CATEX Reports

In our trip to London earlier this month we noticed a few things. Even though we're there every six weeks or so, each time we arrive in The City the landscape is different. Work is proceeding full speed on the new WR Berkley building across from Lloyd's and several of our clients have already moved into the new "Walkie Talkie".

Walkie Talkie WR Berkley Bldg

Our old office on Fenchurch Avenue is being demolished to make way for the new complex being built by Generali and it seems as if Aon (the Cheesegrater) has solved the problem of keeping the trees flourishing in its outdoor atrium.

Aon Cheesegrater Leadenhall Ave Generali bldg

Our new office is on the 4th floor of Lloyd's so we noticed that there is even construction of some type going on in the ground level passage from the Leadenhall Street entrance of Lloyd's to the One Under Lime restaurant.

Amidst the background noise of jackhammers and construction equipment, normally associated with business confidence and optimism, we were hearing a slightly different story in meetings as you will read below.

There seems to be a high degree of introspection going on at 1 Lime Street and in the London market in general. This was confirmed in remarks made during our trip by both Lloyd's Tom Bolt, Catlin's Paul Jardine and Aon's Steve McGill about how the London market could be at a "tipping point".

Add to this William Berkley's challenge about the "moral commitment" of some reinsurers, and S&P's observation that some reinsurers believe only a massively sized catastrophic claim event can straighten the industry out, and one would think there is big trouble afoot.

How could that be, we thought when we looked at all the new buildings springing up? We might have a clue in Stephen Catlin's remarks in which he said that all these fears are "unfounded".

The purpose of our trip was to meet with clients and prospects about our product suite. We made great progress implementing several pilot programs for our Data Vera product. There will be more on that as well as our most recent client Mexbrit, a combination broker/MGA deployment of our Pivot Point Transaction System in over four countries in three languages.

Roger Crombie is here too. We met him for dinner during the trip and we can report he is in fine form. He has begun to notice "drones" --whether he is actually spotting them down on the English coast or reading about them we can't say --but he has begun to think about the insurance implications of them!

As always any comments or questions would be appreciated --either about CATEX Reports or any of our products.

Sincerely,

CATEX

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Changes ahead in London?

When we talk about the London market let's parse the definition a bit. There are a number of people and companies who have moved out of the Lloyd's market because of cost and regulation and set up shop across the street from 1 Lime Street. When we use the term London market broadly it usually is construed to include those expats and the Lloyd's market.

That's why we were surprised to see a few comments lately. It's no secret that the Lloyd's market (the 94 syndicates) are about as close to the definition of a "traditional reinsurer" as you can get when arguing the merits of "new ILS carriers" vs "traditional reinsurers".

Lloyd's itself has shown its flexibility by allowing Nephila Capital, Securis and Credit Suisse to back Lloyd's regulated underwriting vehicles with ILS capital. As we've observed before in this space Lloyd's is nothing if not practical and will follow the money.

Validus Re, XL, Munich Re and Hannover Re all said or did things in the past month that showed they are practical too and have no compunction about using ILS funds when it makes sense to use lower cost capital to underwrite less profitable business.

So far so good one would think? One can almost see the goal of a warm cozy resting place in the future with ILS and traditional capital living together melded into one underwriting market to go after these $2 trillion in new premiums everyone is talking about.

Not so fast. We have people inside the glass houses who seem to be throwing stones out of them!

First we saw Tom Bolt lauding the efficiency of the ILS market in comparison to the Lloyd's market. In a talk given during our stay Bolt said the cost base of alternative carriers run by "fund managers is between 1-2 percent of capital managed, compared to the 10-12 percent cost of delivering a unit of cat risk in the traditional (re)insurance industry."

Bolt

Tom Bolt

He went on to say that the London market takes about 30% of the premium just to deliver the product, including brokerage fees, with around "70 points of benefit baked into the product."

