were quite intense in terms of impact on the market. There is a total focus on managing exposure and managing capital. Clients are trying to find what that optimum balance is between their gross/net exposures against capital, how they weigh that against the issues the rating agencies are putting out, and then what the mix is to achieve optimum returns. So what we have really seen is that everyone is doing a sort of complete "drains up" review. We have never seen more reviews of reinsurance and capital strategies in a year, it is just non-stop.

Clients are going back to basics, focusing on what their objectives are, what their needs are and going through an intense review of what the risks are in achieving those goals. They are trying to understand their exposures through the models: model uncertainty, how does that play out? What is their gross exposure? What are the permutations in their exposures, eg looking at some of the climatic changes going on? Probably the number one issue is what is the capacity out there of traditional, and more importantly non-traditional, capacity and what is the most optimum way to access the capital in that capacity? And the cost, how does that cost weigh against their profitability? So they are really looking at all those elements and trying to understand the various basis risks they may be taking on in terms of some of the solutions they may or may not choose to employ. It comes down to really focused analysis of their risk profile, the solutions around that and a complete exploration of all those aspects.

The trend is dig deep and dig hard and really develop an effective risk and capital management strategy. Going forward into 2007, it is about looking at the reality that if your company is writing North American exposed risk, capacity may not be there and you need to think about how to manage that exposure - how to manage it through your underwriting strategies and manage it through the capital you are going to employ against that exposure, that's the core trend.

Helen Yates: Does everyone agree with that perspective?

Jeremy Brazil: Yes. I think what you're saying is that this year is very much a year of transition. We have the new models coming out which, for a whole host of reasons (mainly for the good), have changed things so that whatever number you think it is, it is going to be a lot bigger than that now. I think a lot of people are concerned about what exposure they have actually got now, what is the miss factor between that and the models, and if you are going to use the models, how robust is that number? Consequently, they are trying to find reinsurance to fit what they have got but I think the rest of this year and the first six months of next year will be such that people will get their exposure down to what their appetite is and then find a reinsurance solution to fit it, rather than the other way around. It is easy to blame the models, but there were a lot of people using them and believing that the output was gospel without really understanding what the numbers were. I think people are going to go back to the more old fashioned way and say "What does it actually look like, can I touch it and feel it?" rather than just say, "I have $1bn of TSI and a one in 250 return period, it is going to be $100m and I am going to be happy with that."

Helen Yates: Is that your experience too Peter?

Peter Grove: Yes. The key point here is focus on exposure, focus on exposure and then focus on your exposure. This is the key, it is the business you have got that you must understand well enough and then decide how much market is out there to help cover that exposure and if that market isn't out there, then what are you going to do about it? Either raise more capital, cope with the exposure that way, or you reduce that exposure and how you manage it, and I think that is the vital thing that has to be appreciated going forward. I am not surprised at all about what David is saying because my expectation after last year was that there would be a lot of managers out there saying, "We really have got to get to grips with our business and it isn't enough that we believe we understand our business, we want others out there to understand our business as well. We need to discuss this with our reinsurance brokers, with our advisers, perhaps RMS, we certainly have to discuss it with rating agencies, perhaps S&P, and then when we have that understanding we can go into the market".

Helen Yates: So what are the key elements of an effective buying strategy?

Marcus Rivaldi: I think what Peter was saying, the key thing is we understand what risks you are running within your business, putting together your business plan for the forthcoming year and looking at some groups that have developed some very extensive and detailed economic capital models. They can look around and say, "Ok, if you buy this, this much capital will continue to be put against that or we look for a way to mitigate that capital". And that could be from taking some very tough decisions about the lines of business you are writing or geographical regions you are writing in. You are looking for ways to offset that capital need through traditional reinsurance or non-traditional sources and, picking up on earlier comments on whether traditional reinsurance or retrocession will be around next year, I think you are right, there are some marketplaces where it is going to be very very tight. We see a huge amount of activity, people coming to us talking about cat bonds and sidecars and that sort of thing, looking for ways that perhaps they can mitigate weaknesses within traditional reinsurance markets. Other businesses are also thinking that maybe they are going to have to fundamentally change what they do and look to diversify. Well, there are risks associated with that as well and from the capital perspective you may believe diversification will give you some sort of benefit, but there may be an increase in operational risk within that business which effectively mitigates any capital saving.

