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Sometimes preparing this newsletter is like watching a high-powered tennis match. The ball keeps whipping back and forth between the players and an observer would see the whole viewing audience turning their heads side to side over and over again.
We noted at the conclusion of last month's CATEX Reports that Endurance Specialty Insurance had come to an agreement to acquire Montpelier Re. That news was surprising enough as we will discuss below but then the news came that the Agnelli family's investment vehicle, Exor, had made an unsolicited all-cash offer for PartnerRe --threatening to wreck the proposed Axis Capital-Partner Re merger.
The Agnelli bid is very interesting, as were the comments of Exor's leader John Elkann. Elkann does not want to break PartnerRe up; believes in its management; will keep its $15.9 billion investment portfolio allocated the way it is; and plan its future success around a strong underwriting strategy.
Ten years ago no one would have raised an eyebrow in response to the proposed Agnelli strategy but today the concept of maintaining such a huge portfolio in secure cash and bonds and relying on underwriting success is definitely sailing against the wind of prevailing strategy.
More gloom from brokers has arrived, too, as reinsurance rates on April 1 business seem to have continued to decrease. The decreases are corroborated by statements from Lloyd's syndicates, some even going so far as saying that certain underwriters have lost their "integrity" and are insuring business they shouldn't be at rates that should be rejected.
Meanwhile one of the savviest people in reinsurance and insurance, Brian Duperreault, has quietly managed to put together a global insurance and reinsurance operation at Hamilton Insurance and this month officially saw his acquisition of the Lloyd's Sportscover Syndicate finalized. A major new player has popped up with US, Lloyd's and Bermuda operations in full swing.
We noticed an amazing article in the London newspaper, The Telegraph, about Excel spreadsheets of all things. We at CATEX have long known about the perils caused to the risk bearing industry by spreadsheets but we think we've been severely under-estimating the problem based on this article.
We have our usual Roger Crombie column too of course. We are inclined to think that this month's column examining "the truth" may be one of his best. If he is right we hope the little caveat asterisk that will be required to accompany financial statements, official reports and history books be named the "Crombie asterisk".
As always any comments or questions would be appreciated --either about CATEX Reports or any of our products.
Stephanie A. Fucetola
Senior Vice President/CATEX
Spreadsheet errors could lead to UK's next corporate disaster
Many readers of CATEX Reports are not aware that this publication (which is sent to over 14,000 people) is prepared and released by a company that develops web-based software for the reinsurance and insurance industry.
This possible ignorance is intentional. We swim in the same sea as do you and, in fact, our interactions with reinsurers, brokers, MGA's, coverholders, and regulators give us a somewhat unusual and privileged view of the risk landscape. We think it's a view that is of interest to readers and we're grateful that our monthly readership numbers validate that hope.
We are careful not to abuse that trust which is why we generally do not tout our own products until much further down in any issue of CATEX Reports. We are making an exception this month and hopefully you will see why.
If you are a regular reader of CATEX Reports you know we have often discussed the data challenges caused by Excel spreadsheets. You know that we think that spreadsheets are great tools but that when you're dealing with hundreds or thousands or tens of thousands of them they can become a plague.
The spreadsheet is only as good as the Excel's creator and then, in turn, only as good as the next person importing the data it contains to another data destination. There are multiple possible points of failure.
If several hundred data fields are entered you can bet that there will be a set percentage of errors or inaccuracies. If you multiply that set percentage of expected errors by several thousand spreadsheets it brings to mind former US Senator Everett Dirksen's quote "a billion here, a billion there, pretty soon, you're talking real money."
Dirksen on left with Ronald Reagan
We know this to be true from first hand experience. We've seen thousands of Excels loaded into our web-based transaction systems via rudimentary "mapping tools" that link incoming spreadsheet data fields with template destination data fields in the recipient's system. The problem is that while the linking or mapping may have been successful no one bothers to look at the hundreds or thousands of data cells now being dumped into a CATEX system of record to determine if they are accurate!
It really was a disaster for some clients until we brought a halt to it by creating our Data Vera product and forcing Excel data transfer to our system exclusively by Data Vera. By using Data Vera we can monitor every, single data cell that's coming in and examine it for accuracy --and even auto-correct it --within a matter of seconds. The audit certificate that accompanies each Excel upload, that reflects every single data cell change made, is a revolutionary advance for our users. Now upstream users can be even more confident in the quality of their data than are the downstream originators of the spreadsheets. Needless to say the instantaneous export of this now structured (and accurate!) data to model templates, legacy systems and regulatory reports is a big attraction.
Enough of touting our own product! Every reader knows there is a problem with spreadsheets in the insurance industry. We know that we're not reporting any news with that fact. But then we saw this headline -- "Stupid errors in spreadsheets could lead to Britain's next corporate disaster" --in The Telegraph. Naturally we read on...
