Global Reinsurance correspondent Roger Crombie welcomed representatives of the Bermuda Government, existing Bermuda companies and start-ups activated in the wake of September 11, and the island's law firms to a discussion of regulation and broader issues affecting Bermuda and the world insurance markets, at the Waterloo House Hotel in Hamilton, Bermuda.
The participants were:
Roger Crombie: Tell us something about yourselves and your organisations.
Kenneth LeStrange: I'm the chief executive officer of Endurance Specialty, a new Bermuda company. We opened for business on December 17, 2001. Before that, I worked for Aon for four years in a variety of positions and before that worked for American Re and Swiss Re. Like some of the other start-ups, we're here to provide capacity and support to the property/casualty insurance market. We have a fairly broad multiline business plan, both insurance and reinsurance products. We've grown to a staff of about 33 people. It seems that everything that we thought was going to happen in the market has basically happened, maybe not exactly the way we would have predicted, but there seems to be ample demand for the new supply of capital in Bermuda.
Graham Collis: I'm a corporate partner at Conyers Dill & Pearman, a Bermuda law firm. The firm and I have worked with a number of the new start-ups and some of the start-ups in the early 1990s.
Jim Bryce: I'm chief executive officer of IPC Holdings and IPC Re. We set up under the sponsorship of AIG and General Re back in 1993, in what is sometimes referred to as the `Class of `93'. We're starting our tenth year. We focussed from the very beginning on property cat and that's what we continue to do right now. We increased our capital in December in line with increased demand at January 1, 2002. We have $1.1bn plus of net worth. With this latest renewal season, we'll have over a billion dollars inception-to-date premium written. We've had a pretty good run, although we had a rocky 1999 with the storms in Europe and we had, of course, the worst loss in re/insurance history in September of last year. But we're still here, with our ratings intact, A+ and A+. There was no negative CreditWatch for us as a result of September 11. We're in the strongest financial condition since our inception.
Dwight Evans: I'm president of Arch Reinsurance Ltd. We are an existing company that had been newly capitalised in the Fall. We operate under a broad platform that includes a reinsurance company in the US, Arch Reinsurance Co, that primarily handles our US casualty business and some of our small, regional property accounts. We're a multiline reinsurer doing traditional and non-traditional reinsurance treaties. We did extremely well early on, hiring a number of talented underwriters and that really helped us get a jump on the renewal market at January 1.
Michael Morrison: I'm chief executive officer of Allied World Assurance Co. We were formed in November and got started in December. We have the backing of AIG, Chubb and Goldman Sachs, as well as Swiss Re. Our capital is about $1.5bn. We're an A+ company. We write broad-ranging property and casualty coverages, both direct and reinsurance, but more specifically direct. We came down to Bermuda with three people and with one man in London. We have now 25; two in London and 23 in Bermuda. Slightly more than 50% are Bermudians. We've concluded a good first quarter. It looks like we're getting off to a great April, taking advantage of the rates that are out there. The name of the game now is, be careful about the risks you select, because money isn't everything, as we all know.
Ifor Hughes: I'm Assistant Financial Secretary for International Business with the Ministry of Finance of the Bermuda Government. My brief at the Ministry is international business. In that capacity, I have quite extensive dealings and contact with the insurance and reinsurance sector, but obviously I also deal with other sectors of the international business community here, such as collective investment schemes, trusts, banking and investments more generally.
Rick Spurling: I'm a corporate insurance partner at Appleby Spurling & Kempe, here in Bermuda. We are one of the larger firms here, along with Conyers Dill & Pearman. We have about 70 lawyers, ten of whom specialise in insurance. Like others, we were involved in many of the recent start-ups, either assisting in the incorporation of the start-up or acting for the investors. In just about every one of the start-ups, we were involved in one capacity or another. We're also involved in many of the recent transactions and corporate structures that are being set up here, including captives.
Roger Crombie: The theme today is regulation, so, Ifor, can you run down for us changes that have taken place from a regulatory perspective in Bermuda in the past couple of years?
Ifor Hughes: There's certainly been plenty going on. It's been both interesting and challenging. Bermuda has always taken the approach of being more focused on quality than it has on quantity, whether that be in the number of companies that are here or any other aspect of business. That, I think, has proven to be, given the times that we're now in, an appropriate way to have gone. I think that Bermuda, to some extent, feels as if the approach it has taken over many years has been validated by the initiatives and approaches of an international nature, on the regulatory side, the tax side, or the anti-money laundering side - issues which, of course, lots of jurisdictions are having to deal with. Bermuda has had to spend considerable time and effort dealing with them, but I think it would have been much more difficult for Bermuda had it not taken the approach it has traditionally taken, which is to carefully vet the companies that form here, to understand what business they intend to conduct here, and to ensure that the people behind them, so far as anyone reasonably can be, are fit and proper persons. This has stood Bermuda in good stead.
An extension of that, I think, is our attempt to ensure that our regulatory environment is appropriate and sensible, and that it focuses on managing risk where risk exists, but it is not needlessly bureaucratic or prescriptive when that is not going to add value or serve any party particularly well. I think that insurance and reinsurance is a perfect example of how that's gone. Clearly, Bermuda has very stringent capital requirements, for instance. Class 4 companies, such as some of those represented around the table here, there is a significant price of entry - $100m of capital. The focus within the regulation itself is also, I think, very much on making sure that where risk exists, it is appropriately targeted, as opposed to conforming with what might be done in other jurisdictions, simply because it is done in other jurisdictions. The market here, of course, is an institutional market. For the most part, it is not dealing with retail lines and so the focus has been, again, an appropriate one.