He was specifically referring to the CAT reinsurance market where the ILS carriers have jumped in with both feet and seemed to think that the London market is inevitably going to write less CAT business in the future because of the cost advantages the ILS carriers have.

For those who still believe in the "today we're down but tomorrow we're up nuances of the cycle" this observation was bad enough but he went on. He said Lloyd's can no longer rely on wholesale brokers to secure the business Lloyd's needs to maintain its position in the global specialty market.

He said that the days of underwriters sitting in London and waiting for wholesale brokers to bring in the business were "long gone and I don't think they're coming back". He said his biggest fear is that someone else would find a way to bring the kind of low-cost, high-speed model provided by companies like Amazon to the specialty insurance world.

He said you "look at Amazon.com --they're doing same day delivery. And we don't get the policy out and it's just an ephemeral promise to pay and it's evidenced by an electronic thing and you can't get it to somebody the same day. And the cost is somewhat expensive to deliver."

Bolt seems to be talking about a future need for a sea change in the way Lloyd's will need to do business if it wishes to compete. His last word on the subject was "I'm just really worried that someone will come along --Samsung or someone --and figure it out."

Now, in addition to having won not one but two Insurance Personality of the Year awards in 2014 Bolt is also known as "Mr. Doom and Gloom." (Counter-intuitive we know). He's certainly quite personable when you're sharing a meal with him but there are those in London who liken him to the Charlie Brown character Linus who walks around with a black cloud over his head.

He would tell you that the ratings agencies and the PRA require him to be gloomy. He needs to see trouble coming before anyone else does and the trouble he looks for is the kind that could cause very big problems if he is right only part of the time. So he isn't going to change --why should he --as he's been right a lot more than just part of the time.

But....ouch and ouch on a lot of levels. Ouch if you are Xchanging Insurance Services and you are have been charged with modernizing the London market.

Ouch if you are a syndicate thinking that you've come to grips with alternative capital and are considering taking the plunge to use the more cost effective capital to underwrite lesser priced business. That won't be enough in itself --Bolt is saying that the expenses baked into your product are too high and can't compete not only in CAT but in areas well beyond it.

And ouch, maybe most of all, for the brokers. The poor brokers --everyone always looks at them first when it's time to extract costs from the equation. (It's unfortunate when one's remuneration is broken out as a line item on a contract). There is no administrative expense curtain to hide behind.

Catlin COO Paul Jardine picked up on this immediately. He said that brokers calling for the removal of traditional "Londonisms" to make the city easier to access are like turkeys voting for Christmas. Certainly when Tom Bolt was talking about the high expense of London he was talking about removing the so-called "Londonisms". Jardine's point seemed to be that if "the push to remove the Londonisms to make it easier to do business with is taken to its natural extreme, it is undoubtedly turkeys voting for Christmas."

Paul Jardine (Insurance Journal TV)

What are Londonisms you ask? They are legion and not even all known to any one person. We can name a few though. For example the requirement that accessing a Lloyd's market requires a Lloyd's broker to place the business. This is the proverbial "third rail" at Lloyd's and you won't ever find anyone in authority at the Corporation even hinting that maybe looking at expanding this access to include cedents and or non-Lloyd's brokers is a good idea.

Another Londonism we know about is that Lloyd's brokers typically receive a 15% comission on business placed into the market. In the US that comission is 10%.

A Londonism you hear about often is the requirement for all Lloyd's business to be transacted through Xchanging which functions essentially as a utility with a monopoly. (It would be a tough spot for anyone to be in). After all how often do you hear people bragging about how good their gas or electric company is when the only option they have is to start burning the furniture in the hearth?

So, let's look again at what Jardine might have meant. Jardine said that if London were to become like any other insurance market in terms of distributionit would be accessed directly. By definition it is precisely these "Londonisms" that distinguish London from other insurance markets and he likened the brokers calling for the removal of the Londonisms as being the "turkeys voting for Christmas".

