Maximum exposure: rocked by the combination punch of corporate accounting scandals and the bear market following the major hit from Sept. 11, reinsurers face a new world of being scrutinized by trading partners while scrambling for capital. (Industry Strategies).

Reinsurers are in a strange position. After a long, soft market throughout the 1990s that kept underwriting income below the breakeven point, fortunes seemed to be lifting beginning in 2000. The global property/casualty market began to harden, investment income was strong and demand was picking up.

The shock of the Sept. 11 terrorist catastrophe hit the industry with unheard of losses, but most of that was absorbed by some of the world's largest reinsurer without a crippling effect. In the months after Sept. 11, a capacity shortfall encouraged the formation of new reinsurers, mostly in Bermuda. But by the end of 2001, optimism of a new, profitable reinsurance cycle was fading.

There were several reasons. The collapse of energy-trading giant Enron Corp. and related implosion of its auditor, Arthur Andersen, signaled the beginning of an ugly round of corporate-accounting scandals that claimed some of the biggest stars of the 1990s stock market rally--WorldCom Inc., Global Crossing Ltd., Tyco International Ltd. and many others. Those failures accelerated the so-called dot-com bust that was already under way, dissipating billions of dollars of equity capital and evaporating the investment-earnings cushion that reinsurers had long relied on the cover their underwriting losses.

A.M. Best Co. estimated last year that $25 billion to $30 billion of new capital had entered the reinsurance market since Sept. 11, 2001. However, the industry lost at least $35 billion at the same time. The capital coming into the market hasn't been able to keep pace with demand.

Rob Bredahl, head of broker Benfield Group's solutions unit, which focuses on the technical aspects of reinsurance, including actuaries and catastrophe modeling, said capital is an "enormous issue" for reinsurere. "The capital base has dropped over the past few years, with declining investment returns and years of rate inadequancy," he said. "Now that the rates are going up, reinsurers need more capital to sustain the footprint of this cycle."

Strategies such as quota-share or finite reinsurance--anything that creates paid-in or "synthetic" capital--are in demand, he added. "Related to that is concern over financial ratings. We've been spending a lot of time helping these companies to shore up their balance sheets and allow them to write business point forward."

Bredahl said reinsurers are in something of a paradox: they're finally getting the rate increases they've been desperate for over the past decade, but they don't have the capital to take full advantage of those increases.

Changes and Headaches

At the same time, reinsurers are struggling to redefine their risk exposures and underwriting strategies to meet a changing risk environment. The new urgency created by the risk of a large-scale terrorist attack has thrown some markets into turmoil. The commercial-property and aviation markets, for instance, were hammered by a sudden lack of insurance coverage and skyrocketing prices. The 2002 Terrorism Risk Insurance Act, passed by the U.S. Congress, alleviated some of that pressure, but there is still a huge question mark hanging over the insurance and reinsurance markets when the Act expires, taking the U.S. government out of the reinsurance business in 2005.

The current hard market is characterized by finite reinsurance features, which Bredahl said have "found their way into every reinsurance contract." Auditors now are "being extremely difficult" about passing risk transfer onto anything that has caps or other risk-reduction features. "The problem for us is that the auditors can't tell us what they're looking at," he said. "One auditor once said that risk transfer is like pornography--you can't define it, but you know it when you see it.

"We're not sure what we're shooting for," added Bredahl. "We put a deal together, believing that it passes risk transfer on murky rules we're interpreting, and we hold our breath. Many times we have to restructure the deal."

Yet another headache for reinsurers is the growing problem of prior-year claims liabilities, related to casualty lines, asbestos and workers' compensation, among others. Primary insurers made headlines throughout 2002 with billion-dollar charges for reserves to cover such claims, dragging reinsurers along in their wake.

"The reinsurance industry, in casualty lines and many other lines, is still far short of rate adequacy," said Rick Smith, president and chief executive officer of global property/casualty reinsurance for GE Employers Reinsurance Corp. "I think we'll continue to see surplus coming out of the marketplace at record rates. That's not going to stop, given the strains on the industry. As more surplus goes out, it will put more pressure on pricing."