In the last couple of years, that approach has been recognised and validated as such. We have had the White Paper review by the UK and the KPMG assessment under that, which made some recommendations for improvement, some of which have already been taken on board. Most notable, for instance, was the full independence of the regulatory authority, something that was not really a practical problem, but Bermuda accepted that it was probably best to be dealt with, if only from a perceptual point of view. Other areas of business were already regulated and supervised by the Bermuda Monetary Authority, which is independent of political involvement. It made sense that insurance be included within that. It has been done, I hasten to say, in a way that has, happily, had support from overseas groups that might be looking to see what steps have been taken, but also the support of the industry here. It's been done in a couple of ways. Some of the structures that existed previously, like the Insurance Advisory Committee for instance, and others, have been kept as a key part of the new structure. And effectively, the Insurance Division of the Registrar of Companies Department in the Ministry of Finance has been moved across. There has not been a tremendous amount of dislocation and I hope, therefore, that there has not been any significant disruption for those entities that are conducting business here, which are subject to that regulation.
I think, in short, we see that in the last couple of years the initiatives that have been out there have been challenging, but Bermuda has been fairly well equipped to deal with them and has dealt with them fairly successfully. The record, I think, would indicate that we are under no illusions that these sorts of initiatives are going to disappear. There will be other aspects to them, some of which may be perfectly sensible, some of which may be more questionable. But I think we feel that we are a market of substance and there is real activity going on here, real value being added by this marketplace, and we recognise the importance that comes with that, of ensuring that the regulatory environment is a credible one. The Government certainly is committed to ensuring that the standard we have established in those areas is maintained.
Roger Crombie: Let me ask the users of Bermuda's services: from your perspective, is the level of regulation pitched about right now?
Jim Bryce: I don't think it's a question of right or wrong, I think the question should be: does it work? I think it does work very well, as evidenced by the fact that 2001 was a very, very rough year. A major oil rig went down, there was an earthquake in Seattle - not very large in terms of loss of life or damage to property - and Hiroshima had a small earthquake last year. If you look at the loss activity in the second quarter, it was the worst second quarter in history for PCS in the US, in terms of the nine cat losses that generated almost $6bn of losses. We started out the third quarter with one of the largest war losses in Sri Lanka, with the planes that were blown up at the airport. That was another half a billion dollar loss. And then we had the September 11 event, which was a tragedy affecting almost every class of business, with the exception of surety - and we added that to the list in the fourth quarter. Overall, 2001 was a record year in many, many regards. We tend to focus on September 11 as the major event, which it most certainly was, but there were a lot of other losses. If you want to talk about tested markets, Bermuda, in the last nine years that I have been here, has been tested many times. Certainly September 11 was the severest test of all and, quite frankly, everyone passed with flying colours.
So, in terms of regulation and making sure that the companies that are here, which are selling a promise to pay, can pay when called upon, it works very well. I would think that what we have experienced is a testament to the fact that it does work here. Bermuda is always described as `the better mousetrap' and 2001 has validated that it is a better mousetrap. And in 2002, the market is stronger than it has ever been in its history, so most certainly something is being done right and the regulation works.
Dwight Evans: I'd like to make a comment. Our capital providers are Hellman & Friedman and Warburg Pincus - both very experienced firms having invested in RenaissanceRe and Mid Ocean - so when it came time in October to put together the capital needed to build Arch into a bigger company, there was never a question as to where we would go. The degree of regulation was not an issue then and it was never a matter of there being an alternative open marketplace. The way other people have operated here made it the place to go. We were interested in being part of the market.
Kenneth LeStrange: I would agree with what Jim and Dwight have said. I might add further that it is hard to imagine many other domiciles where companies could have been formed as quickly and effectively as they were in Bermuda. We also have some prominent shareholders in the financial world, industry sponsors such as Aon and the Zurich Financial Group. Sophisticated investors, I think, take a lot of comfort from having a serious and professional regulatory environment as a further level of security in terms of what is happening with their investment. Bermuda has achieved probably an optimal point in terms of balance, in terms of ease of use, and of creating companies and doing things that companies would like to accomplish - and yet, creating an environment in which that is taking place within well-established and well-thought out regulations. Like others here, I am not sure that we seriously entertained any other domicile for the company. It was almost a natural thought to go to Bermuda first and last.
Roger Crombie: What is it that Bermuda is able to do in two or three weeks that takes so long in other jurisdictions?
Ifor Hughes: The best people to answer that question would probably be those that have tried. Anecdotally, I hear that for start-ups contemplated in other jurisdictions, people put feelers out and went and met with relevant regulators and were told that the process would probably take six months, nine months, something like that. Clearly, some of that has to do with the more prescriptive approach that is taken in some other jurisdictions to rate forms and those sorts of things, as opposed to a focus on solvency and liquidity. I think that plays a role, but I should defer to others.
Graham Collis: The common theme is that it does take six to nine months just to get through all the insurance commissioners and all the hoops. It is just a regulatory nightmare, apparently, mostly bureaucracy.
Kenneth LeStrange: This was touched on earlier. I think the perspective is that people who come to the island - reinsurance buyers, insurance buyers - tend to be relatively sophisticated buyers, who are also generally advised by sophisticated advisers, be it Marsh, Aon or whoever. That is a very different environment than perhaps the kind of environment that most regulatory agencies are set up to manage, where they are concerned about whether forms appropriately cover things and that they are consistent, and whether prices are appropriate and are in keeping with actuarial experience in whatever segment is involved.
There is only one entity here in Bermuda that we must deal with. To contrast that with the US, everything you do there, you get to do 50 times. In fact, there are contradictory regulations there that you have to deal with, in many cases. So I think that Bermuda has taken hold of the notion that the clients who come here are sophisticated. They don't need or desire many of the protections that the regulatory environments in, say, the UK or the US were built to deal with many years ago. I think that insight has been a huge advantage.
Dwight Evans: It is also much easier to control reinsurance than it is insurance, because then you have the public to protect, which is what the US is facing. Bermuda is mainly reinsurance, which is, I think, a little easier to control and regulate.
