Lee Coppack: Since Tokio Millennium Re is such a new venture, Mr Okada, I wonder if you would like to begin our discussion by describing how it is going to work. Your parent company has just entered into a $200 million swap deal with State Farm. What did that entail?

Shin-ichiro Okada: Innovative products have been delivered in several stages. Most people in the market now promote alternative risk transfer. In the broadest range of concepts are captives, rent-a-captives, self-insurance, financial risk, funding cover, securitisation and derivatives. Now Tokio Millennium Re has a new concept of risk, which is risk exchange. Tokio Marine has a significant share in Japan, and our catastrophe aggregation is concentrated in Japan, but very small in the United States or in Europe. On the other hand, State Farm Insurance, the largest non-life insurer in the US, has the same situation in reverse. So, one way to reach the market is to hedge to investors. Another solution is to exchange risks.

In the past, there was a risk broker exchange, a traditional type of exchange of proportional reinsurance, based on the profitability of annual results. That was the exchange of a balance of risks each year. Those kinds of transactions collapsed because of degradation of quality.

In the 1970s, even in the United Kingdom, there remained tariffs, but after deregulation the profitability of each company was reduced. Then the transactions of risk brokers or of treaties collapsed. But the idea was very good, so nowadays we are aiming to recoup the old idea of reducing the total cost of capital without paying additional costs. If we exchange risks, we can reduce our capital cost by maintaining net premiums. The transaction with State Farm is a very good example of this type of new idea. But we do not stick to just one concept. We try to use every kind of hedging scheme, of course including the capital markets.

Lee Coppack: Having heard how Tokio Millennium Re is going to operate, do you think it is a threat to conventional reinsuers?

Michael Butt: On the contrary. I believe they are complimentary and helpful as the clients would effectively be co-reinsuring which will give them an economic interest in the long-term soundness of that which they reinsure.

John Engeström: No, it is not. At Tempest Re we are very supportive of this concept and hope to be able to structure an exchange with Millennium Re. For us, it is a way to receive a bloc of Japanese property catastrophe risks which has been properly modelled and risk assessed in exchange for an equivalent bloc of our US Cat book, thus getting a better portfolio spread at acceptable ROEs.

Lee Coppack: Will such arrangements provide more capacity?

John Engeström: Again, from my company's perspective the answer is yes, since we have available capacity for properly rated risks in most non-US territories.

Lee Coppack: Will Tokio Millennium Re help to increase the ability of Tokio Marine to offer catastrophe cover in its home market?

Shin-ichiro Okada: There are several types of insurance products in Japan to cover earthquake risk. In respect of houses, the government backs the reinsurers, so there is no capacity there for increased programmes. But on the industrial side, it is different. If you go to Tokio, you see a lot of high-rise buildings, but most are not insured by earthquake policies, probably less than 1%, so a big opportunity exists to insure those buildings. If all properties in Tokio were to be insured, the amount would be much bigger than the California earthquake coverage, because the buildings are more congested.

In order to sell those types of products in Japan, we need to diversify our portfolio. Through the establishment of Tokio Millennium Re, we are going to promote and underwrite reinsurance exchange. By doing so, we can lower the capital cost of the Tokio Marine group. Without deterioration in total profitability, we can provide a product to our clients. At the same time, our partner, State Farm, can offer better terms to their clients in the US. So our mission is to provide much bigger, more sophisticated, lower-priced product to our clients worldwide.

Lee Coppack: What other types of deals might Tokio Millennium Re do and what sort of partners are you looking for?

Shin-ichiro Okada: So far, we are looking for products mainly in the area of catastrophe insurance. It is very important whether we can quantify the risks or not. Windstorm and earthquake risk is easier to quantify than political risk. Political risk is almost impossible to assess through mathematical models. A lot of reinsurers failed through not having quantified the risk, so the areas we would like to enter are those in which we are confident of our ability to quantify risk. One good example is weather derivatives or insurance.

Lee Coppack: Max Re is another type of reinsurer. Bob, would you tell us more about it?

