Peering over the precipice: from a valley of near death, reinsurers have clawed their way to another cycle summit. What happens next?

Heading into the second half of a mostly profitable 2004, reinsurers are poised at the summit of a hard-market cycle, many of them having posted strong profit gains amid good pricing and rising investment income, even as premium income has dropped--a sign that underwriting discipline is holding steady. The question on everyone's mind now is, will the discipline hold as competition heats up, or will a false step send the industry down a slippery slope as the cycle turns?

The Jan. 1 renewal season was solid, as most reinsurers reported good pricing levels in most lines, along with continued favorable terms and conditions. April renewals--which include much of the Asia-Pacific reinsurance business--also held firm. First-quarter earnings seemed to confirm the optimism--profits surged, even as premium income dipped, reflecting disciplined underwriting. On top of that, many reinsurers have seen investment income turn upward.

Sean Mooney, chief economist for reinsurance intermediary Guy Carpenter & Co., said reinsurers in general are "on the road to economic recovery," with underwriting profits, recovering investment income and new capital raised by both the new Bermuda insurers and the established European heavyweights. "With the recovery of the stock markets over the past year, and profitable pricing, the industry has been able to rebuild its capital base," he said.

But the optimism is guarded, as reinsurers watch the much-touted return to underwriting discipline, to see if it will hold up in the face of increasing competition and the lure of the investment-income cushion. In certain property lines, pricing is showing signs of softening. Over the past year, many reinsurers have said they like casualty lines--workers' compensation and professional liability, in particular, sparked plenty of interest. It begs the question--if most players are interested in the same lines, will competition erode its attraction?

No, say many executives, such as PartnerRe Group President and Chief Executive Officer Patrick Thiele. The lessons have been learned. Many reinsurers are more selective about the business they accept, even within hot markets, and diversification has become a key component of strategy. For instance, "everyone is interested in U.S. casualty because of the law of supply and demand," he said. "Demand in those areas is up, supply is tight, so prices go up."

Mooney said property pricing has declined gradually in some areas, and the rate of acceleration in certain casualty lines has slowed, but that doesn't necessarily lead to in, paired profitability. "As the market softens, you don't necessarily see profitability slowing. I would still expect profitability to improve through 2005, going into 2006," he said.

Cycles and Moongates

Thiele dismisses much of the talk about underwriting discipline as overdone, noting that basic economics--the ups and downs of supply and demand--points to the inevitability of the notorious property/casualty cycle that others would like to see banished from the Earth. "There seems to be an inordinate amount of attention placed on that angle--where the cycle is, and where it's going," he said. "We're in the business of taking on risk, so it's a process of continually looking at the market and assessing where you are in it."

For Thiele, managing a global reinsurer is similar to an investment portfolio manager's job--you weigh the likelihood of profiting in several different areas, and allocate your resources accordingly. For PartnerRe, that means deciding how much capital should go into property vs. casualty, the United States vs. Europe, nonlife vs. life reinsurance or underwriting vs. investments. Taking all those options into account, Thiele uses as his measure of success a barometer that has been largely de-emphasized by many others in the industry--return on equity.

Our goal over the long term is to maintain a consistent ROE of 12.5% or better," he said. "That's the best indicator that we're allocating our capital most efficiently."

Anthony Stevens, director of the insurance practice at Marsh Inc.'s Mercer Oliver Wyman consultancy, added that one of the critical factors for reinsurers' success now and in the future will be the ability to efficiently allocate capital across their underwriting and investment portfolios, with an eye to keeping the balance sheet as strong as possible. "That is one of two key questions as the market begins to soften--how do you effectively reallocate that capital across the balance sheet," he said.

The other key question for Stevens is how reinsurers can maintain their underwriting discipline in a softening market. Stevens sees reinsurers achieving different levels of success, depending on their business model. The largest, conglomerate-like direct reinsurers--Munich Re, Swiss Re, General Re--will be able to diversify into specialty lines because of their sheer size, but they will at most "hold the line" on their market position. Nimble companies such as the new Bermuda reinsurers will use the broker markets to attack several specialty lines.

Stevens sees the big losers as medium-sized generalists, who can't take advantage of emerging specialty lines and don't have the clout to weather disadvantageous conditions. "The really successful players will combine the best of a direct writer with the ability to be nimble in volatile markets," he said.