Michael Morrison: But not entirely reinsurance. We are a primary company and we also got up and running very quickly. Practical regulation was mentioned earlier. In other jurisdictions, that might be an oxymoron, but not here, where I think the term `practical regulation' is a good description. That is what we long to operate under, something that is practical. Taking an example, you obtain a licence in any country in the European Union and you are in business; you get a licence to operate in a state in the US and you're still not in business. You have to go through another 49 hoops. The attitude taken towards the people doing business in Bermuda is what one might call adult, although that's perhaps not quite the right word. They don't need somebody holding their hands every time they negotiate a policy.
Rick Spurling: I might add some general comments on regulation. I think I'm the only person here who was around (in Bermuda) in 1976, 1978, when we developed the Insurance Act. I think the Insurance Act was probably our first real venture into regulation. I do not think we really had much regulation of anything prior to that. I remember that we had a special committee, consisting of government people as well as many from the business community - mostly insurance managers. The purpose was mainly to provide a body of regulation that would effectively regulate just captives. And after, I think, two years of discussions, the 1978 Act was finally promulgated. We thought at the time that it was an excellent piece of regulation and I think that subsequent experience has proven that to be true. It was done through a co-operative effort, which is the way that we have always done it and continue to develop regulations. We always tend to achieve what I would call a balance between effective regulations as well as the freedom to operate. It is that balance that is really difficult to achieve. Hopefully, that will continue when we get into the next subject of regulation.
Graham Collis: I think that's right. So, if the question is why does it work, it works because it has been put together by government, the industry, accountants and lawyers, put together at that time on a basis that everyone felt they could live with. Five years ago, when the [insurance company] Class structure was brought in, it was again a co-operative effort, asking what does everybody need and putting together a piece of legislation that worked from everyone's point of view. I think that is what has made it. You asked how the regulatory environment has changed in the past five years and, mercifully, it has not. The proof is in the pudding. It has basically worked, there have been very few problems and it has enhanced Bermuda's reputation. I was at the opening of Axis Specialty recently and Robert Newhouse was there. He was chairman of Mid Ocean. He said that when they wanted to set up a new company, there was no question of going anywhere other than Bermuda.
Dwight Evans: When we got here in October, November, we had resubmitted a business plan for the company that was being recapitalised, and that process included a group of people from the industry. There is a committee, at least half of whom are from the industry. I thought that was a really great way to do it, because it is a continuation of the legislation; it involves industry people, lawyers, accountants, regulators, weeding out those who are not really set up in a professional way to get things done right.
Michael Morrison: It is more a matter of negotiating regulation than imposing regulation.
Dwight Evans: The way the process was described to me was to ensure that your intentions are long-term and significant.
Roger Crombie: Ifor, you said you doubt the era of the international initiatives of the past couple of years is yet over?
Ifor Hughes: I think it is not. A lot of the focus now is falling on anti-terrorism, and what protections you may have in place there. I am not an expert in the anti-money laundering area, but the Financial Action Task Force, I know, has now reformulated, if you will, some of the surveys that they now send out to the various jurisdictions and has adopted more of a focus on what provisions you might have in mind to block, identify and prevent money laundering that might have a terrorism aspect to it. There will be other initiatives. There will be, I think, continued pressure on Bermuda and other significant financial centres by those `powers that be' in onshore locations to continue to raise the regulatory bar. We recognise that and are prepared for those challenges, but we are sitting now in a position where we already have ourselves in fairly good shape and are not having to fight a rearguard action to get to where we should be. We are already in an appropriate spot and therefore are able to deal with whatever might come down the road. They are not going to go away; there will still be other challenges, I am sure.
Graham Collis: I am reasonably sanguine about the process. In the end, there are bigger fish to fry and bigger problems than Bermuda. While we keep ourselves at the top of the offshore world, I am usually fairly optimistic...
Ifor Hughes: ...as are we. We are not sitting here in trepidation of further initiatives. But we do not kid ourselves that there will be nothing to contend with either. That's why I said that the approach that Bermuda has taken traditionally has stood us in good stead up until now. There were clearly some jurisdictions, maybe not in the insurance sector but in other aspects of international business, which perhaps constantly followed a strategy of competing at the bottom of the spectrum: being cheap, not asking a lot of questions, that sort of thing. That alternative was never pursued by Bermuda and that alternative, I think, really does not exist any more now, with the initiatives that have taken place on harmful tax, on regulation of financial services, on anti-money laundering. The bar has been raised for everyone, but we were able to clear that bar. In sectors like insurance and reinsurance, we are obviously very significant players now. With that comes the necessary critical mass to be able to deal with whatever new challenges might come down the road, whether those challenges are market challenges, regulatory challenges, or what have you.
Jim Bryce: Following the revelations at Enron in the fourth quarter, I think that - not just for Bermuda, but globally - there will be many more questions about matters such as transparency and critical accounting issues. Going forward, the accounting people will be looking much more closely at everything that we do. In terms of regulation, outside the company, there's going to be a lot more money spent looking, maybe for a second time, maybe for a third time, to make sure that everything is totally transparent. Mention a special purpose vehicle and everyone's antennae go up.
There are legitimate reasons for using them but now they are almost dirty words. And even `offshore' has become a dirty word. Now you have to justify these things, which in many cases are perfectly legitimate. Transparency is going to be a requirement for everyone, everywhere.
Rick Spurling: Do you think that these events will increase pressure on foreign regulators, Bermuda regulators, professionals or others who are dealing with these organisations, to attempt to police and to understand the client's motivation for using such vehicles?
Jim Bryce: I think there's a big question mark, following September 11, which was the event for the industry, over the chain of security. The first question I got from both rating agencies was, what exactly are your reinsurance recoveries? When I said `zero', you could hear the sigh of relief. I think in terms of a Schedule F requirement, which is required in the US for assumed reinsurance and ceded reinsurance, the need is to look at the actual quality of the recovery. That is something that may become more of an issue, again, as part of the need for total transparency. If you lay off the risk, which is perfectly legitimate, where have you laid it off, and under what conditions?