Think this through then. We have Tom Bolt telling markets "You need to be ready to get out of your chair, find the business you want, find the broker who has it and convince him to give it to you."

You have a quote from a Latin American risk manager buried in an LMG report saying "I have found it hard to maintain my relationships with the London market, they are overly reliant on me going to them versus others who are more willing to come to me."

The same LMG report identifies the biggest challenge (Bolt's baked in metaphor again) as being London's expense ratio at 9 percentage points higher than its peers in 2013 driven by higher transaction costs and acquisition costs.

Then there is Aon's Steve McGill saying the time when Lloyd's was the "only show in town" for international specialty risks has long gone and the London market operates in a world where the barriers are breaking down. He said that "connectivity to the client" is all important now as much of what formerly went to London is being written locally.

McGill did not say that those "baked in" expenses were a cause of this deterioration --he didn't have to because of what he said next. He warned that "We might think we are winning the battle but in fact we are in danger of losing the war."

Steve McGill

He said "London is not the only viable subscription market in the world" anymore and "Lloyd's/London is not the undisputed leader in innovation anymore."

Maybe in a signal that one of those turkeys, and the biggest one at that, might not be voting for Christmas McGill said there is "no real differentiation in the value proposition in London. In fact, relative to the local markets, it has declined and in some cases substantially --hence the decline in London's market share."

Aon may have 6,000 employees in the UK, and their new corporate headquarters across the street from Lloyd's, but you can bet they are placing business in markets globally when they get the right price. Smaller brokers may not be so lucky.

There is only so much that can be done until substantive changes come into play in London and it's possible that the first one --after addressing the usual suspects of better technology and more automation -- is going to be on those "baked in" expenses. There is one that sort of sticks out...in fact you can almost see the sparks shooting off its third rail.

What's at stake here? More than we can guess we think. We looked at this comment from Catlin's Jardine who said that even more capital might be needed in the reinsurance market to cope with the growing risk demands of clients. More capital? Now?

John Nelson

Yes. Remember the additional $1.4 trillion in new premiums Lloyd's John Nelson talks about? Jardine says that the influx of new capital is needed now to meet the increase of demand in emerging economies such as China mature and begin to seek more protection against CAT risk. He said that the rise of "mega-cities" will also contribute to increased concentrations of exposure that challenge the reinsurance industry.

This is what's at stake. There is an explosion in the numbers of risks and amounts of premium that can be written just around the corner. If London doesn't get ready soon the warnings seem to be saying it will risk being left behind.

One final note on this. If what Evan Greenberg and Ace are being rumored to be planning comes to fruition they will set up an internal hedge fund reinsurance platform that will participate on Ace's outwards reinsurance (reports indicate as much as 20% may be pushed through it).

Evan Greenberg

It is understood that Ace's net underwriting returns would benefit from the disintermediation of its reinsurance business placed into the new internal platform.

Ace cedes about $5 billion in risk with about 50% of that going to the NFIP and the US crop insurance program. So if 20% of the remaining $2.5 billion is to end up in the new facility that is about $500 million in premium or about $50-$75 million in savings to Ace's net underwriting return.

Back to that "baked in" cost again....

Modeling and Underwriting=No price variation?

Chris Donelan

We noticed another trend this month too. We saw comments by Endurance Re's Chris Donelan saying that even seasoned underwriters are relying too much on risk models. He said that because balance sheets aren't stressed because of benign CAT activity it's become easy to sell products at a lower price. Donelan says this has led to complacency in the industry.

John Charman

Remember who Donelan works for --the CEO of Endurance Specialty Holdings anyone? Yes, John Charman's view on the excessive reliance of some underwriters on models is well known. Donelan says "the industry may be too reliant right now on models that didn't exist 15 years ago" and suggests that there is not enough fear in the market thus leading to complacency.

Complacency about what you may ask? He says "the real risk is always the unmodeled, unthought-of risk. The black swan is something out there that you never thought would happen in your wildest dreams, but when it does, it becomes all so obvious."