Smith, like others in the reinsurance industry, has seen the push and pull of all those developments over the past two years strain the confidence of primary insurers in their reinsurance partners. The reinsurers, in turn, have become more concerned about the strength of their retrocession providers.

"There's no doubt about the frail nature of this industry," he said. "It's caused everyone to rethink what security means. It's been said many times in the industry before, that when you enter into a reinsurance relationship--especially in specialty lines--that's a long-term relationship. You've got to make sure you're doing business with someone who's got a strong balance sheet and who will be there in 20 to 30 years to pay the claim.

"It's a concern for our customers, and for us as well--we buy a lot of retro coverage," Smith added. "So it's forced us to think about the industry, and who you want to pick as retrocession partners, and why. Who would have thought five years ago that Gerling would be out of business? Or Kemper, or Reliance?"

Sounding Off

The emerging skittishness among primary insurers about the financial strength of their reinsurers has been reflected this year by some of the industry's leading executives. Maurice R. Greenberg, chairman and chief executive officer of American International Group Inc., noted in a speech at AIG's annual meeting in May that rating downgrades have been "fast and furious" for reinsurers, something AIG doesn't take lightly. "Primary companies do not want to do business with a reinsurer without adequate capital," he said. "At AIG, we won't do business with a reinsurer that doesn't have adequate ratings. Otherwise, they have to post collateral that meets our standards. We're not going to reinsure with someone who's not going to be around to pay in future years. We've taken a very strong position on that."

AIG, which itself had to post $1.8 billion in reserve charges at year-end 2002 to cover prior-year liability and casualty claims, is in no mood to take chances with the stability of its reinsurance backing. Noting that some capital has come back into the industry in the past two years, particularly in the form of Bermuda-based startups, Greenberg added that "it's not going to replace what was lost."

Berkshire Hathaway Inc.'s Warren Buffett, in his annual letter to shareholders, warned that some reinsurers might not be counted on to honor claims because of their weakened Financial condition.

In his letter, Buffett was coy in his criticism of other reinsurers, referring obliquely to one in particular that "virtually ceased paying claims altogether." Many in the industry believe he was thinking about Germany's Gerling Group, time world's seventh-largest reinsurer in 2002, now out of the business and selling off its reinsurance assets. "Cheap reinsurance is a fool's bargain: When an insurer lays out money today in exchange for a reinsurer's promise to pay a decade or two later, it's dangerous--and possibly life-threatening--for the insurer to deal with any but the strongest reinsurers around," Buffett wrote.

Speaking at a press briefing earlier this year, William R. Berkley, chairman and CEO of property/casualty group W.R. Berkley Corp., said this: "The ability of reinsurers to act as the backbone of the industry is not there any longer, and time ability of the industry to rely on that is something that can't continue."

James Vickers, managing director of broker Willis Group Holdings Ltd.'s Willis Re division, said financial security is among the top subjects on the minds of most reinsurance clients--specifically, reinsurance recoverables. The lead taken by AIG's Greenberg in stressing a demand for security from reinsurers has highlighted this issue, he said.

"Many insurers are carrying large reinsurance recoverables as an asset on their balance sheets, and it's something that regulators are beginning to look at," said Vickers. "But there have also been some quite difficult claims out there, and it's not just tile ability to collect the claims on long-tail business that may not materialize for 10 or 15 years. Its also on short-tail claims--how willing is a payer and how smoothly will tile transaction go?"

There are two sides to security, said Vickers. There is the straight question of financial security--is the reinsurer able to meet claims? The other has to do with being comfortable with the way reinsurers have responded to claims. "For the buyers, I think that is becoming more of an issue than the price of reinsurance. While nobody likes to pay a lot of money, there's no point in paying for something that's not going to respond when you need it to," he said.

"The flip side of that is the reinsurers understand their problem well mad understand that they need to maintain and maximize their ratings to be an attractive market for their buyers," Vickers said. "That is squeezing them, because they've got their own runoff problems and balance-sheet issues on their equity portfolios.

"What I think we're going to see in the United States is the issue of reinsurance recoverables," said Vickers. "People are going to require reinsurers to put up collateral for their liabilities. That is double, but will have a big price impact. Some of the larger, highly capitalized reinsurers are going to argue, 'Why should we have to do that?'"