Bob Cooney: I would describe MaxRe as a convergence company where we are integrating the underwriting of insurance risk or reinsurance risk with re-investment risk or asset risk. As an organisation we are going to diversify our asset allocation and incorporate some higher yielding investment products for a portion of our overall assets, with the view that while we are taking some additional diversification risk, the incremental return or yield we will get from that portfolio will compensate us for the risk. Many of the reinsurance transactions that we hope to underwrite will incorporate a reinvestment approach that is more diversified and we believe higher yielding, which will benefit not only our own shareholders, of course, but also we believe will allow us to offer some very innovative crediting structures in profit sharing arrangements to clients on long tail or long durational liability risks.

Lee Coppack: You have raised more that $500 million in capital at a time when insurance and reinsurance are not very fashionable with the stock market. Who are your investors and what is your appeal to them?

Bob Cooney: We have an array of investors. As a private company, we are deemed a private equity investment for some investors, but some very sophisticated financial institutions have invested in us. There are two founding sponsor investors. Moore Capital, which is a very large diversified alternate asset management firm with about $10 billion of assets under management, is one. They have put in $100 million in capital to underwrite the company. The second sponsoring investor is Capital Z Partners which is a financial services fund headed up by Stephen Gluckstern and Lawrence Chang, both originally key members of the Centre Re-Zurich organisation, specialising in structured finite (re)insurance products. We think that is a strong endorsement to the credibility of our business model and our plan.

We are also pleased that in the private equity raised, we had other sophisticated institutions. Western General is one of our investors. High Ridge Capital, which is an investment fund that specialises in reinsurance and insurance, is another. Aon the second largest insurance broking organisation is also in, so we are very pleased with an array of institutions that have contributed capital to Max Re. We also have a number of individual very high net worth investors that are used to investing in private equity and understand the nature of hedge fund products as well as the reinsurance business. Approximately 40% of our capital was raised from high net worth individual investors.

Lee Coppack: Dick, you have heard Bob Cooney describe Max Re's business plan.

How do you as asset managers for the (re)insurance industry, feel about the reinsurance model which looks at risk across the balance sheet and decides to reduce the level of risk on the liability side to increase the exposure on the asset side?

Dick Press: Bob's hiring Peter Minton to evaluate enterprise risk by focusing on the juncture of the asset and liability side of the balance sheet seems to me highly appropriate. His mandate to get the heads of underwriting, claims and investments looking at the same target strikes me as relatively and regrettably unique. For the industry to evolve profitably and for individual companies to realise their potential, such an integrated approach is necessary. On the other hand, insurance companies cannot afford to lose sight of the fact that they are operating vehicles first and investment managers second. If investors want strictly investment management, they can find a more efficient and likely a more effective way of doing it.

It also should be noted that reducing risk on the liability side implies an improved price-to-risk relationship for the underwriter. The question is: how will this be accomplished? With new business or different terms for renewal business? The implications for the income statement are meaningful.

From a bondholder's perspective, reducing risk on the liability side - and taking more on the asset side - is a positive in that risks on the asset side are more quantifiable than those on the liability side. Asset risks are more transparent in terms of the potential downside and sensitivity to external factors. The rating agencies and the debt markets tend to view life insurance companies as less risky than property/casualty companies for this reason.

Lee Coppack: Mary, we were talking about changing risk profiles of Bermuda companies. OPL has a much more varied asset mix than most reinsurers. How do you see your risk profile changing in the current circumstances?

Mary Hennessey: Until recently, OPL's reinsurance business included a large, very profitable shippers' risk programme which generated significant and consistent annual underwriting profits. Given the risk profile of our underwriting portfolio, we were able to absorb more potential volatility in our investment portfolio and, therefore, had a significant percentage of our investments in equities. This strategy clearly served us well over the last several years, given trends and returns in the US equity markets.

In addition to the shippers' risk reinsurance business, OPL had also developed over the years a growing book of international reinsurance business with premiums from this business in excess of $600 million in 1999. Today, we look to grow that business where opportunities for profit exist. Our new management team is particularly intent on specialty areas where OPL can add value, not only because of our large capital base and strong balance sheet, but also through our technical capabilities and customer focus. This book will certainly have a different risk/ return/ volatility profile than when we also had the benefit of the shippers' risk programme, and I do expect that our investment profile will need to be re-examined accordingly. Our asset allocation model allows us to view alternative scenarios which are responsive to any change in liability profiles.