Helen Yates: And from the insurance perspective, what would you say the elements are for successful buying strategy?

Peter Grove: Focusing on the exposure, focusing on exposure, focusing on exposure. You must understand your business and you must understand your underwriting exposure at all levels of your company. Your board must understand the underwriting exposure, your CEO must understand the underwriting exposure, and your chief underwriting officer and financial officer must understand your underwriting exposure - and that applies right the way down through your company. That is the most effective strategy that you can have. How you go forward from there depends upon what business you write. If you write business in catastrophe-exposed areas then you would look at it in a certain way and your colleagues will look at it in a certain way. If you write other classes of business, obviously they will be looked at in an appropriate way and some of the decisions will involve the requirement to purchase some form of protection, other decisions will be to retain business, but it is something that has to be understood by all colleagues. It is not enough for just general management to look at these things. They have to be looked at and understood by the whole organisation that is involved.

Marcus Rivaldi: That and shareholders as well?

Peter Grove: Yes

Rupert Boswell: I would also add from a legal perspective that if you are focusing on the exposure, as you say Peter, and doing that throughout the year and the people who are doing the buying really understand the business, they can ensure that proper disclosure is made to reinsurers. Then the risk of treaties and wordings being avoided for rescission or being rescinded because of non-disclosure is minimised, because the tradition is still in the reinsurance market not to have innocent non-disclosure clauses. You may have errors and omissions clauses, and they sound as if they are going to mitigate the prospect of rescission, but in fact they don't as a general rule and that is the most profoundly uncertain contract you can have, one that is potentially going to be avoided. So I would add that getting that information over with the help of brokers to reinsurers is a key part of buying - to be sure you have got something at the end to call upon.

Jeremy Brazil: I agree with Peter, you have got to embed it through the whole company from top down to bottom up so people actually understand what the business is all about. You can't have a business model that is predicated on the basis that the ground doesn't shake, the wind doesn't blow, because our view is you have got to assume that 2004 is going to be a typical year now, not an aberration. I think the point you are making is that you have really got to get under the skin of the person you are reinsuring or insuring. You don't want to be in a position where you know you are making your decision based on what the broker says or what the reinsurer or buyer says. You want to talk to the underwriter to see what he is doing and how he is doing it because Peter would rather not have losses, nor would we as an insurer, but if he has them he doesn't want surprises.

Helen Yates: Coming from a very large global organisation, do you have a centralised strategy or does it vary from region to region?

Jeremy Brazil: Well from Markel it varies as it doesn't make sense to have a global solution for some things. It will make sense in other areas to have more specific solutions but we nevertheless have a uniform and consistent approach, which at the moment is very much focused on exposure.

Matthew Grant: There is a lot of variety in the market about how people look at exposure and I would absolutely agree with Peter that for any kind of risk assessment you have got to start with risk exposure. Over the last few years people have seen modelling as being the answer to many of their problems but they actually forget that you have to go back to the original information. I think there is still a problem in the market in the sense that there is still a lot of variation in how much focus people put on exposure. For years at Markel we have seen them focusing on exposure, for some period of time it was to the frustration of some of the people in London, but it was the right thing to do and likewise a limit. But I wonder if it is something the industry needs to take on board, to actually enforce that more rigorously to ensure that there aren't people out there prepared to write business who actually haven't got good information behind it. Because the fear is as the market turns people start to slacken off their rigour on the information they are collecting or writing and we are back to where we were three or four years ago.