Jeremy Pinchin, who took over in July as head of reinsurance and claims for Lloyd's--a new position--said the Lloyd's market is keenly aware of the value of its reputation as a reinsurer. The sixth-largest in the world, Lloyd's improved the strength of its brand through its performance in the wake of Sept. 11, he said.

Pinchin, who was appointed by Lloyd's as special counsel to handle Sept. 11-related claims--both outgoing and incoming--said the market saw it as critical to get its reinsurance obligations right following the catastrophe. Lloyd's took the biggest hit of all from Sept. 11--$3.5 billion in claims paid so far. Yet the market managed to record a net profit of 834 million [pounds sterling] (about $1.4 billion) in 2002, compared with a 3.1 billion [pounds sterling] loss in 2001; improve its combined ratio to 98.6 from 140.3; and boost net resources 85% to 7.5 billion [pounds sterling].

All of that was achieved with the aim of reassuring the primary market that Lloyd's was going to continue to meet its obligations, said Pinchin. "That has shown the strength and flexibility of Tim Lloyd's market, and its importance in the reinsurance area," he said. "The reinsurance has to be done right--broadly, 70% of the market's business is reinsurance."

Lloyd's is also a big buyer of reinsurance, although as such it doesn't have a central point of view as buyer, said Pinchin. "We've left it to individual syndicates. But because of the element of mutuality that exists within the market through the operation of the Central Fund, you do need to manage that contingent risk and understand the issues and relationships we have with our reinsurers," he said. "What we developed as a result of the Sept. 11 project was a relationship with reinsurers and methods of managing those relationships and issues. Now we're going to take that forward into the whole of the outward reinsurance for the Lloyd's market. It's a substantial asset for the marketplace."

While many of the world's largest insurers have said they are becoming more concerned about reinsurance recoverables, Pinchin said Lloyd's hasn't had much trouble collecting on its reinsurance contracts. Lloyd's is embroiled in a legal dispute with six insurers of its Central Fund over recoverables on claims against the fund, but he said that is seen as a separate issue from the market's reinsurance relationships in general.

Otherwise, "the collection of the outward reinsurance for the market has progressed exceptionally well," he said. "We've got strong working relationships with all of our reinsurers, and there is a great absence of disputes in relation to the collection of claims. They're minor, trivial compared to the size of the assets and amount we've collected, and the good commercial relationships we have, and want to maintain, with our reinsurers."

"Lloyd's isn't always the most competitive market, but at tiffs stage of the cycle, they are," said Vickers. "They're in great shape. They've pulled together a lot of capital. Their underwriting units are getting fewer and much larger. It's given them critical mass that appeals to clients, but it also gives them depth to do their own research and marketing. The trick for Lloyd's will be to maintain it over the entirety of the cycle."

For some reinsurers, much might ride on the sustainability of the current hard property/casualty market, said Roderick Thaler, executive vice president and national director for Willis Re's North American reinsurance operation. "We think it's sustainable, it still has legs," he said of the hard market. "In the property segment, our largest client is still getting rate increases and has had insurers ask about entering into multiyear deals. It's unheard of for insurers to want to walk into a multiyear deal at the peak of a hard market."

The issue for such insurers is finding stable relationships and access to capacity, rather than price, said Thaler Chief financial officers of Fortune 100 companies are concerned about price, he said, but they are becoming more concerned about the ability of their primary insurers to maintain access to stable reinsurance markets, an ability that speaks to the primary insurer's staying power.

"Access to capacity is very important," he said. "Stable capacity" is the point. I think there are going to be longer legs in the ability to keep pricing hot. There is even more room for rate increases in casualty and umbrella markets."

Employers Re's Smith said that, while the reinsurer can't control the reactions of primary insurers to pricing and tighter underwriting, "what we can do in our shop is segment our customers. Those that are core, we continue to work with through the market cycles," he said.

"Looking back at how painful the last cycle has been, it is a challenge to come up with the right solution for the next soft market," Smith added. "What I make sure of is that we have the discipline to grow when the market is right and the terms and conditions are right. This game of market share has proven over the years to be no game."

Although there have been some rumblings during the first half of 2003 about the hard market showing signs of slowing, Thaler disagreed. The industry's biggest players--he points to AIG--are determined not to waver on pricing this time around and are likely to succeed ha enforcing market discipline.