We know what a "black swan" event is and have even sat through a compelling presentation in Monte Carlo by AM Best which pointed out there really are only two kinds of swans --the so called white ones and the black ones. AM Best's point was that the hybrid grey swan event was really a white swan because it had been thought of (not in the "never in your wildest dreams" category) and thus should be modeled and prepared for.

Keeping in mind AM Best's view then what Donelan is effectively saying is that there is too much reliance on models for white and grey swan event occurrence. He may even be saying that in the current era of benign claim activity there is not enough fear in the industry to motivate them to properly factor in the black swan events.

Costas Miranthis

We will have to buy a goose or swan whistle by the time we conclude but we thought of what Donelan said when we saw this from Partner Re's CEO Costas Miranthis. He said the transparency in the industry has improved dramatically in the last ten years and that "It's far more difficult now to put your face in the sand and not face the truth."

Then he said that with many risks well-modeled and widely understood there was little differentiation between reinsurers on pricing in what he described as a largely syndicated market.

This was a surprising observation in light of the often cited "race to the bottom" on premium pricing that supposedly can occur when underwriting discipline breaks down and the temptation of premium at any cost becomes too much to resist. We hadn't thought of the idea that the models themselves were acting to standardize pricing.

When you think about it you can see Miranthis' point. The reinsurers all have access to the same commercial modelers as do the reinsurance brokers as do many of the ceding companies. Of course the "trade secrets" used by many reinsurers who internally model the results of the modelers are another story. Nevertheless for Miranthis to make the observation was striking.

When you read Miranthis' comments in conjunction with Donelan's remarks some scary scenarios can emerge. If price differential has all but been erased because of underwriter reliance on modeling, and the use of models is leading to a sense of complacency by seasoned underwriters who have become too reliant on them, then that spells potential disaster.

The only point we can note is that many of the new and emerging risks are located in lines of business and geographic areas that even the modelers themselves are playing catch-up with. Maybe the underwriters will be less reliant as they begin to see new risks for the first time.

To be fair sometimes we are accused of being too much "doom and gloom" ourselves. After all, what do we know stuck out here in the former colonies --maybe not too much says Stephen Catlin. Of course we will defer to him for the last word on this and the current state of affairs.

Stephen Catlin

Catlin spoke last week at the S&P PwC Bermuda Reinsurance Conference and said that fears of the impact on traditional reinsurers from the rapid influx of third-party capital had been overplayed. Catlin said "I saw one broker quoted as saying it's the worst market in a generation --he must be four years old."

He said that he had heard "extreme talk" from reinsurance executives of structural change in the industry and that "it would never be the same again." He noted that cyber risk and pandemic were two of the biggest threats he saw for the industry to contend with.

He said that a "terrorist attack on the Internet would mean the entire world could be hit with the same loss at the same time. It may never happen, but we know that there are criminals and terrorists out there trying to cause damage."

Remember that Paul Jardine who works for Mr.Catlin said that even more capital is needed in the industry. Stephen Catlin said that our "challenge is in providing coverage to our clients, provided we can cope with the systemic nature of risk."

We would presume that either an attack that brings down the Internet or a global pandemic are two risks that the industry needs to be well-capitalized for. Both may also be risks that would break underwriters out of "complacency" and "over-reliance on models".

See, he did have the last word.

CATEX has a web-based application, Data Vera, for cleansing, validating, analyzing and exporting data that just became much more powerful. CATEX and CoreLogic EQECAT have executed an agreement that has resulted in the development of a two-way data link from Data Vera to CoreLogic EQECAT.

Nearly anyone can eventually create an export file to feed to a modeler. The problem is that it takes too long, costs too much and data validation concerns still can linger. That's what makes Data Vera so much better --not only does it do all of the export file work but does so more accurately and quickly.