That combination of attributes is seen in the older generation of Bermuda reinsurers, such as XL Capital Ltd.'s XL Re. Earlier this year, XL Re's chief of reinsurance operations, Henry C.V. Keeling, said in an investors' conference that cycle management and capital management are two of the company's major objectives. "While we are mad intend to be one of the world's top reinsurers, we do not want to be all things to all people," he said. "We aim to be a market leader within our chosen markets. We need to maintain our position as a market of choice."

PartnerRe, one of the crop of new reinsurers set up in 1993 to fill a property catastrophe crunch following Hurricane Andrew, celebrated its 10th anniversary last year, just as a new class of Bermuda-based reinsurers, formed following the Sept. 11, 2001, terrorist catastrophe, was getting into full swing. The so-called Class of 2001 has taken the concept of diversification to heart--hitting the ground running in a number of lines. This strategy sets them apart from the single-mission focus of companies formed either in the mid-1980s to address a tight liability market, or the catastrophe crew spawned by Andrew.

The Bermuda landscape in which the Class of 2001 has taken root is dotted with moongates--circular stone arches built on hotel grounds, in parks and even in private yards. Local tradition has it that newlyweds can expect good luck if they pass through a moongate.

Can Bermuda's magic extend to reinsurance? For executives leading the new reinsurers, their fate has more to do with a shift in market attitude than luck.

Michael A. Butt, chairman of one of those new companies--Axis Capital Holdings Ltd.--said the 2001 group "has much more variety" in market approaches, styles and expertise. "Our contention is that the Class of 2001 had broader opportunities, so they were more diversified," he said. "Bermuda has diversified significantly in the past lour years--there's a diversity of product, of lines of business and geographic scope."

Axis, as well as some of the other new Bermuda companies, also has taken advantage of its ability to open overseas offices much more quickly than the Bermuda companies that have come before, said Butt. That is due in part to some of the other market forces that have converged on the industry. For example, European insurers and reinsurers stumbled badly in the past three years, caught by investment losses as stock markets slumped and by bad underwriting in the past. That has allowed newer players to compete for European business, he said.

Certain lines of business, such as directors and officers liability and political risk--in particular, sovereign risk--are attractive to Bermuda writers, who "can go for the larger risks, meaning risks in the developed world," said Butt.

Axis, like most of the other new Bermuda companies, is both an insurer and reinsurer--two-thirds of its business is primary insurance--adding another layer of diversity to its portfolio.

Like Thiele, Butt believes the market cycle will not take as sharp a downturn now as in the past, partly because the industry has learned its lessons well. The new Bermuda players, which some have feared might ratchet up the competition on pricing, are managed by industry veterans who have seen the market cycle's force.

Aside from experienced management, Butt sees other recent developments working to make the next cyclical downturn less severe. In particular, the Sarbanes-Oxley Act in the United States will three insurers to more carefully weigh risks and keep a tighter grip on underwriting activities. "We require that every reserving committee signs off on their unit's financials, just as a CEO and CFO have to sign off," he said.

Gone are the days when insurers inadequately reserve for bad underwriting risk. "The question now is, how much discretion [in underwriting] will the CEO allow if the result is prison," said Butt.

Europe: The Shadow Lifts

And what of the Europeans? The reinsurance heavyweights such as Munich Re, Swiss Re and Hannover Re, "along with the Lloyd's market, had all taken big hits to their earnings, beginning in 2001, with losses associated with the terrorist attacks in the United States on Sept. 11 and investment losses as global stock markets turned sour. Much of that bad news continued through 2002 and 2003, as the European reinsurers lost billions on investments and--for the Germany-based companies--tax changes. Except for Lloyd's, all suffered rating downgrades as well.

Also, seemingly to add insult to injury, a surging euro gained about 20% in value against the U.S. dollar since 2002, further deflating the earnings of the Europeans.

But as 2003 came to a close, European earnings showed something remarkable. Despite taking a drubbing from what seemed a financial "perfect storm;' most recorded solid recent earnings (See "Net Income of Major European Reinsurers," left). Profitability returned, even as premium volume came down. The market leaders were practicing what they had been preaching throughout 2003--they had become more discerning in their underwriting choices, holding potential clients and contracts to stringent profitability tests and refusing to chase after dubious business for quick profit.