Underwriting discipline is improving among both insurers and reinsurers, since the security of solid investment returns has been snatched from them, said Thaler. A lot of that discipline is being driven by the Bermuda market, where most of the new reinsurance capital has taken root since Sept. 11. "It's driven by the greater need for transparency in catastrophe modeling--examining where, exactly, the exposures are," he said.

Since the destruction of the World Trade Center, the techniques of catastrophe modeling have been expanded to encompass a new range of large-scale risk exposures, said Thaler. Among the most important areas to get new treatment through modeling is business interruption. "With the economic shift to methods such as just-in-time inventory, global production facilities mid mass communications, you're now looking at potential long periods of downtime in a catastrophe" he said. "Business interruption and contingent business interruption is now a big exposure, more so than traditional physical loss."

Bermuda Connection

Vickers sees "a dichotomy coming into the market" between what he calls the legacy reinsurers, which have been around for a long time and have reserving issues and historic investment losses, and the new capital carriers in Bermuda that formed in 2001 and 2002 with substantial amounts of clean capital. While reserving increases seem to be hampering the older players, Bermuda's Young Turks don't hold all the cards either, he said.

"They haven't got the strong ratings, because they don't have much of a track record," said Vickers. "There's a balancing act from their side, as well. In their capital raising, they offered some quite exciting returns to their shareholders, and yes, they've done quite well. But they're nut doing as well as they might have. So they're being squeezed a bit as well."

R. Michael Cass, president of RM Cass Associates hi Chicago and a member of the CPCU Society--an ethics and education forum for insurance professionals--said the clean-capital side of the equation is a big advantage for the new Bermuda insurers, in that they can "pick and choose" their clients mid lines of business, unencumbered by commitments to past business.

The influx of new reinsurance capital into the Bermuda market since Sept. 11, 2001, has helped turn Bermuda into a serious multiline market, as opposed to its traditional base ms a catastrophe market, said John Jenks, head of broker Benfield Group's Bermuda office. Jenks used the term "market" loosely, saying Bermuda isn't really a single market, like Lloyd's, since the reinsurers based there tend to pursue their own, independent strategies.

Bermuda has attracted much of the new reinsurance capital because it is a well-regulated domicile with a good financial infrastructure, said Jenks. But even more important, related to the flurry of startup activity between Sept. 11 and year-end 2001, is the simplicity with which a reinsurance operation can be created there, as opposed to in the United States or Europe, he said. A friendly tax environment and Bermuda's strategic location between the United States and the United Kingdom help, as well.

"We are seeing some of the Bermuda reinsurers setting up platforms outside Bermuda to more easily access and manage working levels of reinsurance," said Jenks.

Among Bermuda's strongest selling points as a reinsurance center is the lack of prior-year claims exposure on the part of the domicile's reinsurers, said Jenks. "Even the 1993 startups aren't encumbered by all those reserving issues, for the most part," he said. That, in turn, leaves most Bermuda reinsurers free of some of the disputes over recoverables that are surfacing between reinsurers and their clients in other areas.

Cass said most reinsurance disputes arise when one or more of the companies involved is going into runoff or liquidation. "Many of these relationships are long term, and the companies would prefer to settle any differences without having to go to the mat," he said. That said, the list of insurers and reinsurers going into runoff since the Sept. 11 catastrophe has been growing. "If you look back 20 years ago, there were probably 200-plus entities in the United States writing reinsurance," said Cass. "Since then, it's down to a couple dozen reinsurers who write any kind of significant business. The "largest five to 10 are writing most of the market."

Aside from Sept. 11 and lost investment income, reinsurers still are shadowed by the huge question of asbestos and environmental claims. Many primary insurers posted big increases in their own reserves for anticipated asbestos claims in 2002, and the corresponding risks to reinsurers will become more of a concern. "As you look at the differences between gross and net claims posted by primary insurers, you see there's a fairly significant disparity," said Thaler. "Where will the burden of that disparity fall? Who's that going to fall upon in coming years? How well are they prepared for it?"