Data Vera can create multiple exports from a single source of data without having to transform, validate and cleanse repeatedly. By implementing enterprise data standards on incoming data, Data Vera can easily export it to any format or standard. Once the data is clean and validated, multiple export files can be created with a click of a button. Compare this to a single, purposed-driven data cleaning exercise.

We wanted to make sure that when data exports are created from Data Vera for CoreLogic EQECAT, that they are 100% in conformance to CoreLogic EQECAT specifications. The two-way interface will allow us to feed CoreLogic EQECAT systems directly.

These interfaces will also ensure accurate information and timely updates with changing models. It allows our clients to keep track of the data exported, the status of the modeling efforts, and store the result sets with the exported data in a single place.

CoreLogic EQECAT is the first member of the CATEX Data Vera ecosystem we are creating. Watch this space for news of new partners

The CATEX Pivot Point Reinsurance Transaction System just went live with Mexbrit Reinsurance Brokers/Forte Underwriting. The press release is here. The interesting part is that, once again, we deployed a reinsurance broker and MGA system on the same platform using the same database.

Of course the systems are different in terms of business functions and processes but the commonality of reporting information available are especially helpful in a deployment made in Miami, Mexico, Brazil, Argentina and Chile.

The Pivot Point System is producing documents in English, Spanish and Portuguese.

From time of contract execution to go live date --a period including enhancement development, data migration and training -- a total of only six months elapsed.

We welcome our Mexbrit/Forte friends on board and promise to visit them again (this winter!) in Miami and Mexico City.

Roger Crombie writing for CATEX Reports takes an off-beat view of the world of insurance

Roger Crombie

Up in the air...a bird...a plane? No..It's a drone....

It looks as if drones might be the next big thing in insurance. No, not your colleagues; mechanical flying objects, which are even now infesting the skies. The drone market is soaring, as it were. Regulation is, at best, nascent and in fact virtually non-existent.

Spain has recently introduced temporary regulations governing drone use. The French are thinking about doing something, following reports of unidentified drones flying over seven of power company EDF's nuclear plants. Three men have been arrested, but exactly what to charge them with is causing some head-scratching.

In the US the focus is on guidance, rather than regulation; the FAA is considering looking into something a little tougher than suggestions.

Last year, UK commercial drone licenses were up by 80 percent, to 359. The BBC, police, universities and film companies are the main license holders, but then individual drone flyers in Britain don't need licenses; in their hands, drones are considered toys.

Since 2010, the Civil Aviation Authority has required would-be commercial drone operators to obtain permission, but there is no record of any application ever having been turned down. The UK licenses dogs, which can bite you to death, and marriages, which end all hope, and that's fair enough. But if you want to send a 50-pound metal object into the sky with whirring propeller blades, go right ahead. Do whatever damage you feel like. If you are prosecuted, send out another drone to accidentally fall on the judge's head. Hey, it's a free country.

Chris Anderson, the editor of Wired, reckons that 500,000 drones have already been sold in the US. Cartman, the unpleasant little fat fellow on the cartoon South Park, has used one. Amazon sells drones for as little as $60. Of a group of free thinkers interviewed on the subject by The Atlantic last month, 31% own at least one drone. A drone trade group in the US believes that the UFOs (unmanned flying objects) could generate 100,000 jobs and $82 billion worth of commerce in the next 10 years.

I'm exaggerating, but only slightly. In April, the UK issued its first punishment related to the recreational use of drones to a man that nearly crashed one into a bridge after allegedly flying it too close to a nuclear facility. The penalty was �3,500 in legal costs and an �800 fine (about $7,000 altogether).

The British regs, such as they are, do not allow drone aircraft to fly over an outdoor crowd of 1,000 or more. So tough cheese if you're in line for the opera with 900 other people and get blown to bits. If a drone breaks down, it would fall 50 to 100 feet to the ground, landing with about the same force as a frozen turkey. Not too bad? Its blades will still be spinning. Suddenly, every trip to the supermarket is a potential Sam Peckinpah movie.