Hannover Re and Swiss Re showed improvement in their 2003 earnings, and carried the trend through the first quarter of 2004. Munich Re took a loss in 2003, mostly from a punishing tax change in Germany that cost the group 1.8 billion euro. The one exception to all the good news for Europe's big reinsurers was France's Scor, which continued to struggle with legacy issues and costs associated with withdrawal from noncore businesses, including Commercial Risk Partners--a disastrous Bermuda alternative-risk business.

The big European reinsurers are here to stay, everyone in the business agrees. But the trauma of the past three years has shaken things loose.

Michael I.D. Morrison, vice chairman of Allied World Assurance Co. Ltd.--another of those new Bermudians--said one area where Allied World is eager to expand is Europe, the mission of its recently opened office in Dublin, Ireland. With the formation of AWAC Reinsurance Ltd., the company will seek inroads into a European market whose provincial nature was shaken by the recent financial problems of reinsurance giants such as Gerling Global Re and Scot.

"The European reinsurers basically fell apart," said Morrison. "We told the Dublin office to focus on writing business in Europe. In the past, German clients had always worked with German companies, and French with the French. I think they are beginning to look around at the global market now."

The new Dublin company also has a London branch, which focuses on U.K. business, said Morrison.

The big, traditional reinsurers have done some self-destructive things in the past, and still do now, said Morrison. "Look at the top four reinsurers in the world--Munich Re, Swiss Re, General Re and Employers Re--they had a combined return of negative 5% from 2000-2002," he said.

Lloyd's of London has been talking a lot about entering the markets in continental Europe on a larger scale as well, and though Morrison acknowledges the Lloyd's market is a competitor, he is not sure they will do as well as the new Bermudans. "They are doing better, in terms of their management and discipline, but Lloyd's has done some strange things," he said, declining to elaborate.

Jan Stormann, head of reinsurance broker Guy Carpenter & Co.'s middle European operations overseeing Germany, Switzerland and Austria, tends to agree with Morrison's view. The relatively conservative primary market in those countries traditionally preferred getting reinsurance from fellow countrymen. The market had always been local.

While the large reinsurers based in Germany and Switzerland still play a dominant role in the market, more insurers are comfortable with the security offered by outside reinsurers, particularly the bigger Bermuda players such as XL Re, a unit of XL Capital Ltd., he said. One could include PartnerRe as well, whose presence in Europe is so endemic that, as Thiele likes to claim, many European clients think of PartnerRe as European, not Bermudan.

The younger Bermuda reinsurers enjoy the benefit of the doubt from clients in German-speaking countries because of Bermuda's track record of stability, said Stormann. Older Bermuda reinsurers, including XL Re, PartnerRe and Renaissance Re, have already proved their staying power and reliability. "Their capital base is very strong," he said of the new Bermudans. "It is easy to understand the setups, and there's no old liability. Our clients seem much more confident in the security of the Bermuda companies than in Lloyd's security."

Lloyd's syndicates wishing to write reinsurance business in the central European market, particularly Germany, have traditionally had a hard time breaking into the market and still do, said Stormann. The problem for Lloyd's has to do with a "traditional German attitude" toward business and the perceived insecurity concerning Lloyd's stemming from years of bad publicity about reserving issues and what was once seen as the opaque nature of the Lloyd's market.

"Nobody really understands the potential issues related to Lloyd's," said Stormann. "Everyone says 'It's probably a flexible security, but I'd better place only 10% of my program with Lloyd's.'" The tendency of Lloyd's syndicates to adjust their reinsurance underwriting capacity from year to year, along with the disappearance of some syndicates in recent years, also contributes to a German sense of volatility in the market, he said.

Stormann sees opportunity for expanded reinsurance business related to the 10 countries that joined the European Union in May. Eight of those countries lie immediately to the east and northeast of Stormann's territory--Estonia, Latvia, Lithuania, Poland, the Czech Republic, Slovakia, Hungary and Slovenia. Together with Cyprus and Malta, those new EU members add 74.3 million people to the 380 million residents of the 15 previous member states.

"I feel this is a major opportunity," he said. "These countries will develop very quickly. There is a big population involved. Reinsurance premiums will increase quickly over the next few years. They need the support and competency from Western Europe. Eastern Europe is a big market, with real potential."

This Year's Places to Be

What are the hot spots lot reinsurance capital in 2004 and beyond? There has been a perceptible shift in emphasis over the past year. Aviation is out, or at least, a yawner, for reinsurance underwriters. There are profits to be made in property, but overall it is the biggest single line to show signs of softening.