One key development ha resolving the exposure of reinsurers to asbestos claims might be the effort of the U.S. Congress to pass legislation that would create a fund to pay medical claims related to asbestos. The proposed fund would be funded by primary insurers and manufacturers implicated in asbestos contamination and would pay out medically valid claims. The key to the plan would be getting tort lawyers to agree to limit claims to those that can be medically verified.

"If such a bill passes, it would be interesting to see what that would do for reinsurers," said Thaler. "Does that accelerate the payouts for asbestos? Does it fall heavily on Lloyd's, or direct writers in the U.S., such as General Re and American Re? And if so, are they adequately capitalized?"

The asbestos-reform legislation under consideration by Congress has thrown another variable into the mix for reinsurers' strategic thinking, said Benfield's Bredahl. "They have to worry about whether they're ahead of the curve in terms of reserving, and whether they've got it straightened out, relative to their peers," he said.

Downgrades of A.M. Best Reinsurer Ratings

Rating activity since Jan. 1, 2001, excluding outlook changes, for
professional reinsurers or organizations writing substantial
reinsurance business.

AMB#    Company Name

00149   American Re-Insurance Co.
86698   Annuity and Life Reassurance Ltd.
        Last rating before NR was C+ (May 29, 2003)
86938   Arig Reinsurance Co. B.S.C.
        Last rating before NR was B+ u (Nov. 21, 2001)
85219   Axa Re
85249   CX Reinsurance Co. Ltd.
        Last rating before NR was B+ u (Aug. 27, 2001)
86514   Commercial Risk Reinsurance Co. Ltd.
85804   The Copenhagen Reinsurance Co. Ltd.
        Last rating before NR was B u (Nov. 20, 2001)
03771   Dorinco Reinsurance Co.
00347   Employers Reinsurance Corp.
85311   GE Frankona Rueckversicherungs-AG
03046   Gerling Global Reinsurance Corporation of America
        Last rating before NR was B- (Dec. 20, 2002)
85476   Gerling-Konzern Globale Rueck-AG
        Last rating before NR was B (Feb. 13, 2003)
86314   LaSalle Re Ltd.
        Last rating before NR was C u (Feb. 3, 2003)
85202   Lloyd's of London
60237   London Life Reinsurance Co.
86934   Overseas Partners Re Ltd.
        Last rating before NR was B++ (May 31, 2002)
84028   QBE Reinsurance (Europe) Ltd.
85598   Scandinavian Reinsurance Co. Ltd.
85027   Scor
86396   Sirius International Insurance Corp.
86506   Stockton Reinsurance Ltd.
87157   Top Layer Reinsurance Ltd
03747   Trenwick America Reinsurance Corp.
        Last rating before NR was C u (Feb. 3, 2003)

        Country of      Rating at      Current
AMB#    Domicile        Jan. 1, 2001   Rating

00149   United States   A++            A+
86698   Bermuda         A-             NR-4
86938   Bahrain         A-             NR-4
85219   France          A+             A
85249   England         A              NR-3
86514   Bermuda         A+             B++ u
85804   Denmark         A              NR-4
03771   United States   A              A-
00347   United States   A++            A
85311   Germany         A++            A
03046   United States   A              NR-3
85476   Germany         A              NR-3
86314   Bermuda         A              NR-3
85202   England         A              A-
60237   United States   A+             A
86934   Bermuda         A              NR-5
84028   Ireland         A              A-
85598   Bermuda         A+             B
85027   France          A+             A-
86396   Sweden          A+             A
86506   Bermuda         A- u           B++
87157   Bermuda         A++            A+
03747   United States   A              NR-4

Source: Rating Division. A.M. Best Co.

Life Reinsurers Face New Realities

While the impact of the Sept. 11, 2001, terrorist disaster was financially bearable for life reinsurers, it shook the life industry out of a long-held belief that it didn't have to be concerned with the impact of a catastrophic event. That and the financial impact of stock markets, interest rates and competition have reshaped life reinsurance to some extent.

"Sept. 11 was a watershed event for the property/casualty industry" said Jim Senn, president of ING Group's ING Re individual life reinsurance operations in the United States. "For the life industry, for as horrific event as that was, it resulted in less than 3,000 lives lost. In the U.S., that created about a 0.3% increase in the accidental death rate in 2001. It was not huge for the life Industry, as for the property/casualty industry."

