Nigel Ralph: We are only seeing the start of electronic trading. It has a long way to go. We have seen massive initiatives, especially in Lloyd’s, and much of it being driven by Bermuda, certainly in the reinsurance market. I think the product still is not as good as it should be, but as soon as the product improves it will be in the interest of the underwriters.

Alex Letts: One other area which I think will interest you all is when we start linking up electronic trading to electronic settlement. The Holy Grail for all of us is that just as we now have contract completed notification to all markets of their asigned lines, at that point there should also be an indication that the payment has been triggered. We are not that far away, and as you have probably read, something is being trialled in Bermuda on that basis. It is automated electronic settlement at the point of closing. I think it will help everybody in the industry to have the cash moving around slightly quicker, particularly the brokers who are struggling in some respects with that.

Andrew Kail: If you go back a few years to the middle of the dot.com boom where you had companies like Inreon being set up, there did seem to be a push towards saying that for certain types of reinsurance it is possible to commoditise that and disintermediate the individual. Is your view that that model is not going to be resurgent or is there still a place for that?

Alex Letts: I think the disintermediation of individuals with commoditisable business, and by the way there are lots of businesses which are commoditisable as many of you know, will be driven by the brokers. The brokers can decide. At the moment, and forgive me if I am wrong in describing this, but a lot of the business comes in in two or three pots through a broker organisation from somewhere out in the US to their Chicago office, on to their London office and eventually it gets placed. Then it attracts a $5,000 or $10,000 premium and by then, you have burned your margin on the way through. The brokers want to see somebody out in Ohio loading the stuff, shipping it through, then it is touched briefly by someone electronically in London who looks at it and moves it through the right syndication process, and off it goes to the market. They have not had to reload or re-key it. Then you have a single product which goes in and out like that and you speed everything up very quickly.

The syndicates say that if you commoditise risk then what value is the syndicate other than being able to offer the lowest price, so you get push back against that from the smaller companies who cannot leverage huge balance sheets on the pricing commoditisation gain.

If you were to ask whether I think commoditisable risk will be traded any day? Yes. Do I think it will disintermediate people? Yes, when the broker decides which people it wants to take out of its chain. I do not think it will happen right now, but it is right at the beginning as Nigel said. We are in the early stages. If you look back at Inreon, that was a facultative trading of risk which Munich Re and Swiss Re wanted to set up to drag risk in on a commoditisable basis. That was not successful, not because it was not a good idea but because of the way it was structured, its corporate provenance, its technologies, the people they employed, the timing and so on. That does not mean it was not a good idea and it won’t happen.

Andrew Brooks: Just going back to Alex’s point about Lloyd’s. I agree with you that there is a reluctance to accept business as a price-driven commodity, but in certain classes it does fit. For instance, a homogenous homeowners book of business can be readily sourced through a network where you can almost have the broker pre-rating it for you, and delivered in bulk right to your desk.

From a Lloyd’s point of view we need to differentiate. For example, we can’t offer a set rate for Florida because we have differential pricing based on the location, whether it’s two miles from the coast or ten miles from the coast. Everything is very, very different. I think Lloyd’s attracts different types of business to a lot of domestic market.

Alex Letts: I totally agree. A huge chunk of Lloyd’s business is specialised and that is where Lloyd’s has made its reputation. On the other hand, if you look at Lloyd’s requirements and its current business mix, I think you will find about 40% of its business is not specialised. I do not want to spend the whole session talking about Lloyd’s, but if Lloyd’s is going to have a role and protect its position in a changing world it has to work out how it can attract more business. A lot of that business will be commoditised business and lower margin. How will it sit within the electronic world? What happens to the underwriters at Lloyd’s? These are all big issues that we are not going to solve today.

Simon Kilgour: A couple of thoughts have occurred to me taking this back to reinsurance buying. We hear from many underwriters that they regard US property as a bit of a commodity. I will defer to Nigel and Andrew, but I think the underwriting approach is that it is reasonably straightforward business. Perhaps there are aspects of an outwards programme which are perhaps easier to handle. We started the discussion off by talking about the difference between traditional reinsurance and some of the alternative products. Nigel has explained that his company offers all products. You are in a situation where a reinsurance programme is bespoke and will be individual to the individual client. I think it is that bespoking which everybody has to focus on, and of course an efficient process must be a good thing. If you are more efficient in your process you should be able to transact good business.

