Bid-rigging, terrorism, hurricanes and increasing regulation, coupled with an ever softening market, spell uncertainty for the renewal season, says Jane Murphy

Reinsurance is a cyclical business. The ubiquitous, yet slightly elusive, cycle provides the backdrop for every enquiry into the state of the business and forthcoming renewals. But it is the faintly elusive quality of the cycle that makes it difficult to predict with a strong degree of certainty; the only constant is change. There are, however, recent signposts on the reinsurance road which can help clarify the view of the road going forward.

The main story of 2005, at least to this point, has been the impact of the crusading prospective Governor of New York (currently New York State Attorney General) Eliot Spitzer. Over the years, Spitzer has earned himself somewhat of a reputation for championing consumer protection issues, the protector of the man on the street against unscrupulous corporations.

In 2003/2004, Eliot's gaze had fixed on the mutual and hedge fund industries, in particular relating to market timing issues.

Last year, insurance brokers came under the microscope, initially for the practice of contingent commissions "and other hidden payments", which Spitzer's team viewed as conflicts of interest. The investigation soon widened as they uncovered evidence of market manipulation, which Spitzer himself, in his testimony to the US Senate's Subcommittee on Financial Management, the Budget and International Security in November 2004, described as "systematic fraud and market manipulation". In his testimony, he drew a picture of a market in which "many insurance lines, from employee benefits to property and casualty, essentially function as insiders' clubs, where those with market clout and power pay for preferential treatment ... the ordinary purchaser of insurance has no idea that the broker he selects is receiving hidden payments from insurance companies, that the advice he receives from the broker may be compromised, or that the market bids he sees may be illusory. This has led to a crisis of accountability."

On the reinsurance side, Spitzer's testimony identifies more possible "bites at the apple" of "undisclosed compensation" for brokers. Following on from the relatively straightforward contingent commissions, the broker may demand that the carrier use that broker for its reinsurance placements - bite two. The broker may have a contingent commission arrangement with the reinsurer which then kicks in - bite three. Finally, the brokers may have investments in the reinsurers to which they steer this business - bite four. Spitzer had identified $845m in contingent commission earned by broker Marsh in 2003; Marsh subsequently set up an $850m fund to refund policyholders, changed its senior management (including President and CEO Jeffrey Greenberg) and ate a very public helping of humble pie. Greenberg's successor last October, Michael Cherkasky, who previously had headed up risk consultancy Kroll (which was bought by Marsh in August 2004) acknowledged in a statement that "certain of our people acted improperly when placing insurance for some of our clients in the United States" and this "behaviour was unacceptable". Marsh deeply regretted these actions, he said, and the company now "pledge to lead the way in establishing and maintaining the highest standards of business conduct and client service. And to restore your trust."

By then, Pandora's Box had been well and truly opened, and the investigation had extended to bid rigging allegations and reporting irregularities.

And the investigating bodies now included the Securities and Exchange Commission, the FBI and a number (and still increasing) of US state insurance regulators. Over at AIG, which Spitzer had originally identified as a leading protagonist in the bid-rigging debacle, the various investigations had uncovered a plethora of at best uncomfortable business practices.

It had previously seemed unthinkable that the head of AIG, Hank Greenberg, would be parted from the company he had built up on any terms but his own; nevertheless, he resigned as chairman on 28 March, and two days later the insurer admitted it had improperly accounted for a finite reinsurance transaction with a Berkshire Hathaway unit, Gen Re. Since then, more AIG heads have rolled, as have several at Gen Re, and criminal charges are being brought. Even the somewhat revered Berkshire Hathaway head Warren Buffet (the second richest man, who is investment advisor to the richest, Bill Gates) has been the subject of speculation over the responsibility he has for managing the various outposts of his wide-ranging empire.

It has been fascinating - sometimes in a car crash-type of way - to watch these events unfold over the last few months. What is even more gripping is trying to assess what impact they will have on the industry. One thing now is for sure - nobody is beyond the reach of these types of investigations.

Go back a year, and the thought of industry luminaries such as Hank Greenberg, one of the most powerful people in the industry, being unwillingly ousted from his seat was risible. Now it is a permanent reality; every individual operating in the business is responsible for their actions, and answerable to investors, regulators, and law enforcement agencies. Subpoenas continue to fly, particularly from regulators focused on contingent commissions or finite reinsurance; this show is likely to run and run.

Another seismic shift of these events is the downsizing in appetite for finite reinsurance, and commensurate rise in disclosure and transparency.

The AIG transaction, which bolstered the insurer's books to the tune of $500m, has led to a slew of different requests for information from regulators.