Sept. 11 had much more of an impact on the group life business than on individual life, especially in the corporate-owned life insurance segment, he said.

Mike Emerson, president of ING Re's group life, accident and health operation ha the United States, said Sept. 11 "cast a different light" on risk ill the group life segment. ING Re discontinued a number of products in the wake of that catastrophe, some related to catastrophes or in areas where the concentration of risk was simply unknown.

Since Sept. 11, life reinsurers have been focusing on something they hadn't been ms concerned with before--concentration of risk. "That is something new, from the standpoint of life and health markets" said Emerson. "We now have both internal and external modeling efforts to study risk concentration. The modelers are just getting started in understanding concentration of risk."

Swiss Re Group, the world's largest life reinsurer, said in a recent issue of its Reinsurance Reporter that all group and individual work-site products now represent concentrations of risk. "Now, having experienced the most severe example of what concentration can mean in terms of mortality, the industry must decide how to reconfigure risk management," Swiss Re said.

Sept. 11 "put a magnifying glass" on the group life segment, said Swiss Re. Every player in the market is watching the competition to see how the market will shake out. "No one wants to be the first to impose hard rules and requirements at the risk of losing both direct and reinsured business," Swiss Re said.

At the same time, capacity is tightening in the life reinsurance industry overall. "There has been increased concentration in the life reinsurance industry because of acquisitions," Senn said. "When consolidation happens it tends to decrease capacity. Also, the performance of both global and U.S. equity markets has affected asset values for both reinsurers and primary insurers, meaning there's Jess capital available."

According to an A.M. Best Co. review of the reinsurance markets in September 2002, the life reinsurance segment will be pressured to sustain earnings and economies of scale as strong, top-line growth in the United States slows. Life reinsurers are expanding into Asia and Latin America, but challenges in the critical U.S. and European markets will become more pronounced.

"The fundamental shift to longer life expectancies and concerns over the adequacy of government pension schemes present significant longevity risks for annuity and pension-fund companies in Europe," said A.M. Best. "In addition, the lack of data to manage morbidity risks, such as critical illness and various health risks, is a challenge."

Over the past 10 years, the cost of life reinsurance had been declining steadily, said Senn. On top of that, interest rates arc down and costs are up for the letters of credit that typically secure reserve credit for term business reinsured offshore. "Reinsurers have to reflect those factors in what they're quoting, which means upward price pressure for clients," he said.

"And life reinsurers are putting those factors in their pricing. Whether the pricing is actually appearing in the market yet is an interesting question," said Senn. "I think the jury's still out, but prices have at least plateaued."

One interesting point about letter-of-credit costs is that, because of regulatory changes in the United States a few years ago, most of the term insurance written in the United States that is reinsured has moved offshore, said Senn. Because of the overall economic environment and capital issues, the related letter-of-credit costs are rising.

"Another thing that will happen is the letter-of-credit needs to support moving this term business offshore are going to increase dramatically, because of what I refer to as the 'camel-hump' reserve pattern for the term business," said Senn. "The level of reserves starts out fairly low, then increases. For a 20-year term policy, the reserve reaches its high point around the eighth to 10th year. The needs are going to keep increasing, so demand is going up, which will tend to drive up the credit price."

Aside from cost considerations, life reinsurers are looking closely at the business they're writing, as well as the business they already have on their hooks, and whether that still is meeting their profitability requirements.

"These trends are being watched closely by ING Re," said Senn. "As part of a major international financial-services company, we have a lot of capacity, but we need to make sure we still have adequate capacity and resources to serve clients going into the future."

Emerson added that ING Re, like other life reinsurers, has to balance capacity with sustainable income. "It's simply not sustainable for us to be a low-cost provider," he said. "So we have to be sure to bundle value with our offerings, such ms our research capabilities and expertise."

Life reinsurers don't get the kind of boost from hardening prices that property/casualty companies do, which keeps capacity from growing. There are also more barriers to entry, because the nature of the life business means there's more administrative work to be done, said Senn. "Starting from scratch, you don't have that long-term information that the established players have," he said.