Kenneth LeStrange: Jim, in addition to the creditworthiness of the counterparties is the willingness to pay, which has become a major issue.
Jim Bryce: I don't think anyone has actually stepped up to the plate to ask S&P [Standard & Poor's] for its verdict on that.
Michael Morrison: The American Reinsurance Association has just issued its summary for 2001. The combined ratio came in at 142%, with some companies well above that. When it comes down to writing cheques for some of these events that have taken place, then you look to see who or where your reinsurers are, and some of them may not be around. I think that this whole reinsurance problem, if you want to call it that, will continue to drive the market higher and higher. The rate increases we are seeing now are not just a rush operation; this is something that is going to be around, in my opinion, for more than two or three years, at least.
Dwight Evans: Mike, let me ask you a question. How much of what you said is dependent upon further deterioration in companies' results coming out of the market?
Michael Morrison: I don't think it's even out of the woodwork. Even now, people have said: "Well, we've got a pretty firm hand on the World Trade Center." I say: "You have? That's surprising." They reply that it's "somewhere between $40bn and $70bn." Thirty billion dollars is a pretty large amount to play with. I have seen estimates of $100bn. Whatever it is, nobody really knows. I can understand if you're out by a billion or two, but if you're out by $30bn, you really don't know what is going on. So that is about to come out. And not only that, but from Enron, from Arthur Andersen and who knows what else is going to come up?
Rick Spurling: And also some of the old risks. Asbestosis - 30 years on, new claims are still arising from that.
Jim Bryce: I find it interesting that with all these wild numbers being thrown out, the one caveat that Standard & Poor's makes in every comment about the September 11 loss is that the industry does not appear to have a problem as long as the total loss does not exceed $50bn. Above $50bn, Standard & Poor's feels there is going to be a serious problem for the industry.
Mr LeStrange has said that the industry has "for far too long been driving 90 miles an hour down a dark and twisty mountain road, staring in the rear-view mirror." In other words, we don't anticipate change. Is that everyone's view?
Jim Bryce: That goes back to the old definition of insurance, I think, that insurance and reinsurance companies are really a car. The chief executive officer is steering it. The marketing department has its foot on the gas pedal. The auditors are on the brake. And directions are being given to the driver by the actuary, looking in the rear-view mirror. And I have to say it seems to be quite accurate, in many cases.
Rick Spurling: No one saw the September 11 bump in the road coming, that's for sure.
Kenneth LeStrange: I think it is important to point out that, while September 11 was an extraordinary and tragic event, despite some of the public proclamations, for anybody who's been in the industry it's hard to imagine something of that magnitude happening all at once and in such a short period of time. You make the case that maybe it should have been anticipated, but there are a lot of smart people in a lot of smart companies out there, and everybody got it wrong.
The World Trade Center is only part of this picture. We have chronically, as an industry, under-reserved. Some of it has to do with social and tort inflation that, again nobody could really control, i.e. asbestos. Many of us thought that asbestos had settled down and, in fact, it had in terms of the paid loss triangles in the early 1990s. And then a whole new class of plaintiff showed up and it is roaring again. There was chronic optimism, I think, on the commercial side of the industry, in terms of what the results really would be in the late 1990s. You can see that, if you're a Schedule P fan, you can go back and look at them now and see that some of those years are still very optimistically set, based upon what we all know about pricing trends, social inflation and economic inflation, and so forth. Apart from the creation of new capital, it seems to me that one of the things that happened in Bermuda in the early 1990s - with `the class of 1993', so to speak - was a change, and a very fundamental one, in the way that capital was deployed, and the science and the professionalism that was used in its deployment, and in the way that the risk was assessed. And that is what I think is going to come out of this past, terrible year that we had in 2001. Clearly, many sources of capital are leaving the business. It seems like every week there's a significant announcement that somebody wants to get out, or the company is being spun off, or sold, or placed into run-off. These are, in some cases, household names. I think that's telling you something.
I think that the people who are now sponsoring companies or adding capital to some of the existing organisations have much different expectations of us going forward. So, the cat companies, which started to use scientific methods and technology, and analytical and mathematical techniques (which, I have to tell you, were absent from the very prominent reinsurers that I worked for before that time) would likewise pass on some of these other lines of business, in looking at some of these exposures. There is technology; there are techniques; there is wisdom that you can apply to this business. The challenge we have all had is that the business has tended to be driven by the lowest common denominator. The most aggressive, or the most inept, or the most naïve company tends to govern the terms of trade. Hank Greenberg has often cited the triple-A ratings that AIG has and has wondered why clients do not differentiate as well between what triple-A means and a B-minus. All of us, clients too, become better educated and more realistic about what this really involves: a promise to pay, a contract on very uncertain events that may be very long-lasting, in terms of their implications.
Michael Morrison: Many of the risk managers had their focus on total costs, without paying much attention to what you're talking about, Ken, which is the long-term liability of their insurer. Time and again, over the last five, six, seven, eight, nine years, the award of a contract has gone to whoever has put in the cheapest price. That has dragged the industry down by its own bootstraps.
To digress for a second, I read and heard quite a bit about, "Gee, with all this new money coming into Bermuda, this is going to flatten the recovery process for the industry, because there is so much money there". Well, I don't know what figures they are using, it could be anywhere up to $16bn - $8bn of new money and $8bn of additional money - but that is not looking at a couple of things. One is, how much money has gone out at the other end? Between $30bn to $40bn has gone out, so the $16bn is not entirely replacing that. Secondly, as was mentioned, some companies are not utilising the capital that they have. They are withdrawing from certain kinds of business, or they are writing far smaller lines. Thirdly, you can look at the new capital coming in - take ours, for example. We write an all-net line, up to $5m, on property. That is not going to blow the market apart. It depends, of course, where you apply that $5m; we apply it on the lower layers. Nevertheless, that is not filling the $30bn-worth that has gone out the back end. So I think it is a combination of factors that is going to keep this market going and Bermuda is not going to be the one that is going to bring it down.
