The use of the phrase "strategic alternatives" sends a shiver down the spine of most within the industry

The mere mention of any changes to a company's strategy rarely heralds any positive developments, but rather tough decisions ahead usually imposed by an adverse development.

"In light of the potential negative impact that adverse rating actions would have on the company's future business, PXRE has decided to explore strategic alternatives for the company." The statement formed part of PXRE's announcement of a $281m to $311m increase in the reinsurer's hurricane loss estimates on 16 February, which has since seen the company's rating plummet four notches, and two counterparties terminate their reinsurance contracts.

In an attempt to understand why one of the Bermuda market's most experienced players has fallen from grace in such a spectacular fashion, one should turn one's attention to the degree of diversification in the PXRE portfolio.

Enter the reinsurer's website and the alarm bells immediately start to ring. Established in 1987, PXRE describes itself as the "original property catastrophe specialist". Click on the overview section for the company, and the following lines of business are displayed: property catastrophe excess of loss, property catastrophe retrocessional excess of loss, property risk excess of loss, marine reinsurance, and aerospace reinsurance.

"Those Bermudans which have emerged from the hurricanes in better shape than others," explains Morley Speed, managing director of HSBC Insurance Brokers, citing Arch as an example, "are the ones with more diversified portfolios. So the diversification process seems to have proved its worth."

According to Grahame Chilton, chief executive of Benfield, addressing attendees at a recent Lloyd's seminar on the future of reinsurance, "The 'lean mean' high risk, high return, catastrophe focused Bermudian reinsurer, which was touted as the new business model post 9/11 has now fallen out of favour. Rating agencies and regulators are looking for greater spread of business and cedants were worried by the scale of losses suffered by some of the specialist cat writers."

Chris Waterman, a senior director at Fitch Ratings, believes that while diversification is a strategy that can work, there are dangers associated with it, particularly when one is entering into completely new lines, "where new teams have to be taken on board and incorporated into the existing control structure." But for the more established players with adequate human and infrastructural resources in their traditional lines of business, Wilhelm Zeller, chief executive of Hannover Re, is confident that they "should not face any of these problems."

Jeffrey Radke, president & chief executive of PXRE, confirmed that the company "has taken steps that substantially improve our risk profile, including increased reinsurance coverage, reducing our peak zone exposure and reducing our exposure to certain large events and second events through catastrophe bond transactions," and aired his disappointment that this risk reduction exercise had not had an impact on the at that stage "predicted" downgrades.

But the question should also be asked, just how far should a reinsurer be expected to "de-risk" their portfolio? It is out of the more volatile lines that reinsurers make the strongest returns. Given the added pressure placed on the sector by the entrance of the hedge funds, which unlike the broker backers of the past have no allegiance to the industry, but rather are beholden to the speedy return demands of their investors, reinsurers that have tapped this capital source must maintain a certain level of return on equity, if they are to ensure the continued support of these new found partners in risk. The key is to balance volatility and margin.