My last point is that the industry also seems to operate on the basis that now it has more information, that information will not be shared with reinsurers until 1 December or maybe 30 November. In the old days you would have an information sheet that was maybe an inch of paper and now might get files and files of data coming through to reinsurers. We have a process where this information can be delivered efficiently, but it is a question of whether it is being delivered in adequate time for the reinsurers to understand it.

To recap, I am saying that the reinsurance programmes of today are different because they are not as traditional. There are these different patchwork pieces with some newer products which have to be bespoke, and that is where the broker will assist. The cedant and the broker have all year to get that programme ready and the reinsurers have less time to decide whether it is a good write or not. They are the ones who perhaps have more of headache now than the reinsurance buyer.

Helen Yates: Do you think that is true Nigel?

Nigel Ralph: In certain cases we can be pressurised by time. It is possible that if say 50% of our submissions arrive in the last couple of weeks of the year then we have an issue. However, we try to speak to our clients and get the data in early and particularly with important programmes we get the prices out early. I think it will really put pressure on the subscription market. Where the broker goes around and tries to get small percentage shares in a hurry, which they do very well, in my view those are days are numbered. I think that is a consequence of the electronification of the market. I think we will see the bigger companies taking bigger lines, even 100% lines, and the subscription market will be squeezed.

Jonathan Barnes: There already are some commoditised reinsurance products, notably the ILWs [industry loss warranties]. I get a daily email with bid and offer pricing from the bank on ILW baskets.

Helen Yates: Are ILWs particularly attractive to capital market investors?

Jonathan Barnes: Where something is commoditised, the margin is more likely to be squeezed, frankly. It is probably better to understand the particular problems of the buyer and table a solution that meets their requirements and get paid for it.

Helen Yates: I would like to come back to Simon’s point about the fact that reinsurance buying is rather like a patchwork quilt of so many different things. Does that also affect the buying of facultative and treaty programmes and how that is balanced out?

Alan Fowler: A patchwork quilt is probably not a bad description because there are a lot of different products out there. I have been in this industry a long time and cat bonds are not a new thing. Most of these products are not revolutionary or brand new. I am not sure things have changed that much. One of the problems with the traditional marketplace is that, to a degree, you are at the mercy of the reinsurance market if you are a large cedant. It is an annual issue and not an ideal situation to be in. The utilisation of capital markets is an attraction.

You mentioned facultative. Going back to electronic trading, we have had an electronic facultative system in place for sometime and it still survives. We make it mandatory for our underwriters that they must use that system and it is linked in with our reinsurers and brokers.

The traditional and the non-traditional marketplaces have always been there. I am not sure there is that much difference. I think the whole process has accelerated as a result of what happened in 2005, but the reality is that at that time considerable new capital came in, and following a very bad year for reinsurers they had a very good year in 2006 and replenished their coffers. In fact, they are in pretty good shape from a traditional point of view. Somebody mentioned these UK flood events being a significant loss to the market. I would question that. It certainly does not appear to me to be a significant reinsurance loss. Depending on what happens between now and the end of the year, I would say the reinsurers are having a pretty good year.

Jonathan Barnes: It is significant to the insurers. This morning one of the rating agencies was being reported as looking at some of the UK companies in the light of that.

Peter Grant: The point Alan makes in terms of diversification of funding sources, if you like, and whether that is debt capital markets, cat bonds and so on. I think often that is underplayed when people are talking about diversification. It is often a discussion about how to diversify your portfolio. Arguably, I think diversifying your funding sources is almost as important, particularly when you find yourself in a position of financial distress, as we have seen in the recent past with a couple of reinsurers who got themselves into difficulties. It was their ability to continue to gain access to the capital markets and continue to have relationships with their retrocessionaires and so on that arguably enabled them to trade out of a difficult situation. Sometimes the discussion surrounding diversification needs to be a broader one than just purely how to diversify your portfolio, because it is also about how to minimise your dependence on a single source of capacity or funding.

Eric Paire: That is really how we would see the interaction between the so called traditional market and the capital markets. As brokers, the nice thing about these two worlds is that they do not react to the same underlying economics all the time. I will just pick a couple of examples. Firstly, the reinsurance industry was shaken after 2005, while the capital markets are shaken now for totally different reasons. Somebody issuing a cat bond today may potentially have a hard time getting an interest and spread because of what is happening in the credit market.