Finally, I would say that when you look at the new companies in Bermuda, and the old companies for that matter, and you look at the management, it is pretty seasoned management and I do not see any of them - I certainly hope none of them - cutting rates any time soon. They have been through the mill several times themselves and they know an opportunity when they see one.
Rick Spurling: Another factor is the future of Lloyd's as a reinsurance market. I know that news is about to come out about the 1999 losses, which may be significantly higher than previous losses. The whole future of Lloyd's and Equitas, asbestosis claims and so on, cause so much doubt that I am not sure what is going to happen. I suspect that they are going to restructure and that they will always be there, but their capacity could be severely limited.
Jim Bryce: What we have seen at the January 1 and April 1 renewal dates, where, for a variety of reasons - either a lack of response or slow response - there has been more business taken out of the London market, in general being placed in Bermuda. Obviously Lloyd's is a very integral piece of the London market, but there has been a shift of premium out of that marketplace into this marketplace.
Roger Crombie: The chairman of the Association of Lloyd's Names blames foreign insurance companies - which would include Bermuda companies - for Lloyd's woes.
Jim Bryce: But the ones who really know the answer are the clients, and that is not what the clients are saying. The clients are saying we are providing the answers, not providing the problems.
Rick Spurling: Bermuda companies support a quarter of Lloyd's capacity.
Michael Morrison: Just a comment: a drowning person will clutch at any piece of flotsam that goes by.
Roger Crombie: Is Lloyd's drowning?
Michael Morrison: There are two `pots' to Lloyd's: the corporate pot and the individual names. My understanding, and I am not an expert on this, is that the individual names are about 80% of the votes, but they only write about 20% of the business. As I understand it, the corporate entities are doing very well. I'm not so sure about the individual names.
Rick Spurling: Lloyd's, at one time, had something like 35,000 names. They now have about 2,500 names. That is a dramatic change.
Roger Crombie: Should Bermuda be worried about proposals before Congress to force the repatriation of companies that have moved overseas, or is it the same hot air we have been experiencing intermittently since the matter was first raised in a New York Times editorial in 1938?
Rick Spurling: The one difference between those previous occasions and this one is that this one is very politically motivated. It's wrapped up in patriotism in the US. The Bush administration seems to be very quiet about it, but there are a number of people who are being very noisy, and no one seems to be opposing it. A significant number of professionals who have been paying close attention to this think that there is a serious risk that something is going to happen.
Dwight Evans: There is a big difference between the recent case of Stanley Works and our business, where we have substantial activity onshore and substantial business ex-US. We are putting a lot into it where we have people onshore, a lot of people, and we will have more people. We are spending a lot of money here. It's a different situation altogether. I think that what people want to eliminate is the flagrant violation. And in the case of Stanley Works, the majority of their business will remain onshore.
Kenneth LeStrange: I am not a tax expert, but from the insurance company point of view, when you are doing business onshore, you pay US taxes on your activities. I suspect that would be the same for a Stanley Works, or any other kind of company. International or global companies have had a long history of working with various jurisdictions to optimise the different tax issues that they have to deal with. I think that the perception that has been created is that by moving a headquarters cosmetically, a company will avoid any or all tax. You do not have to be a genius to look at what major US corporations without a Bermuda company pay in taxes, and realise that there are many, many other ways to lower their effective tax rate.
But I think Rick is right. This one has the flag wrapped around it. It seems to be somewhat tied to September 11. I keep hearing that there is a deep understanding that the capital that is in Bermuda, the capital that was here and the new capital, is performing economically a very important function in the US. You most certainly wouldn't be getting homeowner's earthquake insurance in California without it. Most of the wind [coverage] in Florida, the wind in the Carolinas, the wind in Long Island, the wind in Texas - a lot of that is covered here in Bermuda. If that coverage were not available, those products would not be sold to the public in the US.
Dwight Evans: It is providing a necessary conduit, I think, to get capital into the market quickly and solve some of the capacity shortfall. Not in all classes, but certainly more capital was needed to come into the business for reasons Mike mentioned.
Roger Crombie: Is the industry going to come up with a definitive solution to terrorism coverage, or is it simply going to be fudged?
Michael Morrison: There will be a very quick answer if we experience another terrorist attack. I think the politicians are keeping quiet, hoping it will go away. There does not seem to be much movement. A couple of pools have been put together. There is a pool in London. AIG has a pool. Maybe some others have as well. But it is not a sure-fire seller, as far as I know. I do not know the actual amounts involved, but one does not hear that it is going gangbusters. I think everybody is sitting tight, waiting to see what is going to happen. The assureds are not buying. The price when it does come out, particularly when you have a target at high risk - Grand Central Station, say, or the Sears Tower in Chicago - if you've got one of those, the price is extremely high. Some of them, I think, feel that they will self-insure because they cannot afford to pay the prices.
Jim Bryce: The price is high, and the availability of coverage is an issue. You can only buy $200m of coverage, which, on a property worth billions, is not worth buying at a high price.
Michael Morrison: So it looks like everyone, from the politicians to the buyers to most of the insurance companies, is just sitting tight, waiting to see what happens next.
Jim Bryce: There appears to be no real sense of urgency. Some people's understanding was that the urgency would come from the banking institutions that are lending money for these buildings. So far, the banks and lending institutions have been silent. There just does not seem to be the urgency to push Congress to act. Congress, unfortunately, will not act on its own. It will only act on Bills it is pushed to enact, and no one is pushing right now. I think what Mike said is right; the one catalyst that probably would get everyone moving is another tragic event, which is what none of us want.
Michael Morrison: And banks cannot afford to foreclose, because suddenly they would be the biggest owner of property in the world.
Kenneth LeStrange: There is growing unease among those who finance real estate. They are very, very uneasy. I think you're right, that were there another event, there would be incredible movement to do something, but I think that everyone is holding their breath and, not seeing an alternative that is attractive, is going to let things alone.