What reinsurers like to talk about this year are casualty lines, both in Europe and the United States, particularly the latter. That's where the pricing appears strongest. Directors and officers coverage and other professional liability lines look good--with the caveat that they can be difficult to predict, in terms of loss exposures.

Linda Johnson, executive vice president of U.S. casualty for Benfield, said reinsurers are attracted to the continued strengthening of pricing in many casualty lines. "One of the factors of that interest is that the strength of primary pricing means loss costs should be reduced," she said. Professional liability and umbrella--including personal lines umbrella--are particularly strong among the many casualty lines, she said.

Umbrella lines, in particular, have seen a more disciplined underwriting approach in the past year or two, said Johnson. Rates are up "meaningfully" in umbrella coverage, she said.

Will the growing interest from reinsurers in U.S. casualty lines mean competition that will soften the market? Maybe, said Johnson. "There is a fair amount of new capital in the marketplace, but by and large, they're not competing on price," she said. "The competition is in authorizing large lines, at the signing rather than the pricing stage."

>From the buyer's perspective, primary insurers "have many strategies" when mitigating the risks in their casualty portfolios, said Johnson. Some prefer working with a set pool of just a few reinsurers over the long term, giving them stability but less negotiating power. Others may use a new pool of reinsurers every year--more bargaining by more volatility as well.

A big question for the industry right now--especially for primary insurers--is the fate of the U.S. Terrorism Risk Insurance Act, a federal backstop that backs insurers in the event of another catastrophic terrorist attack. Set to expire at the end of 2005, TRIA's extension would have an impact on the risk-transfer plans of many U.S. primary insurers, said Paul Karon, Benfield's chief operating officer.

"It's a big issue," he said. "There are signs the market is jumping around" because of the uncertainty over TRIA, he said.

Over the past year, global reinsurers have begun to make their big push into what seems for many the Holy Grail of the insurance world these days--China. As the Beijing government continued to liberalize its rules governing financial services, reinsurers saw their opening and, as life insurers before them, clamored for a place at the table.

Swiss Re gabled a license for reinsurance operations in China last year. Berkshire Hathaway's General Reinsurance Colt). got a reinsurance license earlier this year. Munich Reinsurance Co. received a composite, countrywide reinsurance operating license, making it the first international reinsurer to be granted a license on the mainland. Scor and Lloyd's both filed applications for reinsurance licenses in China as well.

PartnerRe's Thiele said China "certainly will be a growing market" for reinsurers, but he prefers a wait-and-see approach. PartnerRe does do business from offices in Hong Kong and Singapore, but Thiele said establishing an office on the mainland won't make sense until there's a clear profit potential. "It's going to be a competitive, thin-margin market," he said of China.

Guy Carpenter's Mooney said China and India are the company's most promising potential growth areas for the near future.

Paying the Piper

The top concern for reinsurance buyers this year, a trend carried over from 2003, is security. Will their reinsurers be there to pay in the future? This is a crucial question--particularly in casualty lines, which tend to be long-tail in terms of loss costs. "The primary insurers are especially concerned about how the cash goes through and who's handling it," said Johnson. "And if the reinsurer is downgraded, can they still come through with a letter of credit."

After a spate of reinsurer rating downgrades throughout 2003, primary insurers are interested in collateralizing and securitizing their reinsurance recoverables. And more so than in January, renewal rounds in June, July and October likely will see more interest by primary insurers in the cash impact they will feel from reinsurance terms, including deductible levels and funds withheld, said Johnson.

Given that legacy issues such as asbestos and liability haunted most of the veteran reinsurers through reserve strengthening last year, the claim by Bermuda's new reinsurers that they have no legacy issues does carry some weight in the U.S. casualty market, said Johnson. But only so far. "That is very attractive," she said. "And many of those new reinsurers have a high-quality staff."

But there is concern among clients over where the new companies will be three to five years from now. "Many of the new catastrophe reinsurers formed in the early 1990s disappeared fairly quickly," she said. "There's lingering doubt about where the new reinsurers will be in five years."

Property rates are coming down, and some casualty lines are "topping oft," said Karon. "There's probably too much capital out there right now," he said. "They're trying to figure out what to do with it."