Thomas Blunck: I totally agree with the points that were made. Most of the companies that have exposure in the critical areas - like the US hurricanes - are going through a total reassessment process of their product and regional strategy but I believe it is something you can't do each and every year. You can't change your portfolio each and every year because you lose your market position. You have to look at the capacity to mitigate the risk on a more reliable and sustainable basis and that is becoming a more important feature in your main insurance buying strategy. Really rely on the capacity you have at the back end because if in the second or third year you don't have it, you have to change the whole strategy at the front end again, which is very difficult of course.

Helen Yates: Just coming back to contract certainty and what Rupert was saying. Sixty-five percent of contracts were certain at last year's renewals, what is your feeling on where we will be at this year's 1 January renewals and the importance of getting that certainty?

Rupert Boswell: I can't say I know exactly what the percentage is meant to be at the moment but certainly we have spent a huge amount of time with our core client base helping them in training and answering queries and we have seen a massive effort to invest in that. What has been flushed out by the whole exercise is that contract certainty in terms of just having a document in place on time is one thing, but the quality of the contract and being satisfied that it is going to do what people think it is going to do is extremely important as well. A lot of people have been surprised by answers we have given to questions as to what clauses mean in particular scenarios and we have been engaged in quite a few assignments, just working through programmes and stress testing them, and I think there has been a bit of an under-investment over the years in that which is understandable because the culture of challenging contracts didn't exist until recently. Now that it does exist and has existed for some time I think you have got to invest in the quality of these things a lot more.

Peter Grove: Focus on clarity, focus on clarity, focus on clarity. It is essential. It is essential that the client understands the cover that he has and it is equally essential that the reinsurance partner understands the cover he has given, and obviously that works well with the help of an experienced lawyer.

Rupert Boswell: I think it is interesting when people talk about investing in the new products. One of the things that is said against the alternative reinsurance market is how costly it is and the time it takes to do a proper deal without people thinking, "Have we actually spent enough money on what we do already and do we take enough time over what we do already to actually be more confident that we will get what we think we should get?" I think the answer is increasingly people are, but there is still a long way to go.

Thomas Blunck: Again, there is a connection with what Standard & Poor's is doing in terms of enterprise risk management. One of their criteria for risk management assessment is quality assurance of new products. Not enough attention has been paid to that in the past including, for instance, the quality and the common understanding of the wording. Going forward, we need a quality assessment of products - including the coverage and the wording in the sense of contract certainty- before entering into a market.

David Priebe: I agree.

Helen Yates: Contract certainty presumably is the way to achieve that understanding?

David Priebe: It is a movement forward. Clearly contract certainty is driving our industry, becoming more efficient and more professional in terms of ensuring that we have clarity at the time of inception or binding but we have to go a step further in terms of ensuring that the language that is on that contract is clearly understood and fully agreed by all parties. It is about having a really rigorous discussion in terms of what is the actual intent, what do those words mean and how does that translate in terms of the performance of the contract?

Rupert Boswell: Insurance contracts are not very long compared to a lot of the contracts that we deal with, so you do not have to spend that much time.

Jeremy Brazil: It shouldn't just be a tick box exercise. I suggest the lawyers should be there to articulate what the two parties actually want to gain from the contract rather than just interpreting it and I think sadly sometimes in the past you end up interpreting it after there is a problem. It is basically about having transparency throughout the whole process.

Peter Grove: I think another very important point to make as well is that it applies to the wordings and it applies to cover notes as well. It is vital that all participants in the business understand the wordings they have, that the underwriters you employ (if you employ underwriters) understand those wordings as well. That follows through to the technicians and obviously the claims staff, that they understand those wordings and are familiar with them at inception. They should always understand what reinsurance cover they have so they can write their business knowing that they have got the cover their management believes they have. It is very important.

Helen Yates: Again does that vary across different jurisdictions, the understanding of those wordings?