Jonathan Barnes: You would expect to see it reflected in the secondary market if it was going to affect new issues and there is no sign yet of the secondary markets’ spreads being affected by the woes in the subprime.

Eric Paire: My point was you have totally different mechanics. As you diversify your source of funding you also diversify your potential access to the market because there is no reason why the reinsurance and capital markets should be facing challenges at the same time.

The other important point is that the risk appetite of both markets is different. In the sense that the upper layer responsible for the cat programmes gets to a point where traditional reinsurers go to the so-called minimum rate on lines. Whereas the capital markets start to be more interested. We see that as very good news for our clients because it has significantly broadened the capacity to give us a price. Furthermore, it alleviates the dependence on the reinsurance market and the upper layer where it may be more reactive using the capital markets, and symmetrically at some other points knowing that the reinsurance market will be much more efficient. Somebody mentioned the technology and speeding up the payment process and that is key because when we are saying traditional reinsurance is not as good as the capital markets, one of the aspects is it is collateralised, and the other aspect is the speed of payment.

Alex Letts: And guarantee of payment.

Eric Paire: You have guarantee of payment and speed of payment, which I see as two slightly different issues. However, there have been tremendous improvements in the speed of payment improvements over the last years. One of the appeals of the capital market solution is that you get the speed. The other aspect is effectively the certainty of payment, which is a post-contract issue and a structural issue. In that sense, I think that diversification is most welcome.

Jonathan Barnes: I also think the consolidation of the insurance industry over the last couple of years has caused the credit risks to become a little more concentrated and that is surely an issue.

Helen Yates: Can we move onto the importance of reinsurer ratings? Are these still very much a part of the buying process?

Alan Fowler: They certainly are as far as we are concerned. We have a mandate of zero tolerance below S&P “A-”. Whether that is right or that is too hard, that is what we do. We have one set of standards for short tail, effectively property and catastrophe business, which is “A-”; and for long tail business we are looking for “AA-” or better, and a very high percentage of our long tail business is in that category. Having said that, a couple of reinsurers were below that point and clawed their way back, so some cedants must see it differently.

Helen Yates: That is a geographical thing though.

Alan Fowler: In those cases, the Continental European cedants were obviously loyal, stuck with it and it came right. I am not saying we are necessarily right, but that is our view. We want to make sure that our reinsurance asset is there to pay when it is called upon.

Helen Yates: By default, if you are buying non-traditional reinsurance, how can you assess the strength of whoever is providing you with that?

Jonathan Barnes: Typically everything is

collateralised.

Alan Fowler: The money is in the bank effectively. We would make sure that anything we purchased of a non-traditional nature was capable of collection after the event.

Helen Yates: What about exit strategies? Is there any concern that your investors might have a bad hurricane season and decide to pull their original investment early?

Jonathan Barnes: In a cat bond structure they would not be allowed to. They would have to sell their bond in a secondary market. Of course, the existence of a secondary market in risk for the cat bonds is extremely helpful to investors. We can buy bonds that are already on risk and then sell them to adjust and tune our portfolio as new issues are offered to us and we receive new inflows into the fund. In terms of private transactions, we would post collateral to the protection buyer to ensure there is no credit risk associated with the deal. We do not get a secondary market in those transactions. We call them illiquid transactions and that is one of the few minuses from our point of view.

Eric Paire: Going back to the point about security and helping your clients to assess the credit risk of their reinsurer, it is not something that is always very visible but it has generated huge work for the brokers in following that. It is not just a matter of looking at various rating agencies who may be concerned by different issues. We now have people looking at the stock price, for instance, and saying that if the stock price is dropping something may be happening and then it triggers further questions to explore that further. It is also looking at the credit default swap [CDS] price that is traded on a given reinsurer and asking ourselves if the CDS spread is widening then something may be happening that we may not be aware of. It has become a quite intensive process, at least at Guy Carpenter, to make sure we are not missing anything. However, of course, it is also complemented by the traditional meetings with reinsurers. It is an enormous amount of information we are getting. Once we have worked on all that we try to come up with an opinion that we transmit to our client. I must say that most of our clients are doing the same job as well, so we support each other to do that.