Rick Spurling: A related risk is aviation risk. I think they are all being put into an insurance company in Vermont. Is the Government a participant in that?
Jim Bryce: The Government is writing it. There was a letter from Mr Greenberg [of AIG] to the Transportation Secretary saying that, basically, the industry is willing to take the risk, and why is the Government writing at subsidised prices and taking it away from the industry when the industry was the one who paid the losses, not the Government? It defies logic.
Roger Crombie: At the World Insurance Forum in Bermuda in February, a panel of clients took the insurance and reinsurance industry to task for just about everything under the sun. Was that representative of what you are hearing from your clients?
Jim Bryce: There are two sets of answers. One would be the insurers, with their clients, which are the insurance buyers, and the second would be the reinsurance companies, which have the insurance companies as their clients. I did hear that the insureds felt they were being overlooked in terms of needs. I did not get that feeling from our insurance company clients. Being in the business, they were more in tune with what 2001 meant as a very disastrous year. Many of our insurance clients had big losses to their cat programs and, quite frankly, they were very happy to see us there at the renewals for 2002. So I think that, for the insurance companies buying reinsurance, there was less of that [criticism]. Of course, no one wants to spend more money, but an insurance carrier is going to know that loss activity is going to generate higher rates. In terms of the insurance sellers, I cannot really speak to that. The insurance companies were very happy to see us on renewal, although not so happy to see the exclusion of terrorism, which they fully appreciate is uninsurable. It's a deliberate criminal act, not a fortuitous event. That's why you really would have to have the Federal Government as a reinsurer of last resort. You cannot stop deliberate acts...
Michael Morrison: ...of that magnitude, because you cannot rate for it. Arson is a deliberate act and that is covered, but nothing ever of this magnitude has occurred before.
Jim Bryce: On the insurance side, maybe there is a slightly different spin.
Michael Morrison: My personal feeling harks back to what was said a little earlier. Assureds usually buy the cheapest, all other things being equal. The cheapest, over the last several years, has got cheaper and cheaper every year. They are very happy to buy that cheap coverage. When something like this happens and there is a dramatic reversal, they usually look back no further than the year before, whereas, in my opinion, they should perhaps look back six or seven years and be grateful for what they have been able to buy over that period. I do not think that happens; they look at what they paid last year, and what they are being asked to pay this year, and that's when the gnashing of teeth starts.
Jim Bryce: Yes, we are selling this promise to pay, but there is only a small fraction of our clients, both insurance and reinsurance, who actually have claims in a year. The majority of our clients do not have claims. Those are the clients who feel that it is fine to take the price reductions, but, as Mike said, they lose over time the perception of what the price should be. Major events have a whipsaw effect that corrects, maybe sometimes too quickly, years of rates going down to levels that are just untenable, if you want to stay in business. Also, it is not just a matter of price, but of availability of insurance. That is one of the things that should be looked at. In the US, we have had one major industrial writer putting out limits of $1bn on a building, who came into clients to tell them that the $1bn limit had now been dropped to $10m. Those are the risks that are not just faced with price, but also the availability of coverage.
Now, with Enron, surety is becoming another one of these dirty words, like `special purpose vehicle'. When you say surety, everyone wants to dive under the desk. In theory, surety is a line of business that should never have a loss, if it is underwritten properly, because you always have the collateral. But now you say surety and people run to the hills.
Roger Crombie: Another criticism is that the quality of underwriting has not been all that it might have been during the soft market.
Kenneth LeStrange: May I be slightly controversial? I do not want to name the company, but there was a notorious annual report containing some commentary, excoriating underwriters for having accomplished all these losses. It said they should have known better and so forth. When it is clear that prices are heading down; when it is clear that every year, coverage is getting broader and broader and broader; when it is clear that, if you are an excess underwriter, every year there is greater and greater pressure to go further down into levels of expected losses or potential losses - what we have done, as senior managers, over time, in terms of the financial markets and so forth, placed a set of contradictory agendas in front of these people. By definition, if you were an underwriter in the 1990s (and there is a generation perhaps that has not been as well-trained), a broad multiline underwriter, you should have shrunk your company. In the capital markets world, if you were a public company, you had analysts following you, and you had shareholders to deal with, how exciting would shrinking the company have been? There are companies, and again I do not want to mention any names, even on the positive side, that have done that, and have done that very well. I think that is one of the things that is going to be interesting, to see if anyone has the nerve to do what we all know is right at the right time - and that is to face the perhaps irrational pressures, and the short-term pressures.
Jim Bryce: I read yesterday of somebody who said that those who complain about the lack of underwriting [skills] really should not be complaining about something they have never had. In many cases, the ones that are crying are the ones that we call in the business the `tears underwriters', versus the `no-tears underwriters'. The `tears underwriters' are the ones that maybe never had [the skills].
Kenneth LeStrange: Jim, we both grew up in the times when you used to work up your pricing on the back of an envelope, usually after lunch. When I was at Aon, it was really quite a remarkable experience for someone who was brought up as an underwriter to see the full span of what is going on in all the companies and to see deal after deal going by where, with that same kind of arithmetic, with that little pocket calculator and a pencil, I could figure out by myself, without an actuary, if the risk was priced at, at best, 50% of what it should be. In some ways, I think that the educational level of the people in the industry has never been better, when you see the kind of education that people are gaining.
Michael Morrison: You can have a good formal education, but it does not necessarily make you a good underwriter. You have someone who has been underwriting for seven years, and for those seven years, their number one question, when they see a broker come through the door, has been: My gosh, I wonder how much I have to cut the premium by this year? They have never had to negotiate a price increase, or a restriction of terms, or anything like that. The new market conditions take a huge mindset change to get someone to operate entirely differently than they have for the last seven or eight years. The other thing I would say is that, in years gone by, some companies have been willing to accept a loss ratio of, say, 102% or 103% because they were after the two magic words: market share. So, they'll take 102% or 103% because that will be covered by investment income and more, so they'll just bring that money in, and it will be invested, and not worry about it. Well, the moment you say you are an underwriter at 102%, you've got 105%, 108%, 112% on your hands. If he is not absolutely concentrating on writing to 100% or less, you have lost him. You've lost his whole mindset. I think you are asking for huge amounts of trouble. I would venture to say that many companies have been more interested in market share than they have in operating profit. It is like the old story about the guy who makes suits; he loses on each of his suits, but he figures to make it up on volume.