Potential nitwit with drone

All that not scary enough for you? Most drones are home-made. Yes, some nitwit with a screwdriver designed the drone you're paying to have record a bird's-eye view of your wedding. Citizen inventors are creating new technologies. What a warm and comfortable feeling that doesn't evoke.

The future, the Guardian newspaper reported, might be in even larger drones. Flown beyond the line of sight and over longer distances, this sector of the market is expected to be worth in excess of $160 billion in due course.

If you really need an excuse to squeeze yourself under the bed and stay there for the rest of your life, consider this. Jim McAuslan, general secretary of the British Airline Pilots' Association, said recently: "The technology is developing quickly and we could see remote aircraft the same size as a Boeing 737 being operated commercially in our skies within 10 years." Oh joy.

My point, insurers, is that the starter's gun has sounded for this particular race. Once the authorities dig their heads out of the troughs and think about it, drone insurance must surely be made mandatory around the world. Well, that's what any sensible person would hope. It's just about the only way of policing drone use.

So this is your chance to quickly come up with a policy of some sort and make billions. Drone insurance is going to be massive - until we are all driven indoors permanently by the bloody things, and the risk of being hit by one stops altogether.

* * *

Roger Crombie is an American Society of Business Publication Editors national award winner. An English chartered accountant who lives in

lives in Eastbourne, on England's South Coast, he writes and broadcasts news and opinion in the US, UK, Bermuda and the Caribbean, in print and online. His main beat is insurance and financial services, with 30-year sidelines in music and humour. All views expressed in Roger's columns are exclusively his own. Contact Roger at [email protected].

November 23, 2014

Quick "Bytes"

This isn't a surprise but one of the biggest reinsurance buyers in the world, Allstate Insurance Company, said its current reinsurance program is the best coverage it's ever had. The company has used the capital markets and traditional reinsurance to reduce its retention and extend it out for a longer period of time. It's a buyer's market....According to S&P analyst

Taoufik Gharib

Taoufik Gharib some reinsurance execs think the industry needs a major catastrophe to thin out the marketplace and reverse the trend of falling premium prices."Some people are looking for a 'big one'." he said which would expose those with lower underwriting standards who have priced risk too cheaply....Probably Ren Re CEO Kevin O'Donnell would agree when

Kevin O'Donnell

he said in regards to FL wind CAT cover "Much of the capital that has entered the business has been particularly fortunate with its timing" and noted that it's been 9 years since a major hurricane made landfall. O'Donnell said that going 9 years without a major hurricane making landfall is about a 1% probability so "investors investing in Atlantic hurricane risk have enjoyed a one in 100 level of return for the last nine years."....Watford Re, an alternative capital reinsurer sponsored by Arch is said to be looking at Italian medical malpractice coverage to expand its book...Wilmington Trust, founded in 1903 by the DuPonts, has been

viewed as fairly conservative (and successful) in it's investment strategy. Wilmington has just hired an ILS team from Wells Fargo...The Bank of England has sent letters to a number of reinsurers asking what they are doing about climate change and whether they are planning for it. As they are the regulating authority it's certainly a prudent move but you have to wonder if they read the trade press...Partner Re warned that the rapid increase of insurable assets in areas prone to natural catastrophe in Asia mean reinsurers have to learn to manage accumulation risk for both countries and markets...After TS Fay and Hurricane Gonzalo left Bermudians without electricity for a

while people wondered about the cost of burying all those overhead power lines underground. The utility, Belco, said it would take ten years and cost $375 million, or an extra $87 per month per customer for ten years...Finally, and maybe Roger is on to something here with the drones but USAA and

State Farm have both applied to the federal government for approval to test drones to better evaluate property damage after a natural disaster. We think

Kerry and Sol in Homeland

of this now every time we watch an episode of the TV show "Homeland"....