>From the reinsurance buyer's perspective, this should be good news, but the issue of reinsurers' ability and/or willingness to pay claims in a timely manner is a growing concern, particularly among reinsurers that have fallen several notches in ratings. "The 'down' reinsurers are paying slowly, and that's frustrating," said Karon. "We at our company are spending a lot of time on that issue, more time than I might have anticipated, calling reinsurers and pressuring them to pay the bills."

Karon said he "can't quantify" the growth of reinsurance recoverables, but he is sure the problem has intensified over the past year.

"Security is a big issue, and it's becoming more so every year," he said. "Companies are starting to monitor the strength of their reinsurance--how much is double A-plus, how much is A-plus or A. They might not do anything about it, but they are watching it more carefully."

Mike McClane, a member of Benfield's financial consulting team, said reinsurance recoverables for the primary property/casualty industry are increasing both in absolute terms and as a percentage of policyholder surplus. Recoverables topped an estimated $200 billion by 2001, he said.

Concerns over reinsurers' ability to pay have increased over the past few years, as some reinsurers failed and many others suffered rating downgrades. That problem is tied to financial strength, and is fairly predictable. What is perhaps more unusual, is that over the past two or three years the willingness of reinsurers to pay their claims has become a greater source of friction between the reinsurers and cedants, said McClane.

"The number of disputes is up," he said. "A lot more reinsurers are reserving their rights and withholding payment."

"Some reinsurers, particularly those in runoff, appear to be actively managing their claim payments," said McClane. "Add to that an increase in the amount of documentation reinsurers demand, and payment turnaround time has probably doubled over the past three years."

Primary insurers are countering the payment problem in several ways, beginning with aggressive follow-up of their recoverables. "To combat increased documentation requirements, cedants should meet with their reinsurers and agree on some reasonable standards," said McClane. Some primary companies are threatening arbitration as a way to ensure the reinsurers give their claims some attention, he said.

"We are seeing more primary companies incorporate payment terms into the reinsurance contract, allowing the cedant to collect interest if a ceded balance is not paid in a timely manner," said McClane. "Also, primary insurers can minimize reinsurance recoverables by employing a 'funds withheld' contract that allows the ceding company to hold the balance of funds intended to pay for ceded losses."

"Prudent selection of the reinsurance partner is also recommended," he said. Benfield tracks claims turnaround time among reinsurers as one way of helping clients sort out the pros and cons of each reinsurer as a partner, he said.

Another strategy that has become more common is the broadening of cancellation terms in the reinsurance contract. These "special termination" clauses now allow a cedant to break a contract if a trigger is set oft, such as the rating downgrade of a reinsurer, said McClane.

Insurers are increasingly hedging their reinsurance recoverables exposure with credit derivatives and related financing methods. "They can hedge their risk against recoverables by securitizing them with the credit of a very large, highly rated global bank, said McClane. Benfield's capital markets group is seeing increasing activity in that sphere.

For reinsurers, negative perception alone can be lethal--if a reinsurer seems unwilling or unable to pay, much business can be lost. Stormann's observation about Lloyd's and how it is shadowed by its legacy issues proves the point. Speaking of Lloyd's, Karon said they "have done a great job" of shoring up their reinsurance operations over the past three years, and are probably as strong as ever in the reinsurance market.

Strength in Diversity

So what do reinsurers need to succeed? A good mix of specialty lines, combined with carefully selected positions in traditional markets--even softening ones such as property--and a solid investment strategy are the basics. Add a layer of geographic distribution--Bermuda reinsurers, Lloyd's and U.S.-based companies are all finding ways to expand in Europe.

China beckons. Most of the world's largest reinsurers are there already, or will be soon. But the consensus on China is that patience is a virtue--serious profit likely will not materialize for a number of years.

Another source of diversification, and one of growing interest to most reinsurers, is life reinsurance. Many see it as a good counterbalance to the legendary volatility of property/casualty markets. Most reinsurers allocate between a 10th and one-third of their underwriting portfolios to life reinsurance, which functions similar to bonds in an investment portfolio--with less volatile, more dependable, though lower, returns than stocks.

Life reinsurance also is less prone to cataclysmic shocks, though 9/11 and the threat of natural catastrophes, such as disease epidemics, has tempered that optimistic view somewhat (See "Life Reinsurers Adopt Catastrophe Modeling." page 32).

"It's a much more stable market," said PartnerRe's Thiele about life reinsurance. Thiele likes European life reinsurance business in particular, where the investment woes of primary life companies have broadened demand for reinsurance. PartnerRe, which has about 10% of its underwriting on the life side, left the U.S. market, where just a handful of reinsurers dominate the life business, to focus on Europe.