Jim Bryce: To get back to Ken's observation, I think the one thing that has changed over the years is the so-called `subscription', at least on the reinsurance side, where everyone takes 1%. In the New York market, there used to be a fellow called "Two Percent Tony", who took 2% of everything. He would just bring it in and take a 2% guarantee. That, plus the fact that people are retroceding, so you do not have that transparency of what is sticking to the balance sheet and what is being passed on, means that style of business is just disappearing. People are putting up large, meaningful lines. In many cases, they are absolute net or the bulk of it is net. Tell a broker he should take 1% today and he will laugh at you, just say: "It's not practical for me to give 1% or 2% lines." The whole method of doing business has changed. The technology today, in terms of modeling, allows us to get a lot deeper into analysing the risk and the exposures, and to take a much more meaningful line. Today, that is giving the underwriters a much greater discipline than, say, taking 2% of everything and how can you go wrong? You had spread of risk. If you got hurt on one, you did not get hurt too badly. Again, most of the clients do not have losses; only a handful do.
That old school mentality is almost completely disappearing. I would imagine that, in the next year or so, it will probably be completely eradicated in all the developed markets around the world, in terms of reinsurance.
Dwight Evans: You know, a lot of the sophistication in models that we endorse gives people, I think, a false sense of comfort that they have done their job properly. They think they have analysed the risk in a technical way and they can do twice as much, three times as much, as they should have. They think they have it figured out. They know what their aggregated loss is. They believe the output from the model 100%. And that is a dangerous game.
Jim Bryce: That is, I suppose, why it is so very important to overlay common sense over the output of the model. The model will give you an indication, but it will never give you the answer. The answer has to come from the underwriter, saying that the output of the model does make sense, or it does not.
Dwight Evans: We always like to keep a portion of our capital unused. We refer to it as keeping some of our powder dry, so that when bad things happen, we are around to - double down is probably the wrong expression - to at least be able to participate in an ongoing market, which is probably greatly improved, after some bad events. It is the obsession with technical models that, I think, gets people into trouble sometimes. How you use the models and how you manage your risk is really the key to being successful over a long period of time.
Roger Crombie: We are in the first week of April 2002. Has the January renewal season finished?
Kenneth LeStrange: We still have a January 1 renewal that we are working on. It was business that was left hanging. It did not get renewed. It could not be supported the way it was being handled. The deal is not done yet, but it might be retroactive.
Dwight Evans: Different clients purchased what was most important to them at a certain price. Then they continued to try to buy what they wanted, either more on the top or more on the bottom, or back-ups, to give them the total protection that they were looking for. In some cases, they are not going to be able to achieve what they want, but they are still trying. Certainly the brokers; that's their lifeblood. They will always tell the client they can sell them what they want.
A lot of companies, too, when they have seen the total price of the coverage that they had the prior year, have opted not to buy as much. Let's say they had $600m in coverage. Now, maybe they will settle for $400m in coverage. They just feel that the price of the extra $200m is just too much for them.
Graham Collis: That sounds as if you feel that a great number of people are going to set up captives now.
Michael Morrison: I guess there is a renewed interest. I do not know how active it is going to be.
Dwight Evans: I think that the market is ready for that. With pricing going up on the primary side and clients wanting to keep more of the risk, it is a perfect scenario for the captive market to really grow.
Rick Spurling: There is no doubt about it: it really is growing. The number of enquiries and the number of instructions to incorporate captives of insurance companies has, I would say, doubled.
Michael Morrison: But how many enquiries actually lead to incorporations?
Rick Spurling: Right now, most do. Not every one, but I would say 90% plus.
By the time they come to us, they have already been through their brokers and their insurance managers. They have thought it all out and decided where they are going. So, by the time it gets to us, it has been pretty well processed.
Kenneth LeStrange: Let us be mindful too, unlike perhaps the crisis in the marketplace that we dealt with in the mid-1980s, most significant US companies, and I think, many multinational and global companies, have one or more captives in place already. It is now just a matter of choice as to the ways in which they want to utilise those existing entities. What I have seen, in account after account, where a captive is already in place, they might have been retaining $5m on a risk for their own account last year within the captive, they may now be keeping $50m this year. All that, you cannot really see. It does not show up in the numbers in any visible way, but I think there is a whole lot already happening in this continuum.
Jim Bryce: The airline people are forming captives for terrorism and war coverage. That has been reported in the press.
Rick Spurling: It will probably peak in September, just before next year's renewals.
Roger Crombie: Have the newcomers to the Bermuda market been able to find everything that they need?
Michael Morrison: So far, yes... at a price. In terms of people that we have been hiring, domestically and from overseas, we have to offer attractive packages to get them to come here. Also, housing has proven very expensive, perhaps one of the most expensive areas for us. I understand a number of Bermudians - and I cannot blame them - move out of their house and move in with their parents or in-laws. The more successful Bermuda is, the more expensive it will become.
Roger Crombie: Another question for the start-ups. Thus far, have you committed your capital in line with your expectations? Or have you been faster, or slower, than you expected in taking up new business?
Dwight Evans: Are we fully utilising our capital? I can speak only for ourselves. I think we are getting there. We have $500m capital in Bermuda and $500m premium, not just from Bermuda. We have a US company in New Jersey and it writes reinsurance from the US. The two combined have $750m in capital and $500m in premium. We still have a little way to go. We are certainly working around the clock. I think we will get there.