The impact of the stock market on life reinsurers isn't direct, said Senn. "Most reinsurers in the United States have a conservative, fixed: income portfolio, as opposed to equities" he said. "The large global reinsurers in Europe have had a lot of losses, because they've had a lot of equities in their portfolios. That reduces capital and surplus, so the organization has to look at how to allocate a scarcer commodity."

But that stock-market shyness doesn't help if interest rates are too low, as they appear to be right now. "If we're using fixed-income securities to back the business we write, we're not earning as much," said Senn. "If we have to pay out a certain amount to our clients in the future, but we're not earning as much, we might not be able to offer the same rates to our clients. Unless there's some offsetting factor somewhere else, falling interest rates mean we have to raise our prices."

Those challenges to life reinsurers have triggered the flight-to-quality phenomenon for the life industry, as for the property/casualty industry. "As Mark Twain once said, it's not the return on my money I'm concerned about, it's the return of my money," said Senn. "In the life reinsurance business there are organizations that are for sale, and one Bermuda life reinsurer sort of imploded. It's always been a concern for people that the life reinsurers they do business with are going to be around for a while. That's really coming home to roost now, because cedants have now had experiences where, suddenly, they've got a block of business with a company that suddenly doesn't look so stable.

"As they move to place their business with a new reinsurer, decision-makers are thinking, 'I don't want to be in a position where I have to answer questions on this decision somewhere down the road,'" he added.

Customers are feeling price pressure from all of that, said Senn. "There's reduced capacity. At the same time, there are other factors pushing them to quality. It's a challenging environment," he said. "They need to deal with this, and at the same time, still be able to present competitive service to their clients, the individual insurance consumer."

Reinsurance Regulatory Road Map Is Under Review

Since Sept. 11, 2001, growing concern about the financial strength of the reinsurance industry as a whole has led to increased talk about transparency and regulatory adequacy as they relate to reinsurers.

The European Union and the Organization for Economic Cooperation and Development both have been examining how to more efficiently regulate--or at least monitor--the global reinsurance industry. While the EU has been studying the merits of a regulatory regime for reinsurers for several years, the OECD--a group of 30 nations with the world's most advanced economies--is moving toward agreement on exchanges of information that the organization hopes will make the global reinsurance markets at least more transparent. Such information exchanges "will act as an early warning system for governmental authorities," the OECD said in a recent paper.

Since the shock of the Sept. 11 terrorist catastrophe and the massive losses it generated for global reinsurers, the OECD has become more concerned that greater risk exposure is being concentrated in fewer reinsurers. "It is difficult to assess exactly how the collapse of a major reinsurer might spread throughout financial markets, given the lack of transparency regarding risk factors among reinsurers and the limited knowledge of the extent of retrocession and retransfers of risk from primary insurers," said an OECD paper on global financial markets.

Groups such as the International Underwriting Association and the International Association of Insurance Supervisors are seeking ways to bring more uniformity to the global reinsurance market, a task made more urgent by a parallel move to adopt a single set of international accounting standards--which European companies will have to adopt by the end of 2005. The task also is made more complex by differing regulatory approaches among major markets.

For example, U.S. regulators operating through the National Association of Insurance Commissioners have been unyielding this year about a proposal from the IUA and the Comite Europeen des Assurances to create an approved list of foreign reinsurers operating in the United States. Such companies would be able to claim they have sufficient regulatory adequacy to allow them to avoid maintaining U.S.-based trust funds at 100% of their U.S. liabilities--currently a requirement for "alien" reinsurers.

At the NAIC's Summer National Meeting in June, an insolvency task force recommended that the NAIC reject that plea to reduce collateral requirements, citing concerns that failing to collect from the reinsurers would stress guaranty funds and penalize creditors and policyholders.

For Howard Davies, outgoing chairman of the United Kingdom's Financial Services Authority, reinsurance represents one of the more obvious gaps in the international financial-services regulatory structure. In a speech in Singapore this year, Davies noted that in some countries, such as the United Kingdom, reinsurers are regulated directly, while in others they are regulated indirectly through primary insurers, and in some countries they aren't regulated at all. While the global market has lived with that "uneven" approach for a number of years, he said, there are signs that business as usual might not be adequate.