Lee Coppack: Jan, are there implications for reinsurance law in the growing

diversity of models for reinsurers?

Jan Woloniecki: There are two broad legal consequences of novel transactions which strike me as obvious. One is regulatory. Is the transaction a contract of (re)insurance for the purposes -in Bermuda- of the Insurance Act 1978? The Bermuda act has a very broad definition of “insurance business”, which includes reinsurance. And unlike the traditional definition of insurance under English common law - English legislation does not attempt to define insurance - there does not have to be an insurable interest.

The person who purchases a catastrophe bond does not have to have an insurable interest to which the property relates. To use the jargon of the money market, it is a derivative product. Yet a catastrophe bond looks like insurance from the point of view of the Bermuda act.

My understanding is that this is the reason the act was amended in 1998, so that it is possible under the act to have a class of transactions which are called “designated investment contracts” which are deemed not to be insurance contracts. Therefore, a company which enters into them does not fall to be regulated under the act.

The second point is utmost good faith - the traditional doctrine which requires full disclosure of all material facts at the time the contract is entered into is confined to contracts of insurance and reinsurance. To the extent that novel transactions are not (re)insurance then the duty of disclosure does not apply. My understanding is that, unlike traditional reinsurance transactions, both parties in fact engage in a large amount of due diligence before entering into a contract.

Lee Coppack: How does the investment community feel about this increasing

diversity in models of reinsurer and reinsurance?

Dick Press: On the issue of cat bonds and the like, I believe that investors will gravitate to these securities from which they believe the risk adjusted opportunity will justify acquisition. Some of the new vehicles concern me in that their use requires the portfolio manager not ignore the need to diversify. The downside of a 1 in 1000 year probability occurring on trade date plus one is strictly a matter of chance with no predictive value that should be inferred by the lack of frequency.

Shin-ichiro Okada: Investment brokers are going to make a profit through dealing with insurance risks, because they have good knowledge about investors and good relationships with them, which is important, even for insurance people. In order to hedge risks, we try to access investors and utilise capital capacity from them.

Tokio Marine securitised Tokio earthquake risks two years ago. We aimed to collect capacity from investors. That may have an impact on the insurance industry, because the securitisation of risks means that non-licensed people are going to take insurance risk, but still we decided to securitise risks and utilise the capacity from investors because we thought that would be good for our clients. So it was a market-driven decision.

Lee Coppack: So far, however, cat bond issuers have had to offer quite high interest rate spreads to interest investors, haven't they?

Dick Press: The length of time it took mortgage backed bonds to get acceptance in the marketplace might also serve as a guidepost as to when cat bonds, for instance, will find acceptance. The spreads on mortgage backed issues after they first surfaced in the early 1980s were due to investors' lack of familiarity and a relatively small and narrow supply. As new issues addressed specific portfolio needs, volume in general increased and investors began to appreciate the opportunities as well as the risks, spreads declined. However, this did not happen overnight but took the better part of the decade.

Lee Coppack: I have heard it said that one of the virtues of reinsurance is the flexibility of the contract. It may not be a good analogy, but every time someone amends a shipping charter party, it seems to lead to litigation. Is the same true in reinsurance, Jan?

Jan Woloniecki: Actually the problem with reinsurance contracts is that historically in the London market -and in Bermuda in the past- very little thought was given to the terms of the contract. The typical form of contractual document, the slip – which was once described by a leading commercial judge in England as “a laconic document” - contains the bare essentials of the transaction, the premium, the limits of coverage, but not the full terms of the contract.

Frequently no attention is paid to the relationship of the reinsurance contract with the underlying insurance contract, no thought is given to the law which governs the reinsurance contract or how any disputes are to be resolved. You could write a book about the problems this causes. In fact, I have done so! And it is not a new phenomenon. English judges have been criticising underwriters for their casual approach to contract wordings for at least 200 years.