Graham Collis: A lot of people have not written business as fast as they had expected, but on the other hand, they are being very choosy. They are being very picky about what they underwrite. My impression is that they are not in a great hurry to utilise all their capital, but are looking very carefully at what is out there.
Dwight Evans:You are right. Underwriting in this market - everybody talks about it being a hard market. I think there are certain classes that are hard; others, I think, that still have issues, whether it is informational, data averaging, or trying to figure out what the right price should be. In the cat market, rates are up and prices are up. That is one of the strangest things I have seen in a number of years. We could not write a cat line on the Royal [& SunAlliance] program in the UK. It was done before the end of December, with a 60% rate increase, and we could not even get onto the program. Yet there are other areas, like personal accident, where pricing went ten times, 20 times the expiring rate... and is still going.
Michael Morrison: I look at it slightly differently. We came down here with two underwriters and have built up from there. One cannot expect to utilise capital with two underwriters, or three, or four. I am very happy with the amount of premium that we have written, the amount of business that we have seen, the amount that we have bound. It will continue to increase, I believe, as we hire the people who are capable of handling the business that we are seeing. Another area of growth is the lines that we will get into. We will not write business that we are not capable of understanding. As we get the expertise, so we will enter new lines of business. We expect to have it build as we go along. The curve is sharply rising.
Jim Bryce: We are exactly the opposite. We have been up and running for nine years. We are utilising our capital. We reloaded the capital in December in response to clients visiting us in October and November, saying the fact that we kept our A+ rating, the fact that we did not get into negative CreditWatch, the fact that we were there after September 11 as a substantial reinsurer, meant that they wanted to do more business with us. That really gave us the impetus to go out and raise the capital. That capital at January 1 was pretty much on track to satisfy the requirements of our clients, also in terms of the program that Dwight was unfortunately unable to see. We got twice as much as we had last year. The difference is that we were already up and running and we were able to take advantage of that. I guess we were in the same position back in 1993 that the new companies are in now. It took us time to market ourselves, distribute the balance sheets, introduce the company to the brokers, and introduce the company to the clients. Quite frankly, at the beginning, marketing is a non-stop issue: going out, meeting the client, meeting the client again, meeting the broker... The broker, the ceding company and the reinsurer, that's the triangle and you have to cover all three bases to make sure there is a partnership that is going to work. So I am sure that in 2002, there will be plenty of opportunities for all of us because, as we have said, a lot of capital has left the industry in 2001 and a lot of people are continuing to pack their bags and leave the marketplace. In some cases, you hear of a new company every day that is out of the property reinsurance business, so certainly there will be enough business for all of us.
Roger Crombie: One final question. How much more success can Bermuda stand, from the perspective of infrastructure: housing, schools, roads and so on?
Graham Collis: That's a good question. It is a matter of public debate. The Government is concerned about it. I think a lot of the companies are concerned about it. The Government, to give them credit, has been very good with this round of insurers, in processing their incorporations quickly. The Immigration Department is never speedy, but in allowing new executives, they have been handing out temporary work permits quite quickly. It is incumbent on the new companies to make an effort to utilise Bermudian staff, and I think that by and large they have lived up to that. But obviously, the numbers of Bermudian staff are becoming limited, even at the lower levels. It may be self-regulating, in that it becomes a pricing issue. If you cannot hire a receptionist or a secretary, the laws of supply and demand will push the price up. It is certainly an issue that Bermuda has to watch. In the good times, several years ago, people were having this conversation. We have significantly expanded since that point. In some ways, people are saying that, in times when our tourism industry is at rock bottom, we need these companies for a variety of reasons: to keep our airlift going, to keep people employed, etc. It is something that, clearly, everybody needs to be mindful of.
Dwight Evans: We just started. We are building everything from scratch because we are new, including on the human resources side. We just started a tuition reimbursement plan, because there were two Bermudians we were hiring, who were going to school. We were happy to pick up their tab to help them with their schooling. I am really excited about doing that, because you gain more loyalty from the people and we are giving something back to the country that we are in. I think everybody will. I think everybody here is pretty professional that way. I have been really happy with the Bermudians we have hired. For example, we have people who would run all the way down the hallway to pass on a telephone message and then run all the way back because their phone is ringing. You think to yourself: this is really good stuff.
Michael Morrison: The problem I see us creating for the rest of Bermuda is - you mentioned the price of receptionists going up - when we run short of receptionists and we start to pay a little more, then all the other businesses in Bermuda suffer because of the raised prices. That is something we have to watch out for.
Graham Collis: There is always an ebb and flow. From Bermuda's perspective, two or three years ago, it was all the telecommunications companies moving in here. They moved on; these [insurance] guys move in. I do not think we are at a crisis point right now, but there are certainly concerns, both for Bermudians and for those coming in, because a lot of the people you want to employ have children. They want to put them into good schools. There is a limit to that. So it is something that is in everyone's interest to manage.
Rick Spurling: Certainly captives do not put much of a burden on the infrastructure. The big start-ups that we are talking about here, which want to employ personnel in Bermuda - that is definitely an infrastructure problem, which is really something that has to be managed. For the Government to manage it, we have a great deal of room left. Also, if we want to be a major worldwide global reinsurance centre, we are going to have to accommodate people and find solutions. We cannot succeed otherwise. One of the benefits of having these reinsurers here and establishing their own offices is that we have a real market here in Bermuda and we have substance here. One of the great criticisms of offshore jurisdictions is that there is no substance. What we have here goes a long way to counter that argument. So I welcome it and I think it is a great development for Bermuda.
Graham Collis: As lawyers, we benefit substantially, but it is a political issue. There are people who are concerned; there are people who are aggrieved. There are people who want to rent houses and think that they are being asked to pay too much. It is amazing how resilient these insurance companies are. I remember when we set up Mid Ocean in 1992, Bob Newhouse complaining about the level of rents in Bermuda - and they are much, much higher now.