The increasing value seen in life business among reinsurers is most noticeable at the world's second-largest reinsurer--Swiss Re. About 33% of Swiss Re's current business is life/health insurance and reinsurance, up from 15% in 1994. Current CEO John Coomber, who replaced Walter Kielholz late in 2002, crone from Swiss Re's life/health business, where he directed Swiss Re's growth into the world's largest life reinsurer. Coomber presided over the 2001 acquisition of Lincoln Re. That $2 billion acquisition boosted Swiss Re's U.S. life/health reinsurance market share to 29% from 18%.

In addition to life reinsurance, Swiss Re has a unit called Admin Re, which speciallizes in acquiring and administering closed blocks of life and health insurance business.

Munich Re, the world's largest reinsurer, has bumped up the portfolio share of its life/health premiums to 32% of total reinsurance premiums in the first quarter of 2004, from 25% a year earlier. In its primary insurance segment, life insurance is the largest line, with 37% of the premium total.

Risk securitization is another pet project of Swiss Re's and an area of interest to Guy Carpenter, both of which have participated in the development of several catastrophe bonds to cover specific risks. Mooney said securitization is still a small market, though showing "strong growth from a low base."

As a means to package risks in a vehicle that can be sold to investors, securitization is something of a complement to traditional reinsurance, rather than a replacement, said Mooney. It works best on specific risks--typhoon or earthquake hitting a certain area in a certain time frame, for instance. "A small company in Florida, for example, might want to securitize a hurricane risk in a year when their bottom line looks especially strong," he said. "They will say, 'we've got a good thing going. Let's not blow it on the risk from a single storm.'"

Perhaps the market's motto should be--many risks, many solutions.

Net Income of Major
European Reinsurers

               1Q 2004    1Q 2003    Year 2003    Year 2002

Munich Re         534M      -557M        -434M         1.1B
Swiss Re            NA         NA         1.7B         -91M
Hannover Re      96.9M      71.2M       354.8M       267.2M
Converium        65.7M      25.5M       185.1M       106.8M
Scor               32M        31M        -314M        -455M

Note: Munich Re, Hannover Re and Scor are euros, Swiss Re
in Swiss francs, Converium is US$.

Source: Companies' earnings statements

Key Points

* Nimble companies such as the new Bermuda reinsurers will use the broker markets to attack several specialty lines.

* Pricing seems to be strongest in casualty lines, both in Europe and the United States.

* China interests reinsurers, but serious profit likely will not materialize for a number of years.

Learn More

PartnerRe Group

A.M. Best Company # 86411

Distribution: 35% direct and 65% reinsurance brokers

XL Re Ltd.

A.M. Best Company # 86106

Distribution: Reinsurance brokers

Axis Capital Holdings Ltd.

A.M. Best Company # 12557 (Axis Reinsurance Co.)

Distribution: Reinsurance brokers

Allied World Assurance Company Ltd.

A.M. Best Company # 84808

Distribution: Reinsurance brokers

Munich Re Group

A.M. Best Company # 86577 (Muenchener Ruecksversicherungs)

Distribution: Direct and reinsurance brokers

Swiss Re Group

A.M. Best Company # 85010

Distribution: Direct and reinsurance brokers

Hannover Ruecksversicherungs AG

A.M. Best Company # 85070

Distribution: Direct and reinsurance brokers

For ratings and other financial strength information about these companies, visit www.ambest.com

Life Reinsurers Adopt Catastrophe Modeling

Many of the larger reinsurers have been building up their life reinsurance portfolios as a hedge against the more volatile earnings cycles of property/casualty business. While life reinsurance is seen as a more stable, reliable earnings vehicle, pure life reinsurers had been dwindling in numbers over the years, due to the scale required to succeed.

Like primary life insurance, life reinsurance relies on traditional mortality tables and historical loss data. New modeling tools, however, have made the scene since the Sept. 11, 2001, terrorist catastrophe, which drove home the point that life reinsurance, too, can suffer sudden, massive losses from a single event. This new risk horizon led modeling consultancy Risk Management Solutions to do a study on the possible impact of major events, both natural and man-made, on life and health insurance and reinsurance markets.