I have been saying for years (before I ever came to Bermuda) that prevention is better than cure, and that it would save the reinsurance industry money if it paid attention to contract wordings and had lawyers to draft them - rather than calling in the lawyers when there is a dispute. Perhaps fortunately from my perspective, as someone who makes a living advising on insurance and reinsurance contract disputes, few seemed to have learned the lesson. But, having said that, I note that the Bermuda market has developed a standard form, the so-called XL or Bermuda form, for direct liability insurance. Even though this was carefully drafted by American lawyers, it has still given rise to disputes.

Shin-ichiro Okada: Reinsurance enjoys complete flexibility, but reinsurance is only one category of a number of hedging schemes. Reinsurance is just one type of option of derivative transactions. If we use reinsurance or insurance, the insured's interests are paramount, but if we take the option we do not need such insured interests behind; this is a big difference between reinsurance and derivatives.

Tokio Marine started selling weather insurance last summer, but now in Japan, other financial institutions such as banks started selling weather derivatives, as they have in New York. So the derivative types of transactions are more easily carried out than reinsurance transactions. There are limitations on the use of just reinsurance. We should be more open to use a wider range of products to meet our clients' needs.

Lee Coppack: Is there a risk that in the use of increasingly sophisticated forms of reinsurance, some of which are self-confessedly financial engineering, the real stability of ceding companies is more dependent not just on that of risk carriers but also the quality of their contracts with those risk carriers, and so less transparent to regulators and rating agencies?

Michel Butt: Yes, there is a risk particularly of lack of transparency and understanding and quite possibly of mismatching exposures. However, as always this risk is likely to be higher for the less competent or the less well capitalised, but overall, despite this, these products will add value.

Jan Woloniecki: Any ceding company that thinks it has “transferred” its risk by entering into a contract of reinsurance is wrong - it has merely exchanged the risk which it originally assumed for the credit risk of the reinsurer not being able to meet its obligations. One of the features of the so-called financial reinsurance or finite risk contracts that I have seen is that typically the obligations of the reinsurer are secured by a letter of credit (LOC) - so one has the credit risk of the confirming bank as opposed to the credit risk of the reinsurer.

What has struck me as genuinely alternative about alternative risk transfer is that you have a higher degree of confidence that the money is actually there to pay the claims if they arise. I am thinking of catastrophe bonds, for example. I have had no direct experience of dealing with rating agencies - I do know that regulators in the US are suspicious of new kinds of transactions, Bermuda has welcomed innovation by amending its legislation to provide for designated investment contracts, which I have already mentioned, and to recognise that a captive which writes only the risks of its parent does not have to be regulated in the same way as a billion dollar property catastrophe reinsurer, hence the four classes that were introduced in the Bermudian legislation in 1995.

John Engeström: They should not pose any risk to the cedent since they are worked out in cooperation and with full disclosure between cedent and reinsurer. They are clearly not plain vanilla and will not always fit readily into regulatory reporting categories or rating agencies capital adequacy models.

Dick Press: I would agree that the quality of contracts has become a more important factor in determining the stability of ceding companies. Management vigilance is essential. The recent Unicover blow up demonstrates the growing importance of contracts in determining what liabilities a company may have to a loss. Participants involved in Unicover have spent a lot of time determining what kind of exposure each participant has to losses incurred from the pool. Rating agencies also have taken some time to adjust the ratings of those companies involved with Unicover.

The reinsurance markets are getting more complex. With more complexity,contracts have a more important role in determining how much exposure companies involved in reinsurance have to potential liabilities. If we are looking at this issue in terms of the organic nature of a reinsurance company, then diversification relates to the types of risk that a reinsurance company underwrites and the types of protection that a reinsurance company will use to limit exposure to a single loss or customer. In this sense, diversity enhances the credit safety of reinsurance companies in that it makes a reinsurer less exposed to a single liability, i.e., a major catastrophe or liability lawsuit, or less dependent on a single type or source of reinsurance.

I believe that more than anything else, however, the key for insurance companies will be the quality of the personnel they hire and the opportunity that lies in writing non-standard policies, as Okada-san has already demonstrated and as Bob Cooney intends to accomplish. The spread and diversification of risk speak to the heart of the insurance business. Investors pay a premium for growth and consistency. Diversification plays an important role in accomplishing both.