"There is evidence to suggest that reinsurers have been taking on more credit risk than before, often transferred out of the banking system through derivatives such as credit default swaps" said Davies. "So, we cannot now gain a full picture of how financial risk is being transferred around the global system, without a clear view of the balance sheets, and the risk management of large reinsurance firms." Davies said that "progress is being made" by the IAIS on reinsurance supervision. The European Union also is considering a directive on reinsurance. "But we are not there yet," he said.

As primary insurers, and even their corporate customers, make ever-louder noises about their concerns with the staying power of the reinsurers that back them, transparency is a matter of hot debate. Reinsurers have become more transparent in the past year or so, said R. Michael Cass, president of RM Cass Associates in Chicago and a member of the CPCU Society--an ethics and education forum for insurance professionals. "But since I've been involved in the industry for 30 years, I have to say that it can be fleeting."

When insurance markets turn soft and reinsurers, as well as their ceding companies, start chasing premium dollars with more intensity, "fewer questions might be asked" than in a seller's market, he said. "Due diligence might not be as important as in a hard market."

Cass said that if the EU can devise a uniform regulatory approach to reinsurance, it can give reinsurers operating there a competitive advantage by making the market more transparent and hence more reliable. It could also force U.S. regulators to change theft own approach to keep in step with the Europeans.

There is also movement on the tax front regarding the treatment of cross-border reinsurance transactions. For instance, the United States and the United Kingdom in March concluded a tax treaty that essentially updates a 1980 treaty on the rules by which British insurers and reinsurers can claim exemption from the U.S. federal excise tax on insurance. The new treaty, which takes effect Jan. 1,2004, will tighten the rules for such exemptions, making it harder for U.K. companies to use a "conduit arrangement" to pass the benefits of tax exemptions to parties that might not otherwise qualify, said John P Dearie Jr., a partner with the New York law firm Edwards & Angell LLP.

Dearie said the most likely impact of the new treaty on reinsurance markets would fall on business done between U.K. reinsurers and companies in Bermuda and Barbados insuring U.S. risks. Under the new treaty, some of the business U.K. companies do with companies in those jurisdictions would be subject to federal excise tax. "The treaty levels the playing field somewhat in that it removes some of the tax advantages U.K. companies had," said Dearie.

James Vickers, managing director of broker Willis Group Holding Ltd.'s Willis Re division, said there has been an evolution in regulation over the past 10 years. "Back then, the average insurance regulator wasn't the same as a banking regulator every market that bought insurance was quite different than ordinary financial services or banking" he said. "They've now come to realize that, with convergence between the insurance and banking communities, there isn't as much difference. Particularly in the 1990s, some reinsurers and one or two primary insurers got into writing credit derivatives and credit swaps, which are really a batik's business.

"Inevitably, a few people got badly burned by that, and have or are in the process of pulling out" he said. "So there was some 'contamination' from the banking industry into insurance and reinsurance. That was quite a rude awakening for the regulators. In the United Kingdom, we're all going to be regulated by the FSA, under one hat."

In the United Kingdom, the FSA has issued some consultation papers and taken recommendations, and it's tightening up its rules regarding insurance and reinsurance. The same thing has been happening in Australia, said Vickers. "The problem is that not everyone is tightening up at the same rate," he said. "With reinsurance being such an international business, regulators are concerned about regulatory arbitrage. If you have certain rules in the U.K. or the U.S. you can insure someone in a certain way, but in another area, they may be regulated differently."

The life industry, particularly in the United Kingdom, is having a tough time, he said. "The FSA is looking very closely at life reinsurance deals to see exactly what's done. They are not happy that these things are essentially out of their jurisdiction," he said.

From an international standpoint, American regulation is very complicated, and for reinsurers, from a bureaucratic point of view, managing each state can be a headache. "However, American regulation is well documented, so if you can read the manual, you can understand it," said Vickers. "In a lot of other countries, regulation is still open to interpretation by the individual regulators."

Regulatory complications aside, the reinsurance industry is advancing ha terms of security and reliability, said Vickers. "I think that the scales have been dropping from people's eyes a bit," he said. "Regulation of the industry is getting better. The offshore nature of the business is a problem for regulators, but for large players, especially, it is better. There aren't the scandals around, like there were 15 years ago."