Peter Grove: I think it can be a problem for a global company. Obviously language is a problem as well and more often than not the language used on the contract wording is the language of the head office. If it is an American or a British company obviously it will be in English, if it is a company from Central or South America it could well be in Spanish or Portuguese, so that is a very important point you made. It is important, if that is the case, that there is some sort of translation given so that globally colleagues understand what wordings they have.

Helen Yates: If we can move on to the actual negotiation process - we have Monte Carlo and Baden Baden coming up and I am sure you are all getting prepared for that again. How does that process work?

David Priebe: Well it is like all things, the process starts off by making sure we have clarity of exposure - what the cedant says is the exposure - and we make sure the reinsurer understands that exposure to the best of their ability. Then it is about working it through in terms of what is the structural design? What is the actual coverage that is looking to be achieved? And driving it through on a number of points in terms of the form of coverage. What is the basis of the coverage? What is the breadth of wording? What is the aspect? It is a give and take. Obviously our clients, most importantly, want clear coverage and they want to know that when the loss happens it will respond. They also want to have that wording follow their own original coverage as best as possible so, what is the understanding of the original business and how does that flow through to the reinsurance contract or the insurance securitisation contract? A very intense discussion around what the basis of coverage is and then the cost of the product affording that takes place.

It is like all negotiations, both parties are looking to achieve their maximum aim but are also trying to find a balance between the two where everyone feels it is a fair and reasonable proposition. In most cases the negotiations are particularly with the reinsurers. We have many counterparties that we are negotiating with simultaneously to try and find the optimal solution for the client, and then the client weighs up the pros and cons of the terms of one counterparty versus another one and makes a decision as to what is the right solution for their firm. And it is not always price. It is a combination of price, coverage and quality for the counterparty credit. What is becoming more interesting is the range of products away from the old traditional reinsurance product, which was done in good faith, to an insurance securitisation contract where you really have to button down every single detail before the transaction is actually executed and completed. So it's a very intense, focused and very involved set of discussions.

Marcus Rivaldi: Do you think the discussions this year are going to be even more elongated in terms of the breadth of coverage offered in a long contract compared to what might be offered in the same contract this year, and the need to perhaps fill holes with non-traditional products? Is it going to be a big job for you guys?

David Priebe: I think it depends which geographic area we are working in. We are already in a world of patchwork quilts and so you have your core programme, most cedant companies say their core reinsurance programme, depending upon where it is. But if it is a major US company their core programme probably isn't fully complete. There is just not enough capacity to fill out the billion dollar needs of those companies. So then you have alternative products coming in to fill those gaps and I think the issue there is really understanding some of those alternative products. They may be on a parametric basis, maybe with some form of index trigger, so what is the basis risk that is being assumed by the company? And sometimes you have timing differences so have gaps in time and overlapping of cover so it is going to be a very involved and intricate management process for the ceding company.

Peter Grove: Marcus' question is so important because we could be going through a period of change. A lot depends on whether there is a major catastrophe this year or not, but because of that I think it is so important to start early. There is something else that is different as well and David has really brought this home, we are no longer just dealing with the old relationships of the client and the reinsurer, the established reinsurer. Those represented round this table today are actually from the traditional reinsurance end of the business or the traditional buyer, but more and more we could be entering the world of capital markets and there we have a completely different way of looking at business. The relationship with the capital market is a very different one to the relationship that one has with the traditional reinsurer and client. Therefore the intermediaries' role is more important this year than ever before because that intermediary - subject to licensing rules - will be expected by the client base to actually translate and speak the language of both markets: the traditional reinsurance market obviously but also the capital markets. Just to bring Rupert's points home as well, because of this, it is essential that lawyers are dealing with this and contracts are there and everybody understands in clear language how the contracts go forward.

Rupert Boswell: Contract uncertainty and cultural uncertainty. I think people are just not used to the capital markets and that culture is behind everything isn't it? Because we are talking about the criteria you look at, in terms of the willingness to pay and whether cash squeezes lead you to stop paying on time. But certainly I am fascinated to see when these products are called upon whether the capital market promise, which is just like night follows day, is true or not and if you get your money by return of email. Because obviously in the insurance business it is true sometimes and not true other times, but for the capital markets that is part of their sell isn't it? That it is just automatic.