Shin-ichiro Okada: Yes, there is the risk of less transparency to the public, but reinsurance is a transaction between professionals. So if the reinsurance is transacted between experienced experts, not just accepted or refused through market brokers, then that is all right. We do not just take risks through market channels. We are the experts on risk, and if we should accept risks, they should be quantified through computer models.

Another point. Now, in order to write business, we need to have high ratings from the agencies such as Standard & Poor's and Moody's. Without them it is impossible to transact business. So all the players in the market are required to be transparent to the rating agencies, which guarantees a degree of transparency.

Lee Coppack: Max Re is different, a new model. How are you affected by the rating agencies?

Bob Cooney: Well, all reinsurance companies really are in two businesses. They are in the insurance risk underwriting business, whether that is property and casualty or life and health products. Obviously you have got to do that conservatively and profitably. The second business which we all have is the asset investment risk, those assets that we invest, the premiums and reserves, that hopefully will give consistent returns over time. We are going to diversify our approach to the assets side and be more opportunistic in the sense that we will be using some alternate investment products to complement a traditional bond portfolio.

We believe that the management of that risk can be done conservatively and prudently. Indeed, we think on a risk adjusted return basis, it may be a less risky strategy than just investing solely in fixed income, for example. That strategy can be quite risky in a rising interest rate environment, as the bonds would decrease in value on a market to market basis. The rating agencies will look very carefully, I think, at the quality of our investment managers and the performance over time obviously. But we think that it is a risk that we can balance and underwrite and combine that with conservative insurance risk underwriting.

We have been pleased with the initial rating we have achieved as a start- up company, which is A- from the A.M.Best Company. I think it is the highest rating they have given an independent, start-up company with no operating history. We expect in due course to obtain other rating agency approval.

Lee Coppack: Are rating agencies a blessing or a bane?

John Engeström: There is no doubt that they are the informal global regulators. Cedents look more to them than to statutory regulation when assessing the financial strength of reinsurers. Let us not forget, though, that rating agencies are commercial institutions. In recent years they have extended their product lines and geographical coverage in order to generate more revenue. Consequently, they are stretched in terms of analytical resource and up-to-date modelling techniques. At Tempest Re we have a continuous dialogue with S&P to upgrade their rating model. Some progress has been made, but there is still a gap between our dynamic portfolio management technique and their deterministic model.

Michael Butt: Do you think reinsurers could approach rating agencies on an industry wide basis to develop consensus methods for rating?

John Engeström: I do not believe that is a realistic way ahead. It is probably more productive to discuss theory and methodology one-on-one.

Lee Coppack: Mary, you have recently moved here from the US. How would you contrast the US regulatory system with Bermuda?

Mary Hennessey: There are pluses and minuses with the US system. The 50-state system of regulation often makes it difficult to introduce new products on a timely basis, in contrast to the regulatory flexibility here in Bermuda. The US regulatory system purportedly is very tough on companies with the objective of consumer protection, there nevertheless have been some spectacular failures where a given company's financial struggles were well known in the industry, yet the regulator seemed slow to react.

With regard to new models of reinsurance like weather derivatives, I am not certain that these contracts were actually reviewed by regulators in the US before being done, but given the adverse experience some reinsurers have had, it might be the case that they could be examined after the fact.

Lee Coppack: Before we get too carried away with how things can develop in the future, should we not also look at what has gone wrong with reinsurers in the past? Jan, from your experience what do you believe are the main causes of reinsurer mortality?

Jan Woloniecki: I am tempted to say “original sin”. Seriously, I would describe myself as a pathologist of reinsurance transactions! In my experience, incompetence and greed have been the cause of corporate failure much more frequently than fraud, although fraud has happened in Bermuda and in other allegedly better regulated markets - i.e. London and the US. I think the brokers call it naive capacity. That is what we had in Bermuda in the early ‘80s.

It is instructive to see the changes that have taken place in Bermuda since I arrived in late 1990. ACE and XL were new born babes then. None of the “big cats” had been formed. We were engaged in burying the dead from the 1980s. Companies which were the leaders of the Bermuda market in the early 1980s when they moved from simple parent - captive risk taking and took on significant third party business were in liquidation or in run-off.