The study, "Catastrophe, Injury and Insurance," was released in May and sponsored by companies including ING Re, Ace Tempest Re, Endurance Specialty, Swiss Re, Guy Carpenter & Co. and Willis Group.

The study's finding included the following:

* A 7.1 Richter-scale earthquake in Los Angeles on a weekday would result in 4,500 fatalities and more than 100,000 casualties, causing projected claims for life, accidental death, workers' compensation and health insurance of about $10 billion;

* Three simultaneous terrorist truck bombs in downtown Chicago would cause 5,300 deaths and 87,600 casualties and result in $427 million in life insurance claims, and up to $4 billion in workers' comp claims;

* Anthrax released in Chicago could cause 106,700 deaths, 942,000 casualties and more than $10 billion in workers' comp claims, in addition to millions for life and health claims;

* A severe influenza pandemic could cause more than 200,000 deaths, t0 million casualties, and $2.6 billion in group life claims, plus $6.4 billion in individual life claims and $30.5 billion in health claims.

Eric Rasmussen, vice president of risk management with ING Re, said RMS used existing data to study risks to life and health lines with an eye on concentrations of population. "After Sept. 11, the markets began to look at concentrations of risk," said Rasmussen. "The industry had always used the crutch that risk concentrations were hard to model because people move around. But the reality is that many companies' workforces are concentrated in certain areas."

RMS went through a number of scenarios, including terrorist attacks; industrial accidents; train derailments involving chlorine gas; earthquake and influenza epidemics; and their possible impact on life and health insurance. "It's a tool the life and health industry can use to model their risks, on the heels of what the property/casualty sector had been doing since Hurricane Andrew (in 1992)," said Rasmussen.

There had been some work on life/health risk modeling before Sept. 11, but not much, said Rasmussen. The terrorist attack was a wake-up call, prompting life/health underwriters to push harder for catastrophe models.

Other recent events, such as last year's bird flu scare in China, and the appearance of severe acute respiratory syndrome in the Asia-Pacific region the year before, added to the sense of urgency among life and health insurers for better exposure data. More than 8,000 cases of SARS had been identified by the World Health Organization as of year-end 2003, with 774 known deaths. The significance of SARS was its rapid global spread--from its supposed origin in China to the rest of the Pacific Rim, and on to North America and Europe, within several months. For health researchers, SARS brought back memories of the flu pandemic of 1918, which is thought to have killed some 20 million people worldwide.

"With the bird flu incident and SARS, and pockets of that in the U.S., industry experts we talked to think there's a perfect storm brewing--that we could be lining up for a significant outbreak," said Rasmussen. "As an industry we've gotten so focused on terrorism that we have to take a step back and say there are other events that affect us as well."

As a life reinsurer, ING Re can take the findings of the RMS report and use them to educate insurers about their risk exposures. ING Re can begin to take stock of its own loss exposures and create estimates of possible losses based on the scenarios outlined in models such as that of RMS, said Rasmussen. "Based on the data we have, we can determine whether our expected losses are within the tolerance levels we have," he said.

Primary life insurers can use such data to assess their need for reinsurance--whether they need catastrophe coverage or per-person excess, and whether they need to start looking at their exposures from a geographic perspective.

"As reinsurers, we have to look at whether we need to address our risk concentrations by diversifying our portfolio more, whether we need to consider retrocessional coverage, or apply occurrence limits," said Rasmussen. "These tools are all available, but this information adds specificity to those decisions."

Since Sept. 11, ING Re's clients have changed their own approach to doing business. They have begun to include specific information in their submissions, down to the number of employees at a client's locations, and where each employee might be at a given time, said Rasmussen. "It used to be that sometimes we'd see little more than an address for a covered client's location," he said. "But the insurers are now much more interested in providing that data, helping us to track specific concentrations of risk."

Companies that write individual life contracts, for example, had previously seen their risk concentrations as not being severe, when in fact they are. One life insurer writing individual policies in New York believed it had little exposure to an event in downtown Manhattan, since many of its policyholders lived in suburbs around the city, from Westchester to Long Island, said Rasmussen. But once the insurer gathered the data, it discovered many of those people worked in downtown Manhattan.

"They had the concentration of risk, and they didn't realize it," he said.

Risk concentrations so far are having only a minor impact on pricing for life insurance and reinsurance, which may change over time, said Rasmussen. At this stage, modeling and data-gathering are gaining momentum, as underwriters learn how to better identify their risks.