David Priebe: Yes it is part of their sell, but part of their sell is also fully collateralised capacity. So from a credit standpoint, assuming it is fully collateralised and it is in a trust so that piece is more certain, your question is important, will they honour the letter of the contract and will they make sure there is no misunderstanding of that contract so they will pay on that event?

Coming back to Peter's comment about the need to have someone working that entire process, from a Guy Carpenter perspective we are gearing ourselves to make sure we can cover the full range of capital solutions. We want to be able to assist our clients in understanding the issues they are facing in terms of cover interpretation, basis risk interpretation and cost efficiency of one solution versus another solution, or one capital provider versus another capital provider. This is paramount and that is really where our business is shifting, be it from a purely executional role to a really fully involved consultancy with the ability to then execute those solutions into the various capital markets.

Rupert Boswell: Thomas' point is interesting in terms of longevity. How long are they committed to be there? And if they suddenly pull out and somebody is committed at the front end to a business model that now isn't going to be supported, that could be quite a shock to the system.

Thomas Blunck: The discussion over coverage, wording or data issues starts directly after the renewal has finished and is not confined to Baden Baden or Monte Carlo. We have continuous contact throughout the whole year with brokers and clients. These numerous contacts also comprise detailed discussions with the product line managers of the client's organisation with whom we discuss topics like portfolio composition and future portfolio strategy. Based on these discussions we try to recommend a reinsurance structure for the next renewal that might include, as a complementary product, capital market solutions. But as David said, I also think that traditional reinsurance will continue to be a main pillar in over 90% of reinsurance programmes. Nevertheless, traditional reinsurance and capital market products can, for instance, be combined in one programme, the former offering ultimate net loss coverage for lower attachment points and the latter complementing the programme at higher attachment points, eg cat bonds for worst case scenarios.

Jeremy Brazil: I think there is only one cat bond that has been paid out on and I suppose my view at the moment is that it is more of a short term solution because there is a need right now. I suppose the worry is that if your model is reliant on those being around for a long time and if we have a very poor season this year, I can see there being more of those types of products potentially and less traditional, and if it is a very quiet year I can see it perhaps going the other way. But they are quite complementary and you are right, people are ending up with a patchwork quilt, which is possibly going to have duplication of cover or actual gaps.

Helen Yates: At the mid-year renewals there was a lot of talk about diminished reinsurance capacity for hurricane-exposed lines. Could non-traditional products ever become the dominant solution in that area?

David Priebe: Right now if you just put the pure numbers out there, there is probably $200bn of traditional reinsurance catastrophe aggregate placed globally and I think right now we have $6bn in force in cat bonds and insurance securitisation tools so it is growing and it is extremely important, but will it become dominant? Not in the near term. But maybe if we can truly break down our insurance risk into something that is commonly understood and commonly agreed, and you get a truly tradable market, in time it might get there. But that is the Holy Grail.

Thomas Blunck: I agree. If you take your time, for example five years, they will continue to be a complementary product but they will not become dominant.

David Priebe: But it is a very valuable component of your overall risk and capital management strategy and clearly it is going to grow. We estimate it is going to grow by two to three times its current levels in the next 24 to 48 months.

Matthew Grant: A very good point is the ability of these bonds to actually pay out. I think at the moment what has happened is there is an increasing desire to place them and we are seeing a difference between the ease that people structure transactions to place them and find investors for them, but particularly, where they are not in the rating market, I think there is a difference between how easy it is to place them and how robust it is going to be in a payout. I think it is going to be that way because it is somewhat untested just now; there is still a payoff in the market to go to. It might be something that is truly commoditised and therefore you can reduce the cost and the transaction time to actually place them, but that to me is going to be one of the major drivers to actually prove the success of that capital market.