We now have very sophisticated insurance professionals in Bermuda. The brokers no longer treat this market as naive and have gone elsewhere to place the bad risks. We have billion dollar companies - $100 million is the minimum price for admission to the exclusive club of Class 4 insurers and that is now regarded as a modest capital base for a catastrophe reinsurer. Indeed, I once heard an insolvency practitioner complain that the Bermuda market was over-capitalised. That was about a year or so before New Cap Re went bust.

New Cap Re is a classic example of what goes wrong. Taking on bad risks and/or insufficient premium to make an underwriting profit is at the heart of every reinsurance company failure. There has often been a disconnection between the underwriters and the claims people. I have tended to deal with claims managers (who typically have a low opinion of underwriters). The successful companies will be those where there is communication between the two.

Lee Coppack: What do you think will be the most important qualities for reinsurers over the next three to five years?

Shin-ichiro Okada: Who will win the race - insurers, bankers or financial people? The answer should be that there will not only be one winner, but several winners. The most important factor in winning will be the company's qualified staff. Companies' products are becoming more complicated. Staff need to be qualified in several types of products, with experience in insurance, in financial products and mathematical expertise as well as the ability to deal with transactions. Through models, they might have been provided with data from clients. They have to put that data into models and calculate risks in order to make the best presentation to clients

Each company should be equipped with capable and qualified people. How to educate, train and stimulate their spirit is very important. Companies need a respectable and sophisticated spirit. Without that, no one can win the race.

Mary Hennessey: I agree with Mr. Okada. In my view, reinsurance is a professional services business where having good people can create opportunities for us. Reinsurance is increasingly a technical, complicated business which requires integration of both quantitative analysis and qualitative or macro business insight. In the past, relationships were a major reason for selecting one reinsurer versus another, whereas today our customers seek financial partners who can provide not only risk transfer but also fit other key needs.

For instance, they look to us for designing or enhancing existing capital management strategies, assistance in bringing new products to market, evaluating and structuring mergers and acquisitions, etc., mitigating the impact of withdrawal from products and/or markets etc.

Given these complex business needs, the kind of people I am looking to attract to OPL need a blend of skills. By this I mean deep, technical understanding of the business with a bias toward quantitative analysis, plus strong consulting and client interface skills, good communication skills, both written and verbal, a high energy level and the ability to work as part of a multi-disciplined team.

This last characteristic is important, and different from the old model where the account executive was the sole contact with the client. None of us alone has the breadth of skills and knowledge to assess customer needs and deliver solutions, and professional teamwork creates tremendous value.

Lee Coppack: I would like to ask all of you for your comments on how you see the reinsurance market, particularly in Bermuda, looking in three to five years? More consolidation? More diversity?

Dick Press: The industry is growing slower than GDP. It is a price taker, not a price maker because, among many other factors, it does not control its distribution. People buy insurance because they need to, not because they want to and, therefore, insurance is not like branded products like Coke and Rolex. It is basically a commodity.

In view of this, we definitely anticipate more consolidations. In a weak pricing environment, that may be the only route to survival. However, consolidation frequently produces even greater excess surplus and even more price competition, which is a vicious spiral. This is already reflected in the market. The insurance industry accounts for less than 2 1/2% of the S&P index, down from 5% not that long ago.

I am not sure that Bermuda will look much different in terms of the number of companies involved. However, I do believe that Bermuda, due to its favourable regulation, its tax policies and its proximity to the US, will continue to attract more capital than other markets in the industry and will realise more growth than the rest of the industry. There will be more diversity in Bermuda as Bermuda companies continue to underwrite more risks in more markets. Bermuda is emerging as the reinsurance market with the best management talent. Such intellectual capital inevitably will attract more financial capital than the rest of the industry, thus feeding a positive, self-reinforcing sequence.

Jan Woloniecki: There is now a critical mass of people and of capital in Bermuda. I think the industry is here to stay. My managing partner, Rod Attride-Stirling, was interviewed by the local press recently and asked what he would like to see most in Bermuda and he said 1000 more reinsurance companies. Well, I do not think we will get as many as that. There is a finite amount of capital that is ava