The investigations are ongoing, and where they will end up still appears unclear. What is less doubtful, though, is that insurers are showing a distinct lack of appetite for finite reinsurance. And with capacity apparently quite plentiful for more traditional reinsurance products, it is questionable whether finite reinsurance has a future as anything other than a marginalised offering.

On the other hand, the European Union's Reinsurance Directive - the first time a unified system of regulation for reinsurance has been attempted - still accommodates a separate regulatory regime for the treatment of finite reinsurance, although it is definite in its requirement for risk transfer within the deal.

Although the Reinsurance Directive is likely to hit the European statute books before the forthcoming renewal season, it is unlikely to have any marked effect on the 1/1/2006 business due to the two-year period each European member state can take to put it into domestic legislation. The current standard reinsurance regulatory environment within Europe is for zero or light touch oversight by a regulatory body; that will change over the next couple of years or so to a standardised regime. However, only a small percentage of the European member states currently support a reinsurance industry of any note, and of those that do, regulation is either well-established or imminent. From the reinsurers' perspective, the demands and costs of compliance will start becoming clear early next year.

TRIAge?

Terrorism - an issue which has its own sad resonance around the time of the Rendez-Vous - is another topic that has exercised the sector recently, both in respect of terrorist attacks and because of the future of TRIA.

Willis North America succinctly encapsulated the main message of the US Treasury's TRIA Report: "it's time to fly on your own". The report essentially states that TRIA's existence stops the growth of a private market in terrorism cover, and that policyholders are going to have to look at alternatives on renewal. In its report, the US Treasury recognised that the absence of TRIA is likely to lead to an increase in rates and an effective decrease in capacity, but it reckons that the situation will stabilities in the longer term. This, reported Willis, is because of the increasing sophistication of catastrophe models, and because policyholders' surplus is increasing (an indicator of capital at risk). Insurers may turn to the reinsurance market to help with capacity issues, as well as looking to capital market offerings to raise surplus. But from the Treasury's point of view, TRIA "crowds out development of some reinsurance markets, and delays the development of private capacity."

Willis is guarded about the extent to which reinsurers can take up risk in a post-TRIA environment. "There are constraints on reinsurers' abilities to absorb significantly increased terrorism risk in a post-TRIA environment," stated Willis. "Expiration of TRIA would lead to an increased demand for terrorism reinsurance, but not a significant increase in supply. The expiration of TRIA would not, we believe, stimulate much additional capacity, and certainly would not engender more than $4-6bn of terrorism reinsurance capacity, much less than the $100bn backstop provided by TRIA. The constraints on reinsurance capacity for terrorism are self-evident to anyone who analyses the availability issue from a reinsurer perspective."

Willis notes that the prevalence of publicly-traded reinsurers, subject to scrutiny from investors and analysts, may constrain terrorism capacity because of the need to manage peak accumulations. With the US reinsurance market capitalised at $50bn at the end of last year, and assuming that reinsurers would be willing to lose a maximum of 10%, then $5bn would be available within the market. Willis suggested that this figure - optimistically - could be doubled with international capacity, resulting in $10bn available capacity, a far cry from the $100bn available through TRIA. Doubtless, there is some lobbying for the retention of TRIA, which may yet be retained as a facility; another example of the uncertainty surrounding the forthcoming renewals.

Tempest, terrorism and turmoil. Such factors are likely to influence the renewals season, but it is still too early to say to what degree.

And there could yet be another market shock to shift it on its foundations.

Whatever happens, it's not going to be dull.

- Jane Murphy is a freelance contributor to Global Reinsurance.

The big blow

Each year, there is a hot topic which emerges around the time of the Rendez-Vous: two years ago it was the impact of rating agencies; last year it was the four major windstorms of the 2004 season. According to Tropical Storm Risk (TSR), this year's Atlantic hurricane season is likely to be "exceptionally active". William Gray, the eminent forecaster from Colorado State University, has gone even further to predict this year as "one of the most active hurricane seasons on record. An above-average probability of US major hurricane landfall is anticipated." According to Professor Gray, there is a 77% probability of a category 3-4-5 hurricane making landfall somewhere on the entire US coastline, compared to an average last century of 52%.

According to TSR, July 2005 recorded the highest hurricane activity for the month since 1950, and the overall season this year is likely to be double the average level of activity. In particular, it is suggesting two hurricanes are likely to hit the US, as well as three other tropical storms. TSR predicts 15 tropical storms for the whole season, including nine hurricanes and four intense hurricanes. "Following the ravages of 2004, the current and projected climate signals now suggest that we should prepare for another exceptionally active Atlantic hurricane season in 2005, a factor which underlines the ongoing need for vigilance on the part of governments and citizens alike," according to TSR's Professor Mark Saunders.