Alan Fowler: When I mentioned the “A-” feature, that is the minimum standard. It does not mean to say we are going to use anybody just because they have an “A-” rating. There is a difference between the catastrophe play which is a commodity you are buying, where by definition you are buying a big stretch of cover and will need to access a lot of markets, as opposed to other long tail and specialist covers which are placed with fewer reinsurers. We like to look at it as a partnership with a lot of dialogue between ourselves and those players. There are a number of reinsurers out there, but your serious relationships will probably be with a dozen or so companies.

Helen Yates: Looking at these long-term relationships and the new start-ups that entered the industry after Hurricane Katrina, what is your view on that in terms of the fact they do not have as much of a track record? Do you feel comfortable with them?

Alan Fowler: Again, on a short tail-basis with capital provided, they have their place in the market and you weigh up the merits. It might be good to come back to Peter on this, but one of the interesting things from a diversification point of view is that following the change that happened after 2005, those companies entering have now been less inclined to be single monoline catastrophe players. From a rating point of view, I think diversification is being looked at in quite a key way, which would not have been the case when capital went into Bermuda on previous occasions.

Peter Grant: Our official stance is that good diversification has always been a positive attribute of financial strength. There is nothing new in that. Certainly in terms of the way we form our analysis, even despite the fact that we are now quantifying the benefit of diversification within our capital model, diversification is no more of a priority for us now than it was historically. That being said, to the extent that we may be in a heightened phase of natural catastrophe losses, then obviously a monoline cat writer is arguably more exposed today than it was five years ago. However, there has not been any fundamental shift in our thinking. For us, the decision to at least give partial benefit to diversification around capital models was really because of the level of push back we were getting from the industry itself.

Having said that, there is the contrast between the 2001 and the 2005 classes [of start-ups in Bermuda]. 9/11 was such a market-changing event that it (a) impacted confidence and perceptions of riskiness generally, and (b) had a broader impact across a number of lines of business. A number of new entrants were able to come in and quickly establish themselves in direct reinsurance across a number of lines of business. For the Class of 2005, formed after the 2005 hurricane season, their opportunities were always going to be in a narrower area of the market, which is exactly what has happened. They are often sitting on a billion dollars’ worth of capital, they have premiums of around $500m and going into a softening market they have to do something. As we are seeing now, many of them are looking to diversify through M&A activity, and that is not surprising.

Jonathan Barnes: By encouraging diversification, if that is achieved organically rather than through M&A, is there a danger that companies are being encouraged to underwrite business outside their core competency?

Peter Grant: Absolutely. It is a bit of a truism, but it is very easy to diversify your top line and very challenging to diversify your bottom line. Anyone can go out and write a lot of business in any line of business by looking at incumbent players and writing poor quality business. However, just because you have diversified your book at the top line does not mean that will be a positive lead indicator of financial strength. In actual fact, it is going to be significantly negative.

Jonathan Barnes: This is where the quantitative judgement in the rating process becomes so critical.

Alan Fowler: That is certainly an area we would look at to make sure that the operation had a sound basis in sense and quality of operation.

Gary Wells: With new start-ups, firstly you want a lot of capital in it, but there is a far more rigorous process in getting these new companies authorised now. The regulators are far more stringent and they want to see evidence of good modelling, understanding exposures and what you are going to underwrite going forward. New companies coming into the market have slightly more rigour to them than might have been the case a few years ago.

Simon Kilgour: If you have a lot more people selling apples then the price will go down, will it not?

Nigel Ralph: Correct. What they do bring to the market is that they put the existing market under pressure, so whether you use them or not does not actually matter. As part of the traditional reinsurance market, if you know there is a new player coming in, it puts the existing market under pricing pressure and that is quite healthy in the long term.

Simon Kilgour: So it would be alright for you to buy it then if it is cheap enough?

Alan Fowler: It goes back to whether it is secure enough. It is getting that balance right. In the last few years at the point of purchase, I have found that once you hit a strike price that is acceptable to the market – and that is not the lowest price – you will get your programmes home without too much difficulty. If you get that initial price wrong by trying to pitch it too low then you will go half way around the market and have to start all over again to complete. It is always difficult to know whether you have got it right with hindsight, but I think doing the negotiation with the leads and going to a number of markets and then striking a fair price for those markets is what has happened. Certainly, that has been our experience since 2005. If you don’t give the market what it requires at a fair price then I think you will struggle. We have seen one or two companies struggle.

Nigel Ralph: That is where the broker is fundamental.

Alan Fowler: It is not driving the lowest price. It is driving a realistic price that gives room for everybody that you wish to take part.