The article cites a study done by a company named F1F9 that provides financial modeling and business forecasting to large firms. It stated that 71 percent of large British businesses use spreadsheets for key financial decisions. No earth-shaking news there, we thought. That number was then bolstered by "speadsheets are used in the preparation of British company accounts work up to 1.9 trillion GBP." Well, that number got our attention so we read on.
This next sentence really caught our attention: "16 percent of large companies have admitted finding inaccurate information in spreadsheets more than 10 times in 2014." Now you're talking--we were fully captivated and read on.
The article cited a Grenville Croll who is the chairman of an entity called the European Spreadsheet Risks Interest Group saying "Spreadsheets have been shown to be fallible yet they underpin the operation of the financial system. If the uncontrolled use of spreadsheets continues to occur in highly leveraged markets and companies, it is only a matter of time before another 'Black Swan' event occurs causing catastrophic loss."
"Another Black Swan event"? Had we missed something? Maybe we had.
It seems that in 2013 JP Morgan lost some $400 million because of a spreadsheet slip-up. In 2012 a spreadsheet error in the rail franchise bid process for a railway in the UK cost taxpayers nearly $100 million and a study examining the Enron collapse in 2001 showed that 24 percent of Enron's spreadsheet formulas contained errors.
These statistics were troubling enough but this sentence was terrible: "The report warns that while 33 percent of large businesses report poor decision making as a result of spreadsheet problems, a third of the financial decision makers using spreadsheets in large UK firms are still given zero training."
The article quotes a professor at Delft University for Technology in The Netherlands who said "The Enron case has given us a unique opportunity to look inside the workings of a major corporate organization and see first hand how widespread poor spreadsheet practice really is. What's truly shocking is that there seemed to be a culture of total acceptance that mistakes were simply part of working with spreadsheets. Some people were sending more than 100 spreadsheets back and forth on a daily basis which proves that there was no agreed system or standardized way of working."
We have to admit that this article stunned us. Certainly we didn't think that the insurance and reinsurance industry was the only sector which encountered spreadsheet challenges. We were, however, surprised to see that the challenges are so pervasive throughout all industries and presented such a potentially lethal threat.
From our own experience we have seen batches of spreadsheets passed from one to another on the risk chain without any verification of their completeness much less their accuracy. We have seen risk bearers underwrite coverage for what they believe the spreadsheets contain when in fact the spreadsheets tell a different story. And we also know that the problem of getting accurate spreadsheet data into the model templates has caused modeling companies offer their own "in-house" data services to map data to model templates.
We had no idea that the need for our Data Vera product was so prevalent in today's world but you can be sure we took note of it. We created Data Vera because we operate the systems of record for our clients. If inaccurate or incomplete data is entered onto our systems it will inevitably produce erroneous results. That becomes our problem.
That's why we added Data Vera as the only way spreadsheet data can be placed into our systems. We ensure that the data is accurate and complete --you will see the name of the employee who made any data change and what that change was and when it was made. Data Vera gives our clients a potent tool to ensure that they are not in that group of companies reporting "poor decision making as a result of spreadsheet problems."
Maybe we should write a letter to the editor at The Telegraph and tell them we have the solution?
A big name in Europe makes a big play in reinsurance
Agnelli family vehicle seeks to buy Partner Re
Most Americans have heard of the Agnelli family's most famous brand name but are unaware of the family itself. This unfamiliarity is not the case in Europe where the Agnelli name has been known for over a century ever since 1899 when Giovanni Agnelli co-founded the company named Fabbrica Italiana di Automobili Torino,which later became known as Fiat.
The company began producing cars in Turin, Italy in 1903. By way of reference the first Ford factory in the US was opened four years after Fiat was founded. In 1906 the first Fiat car dealer in the US was established, in Manhattan.
The Agnelli family has been an important part of European commerce for 115 years and is one of the richest families in the world. Their investments, run through the family investment company Exor, range from a 29% stake in Fiat/Chrysler to ownership of the Italian football team Juventus.
John Elkann, the great, great grandson of Fiat founder Giovanni Agnelli is the CEO and Chairman of Exor and he certainly made some news in the reinsurance world two weeks ago. Exor came out of nowhere with an unsolicited bid to acquire 100% of PartnerRe for an all-cash amount of $6.4 billion. Depending on how you calculate the Exor bid it could be as much as 16% more than the bid for PartnerRe made by Axis Capital which is an all stock bid.
News of the bid was a shock to the industry. Exor had played its cards close to the vest and no advance signals were made public about their interest. Exor had been a founding minority investor in PartnerRe in 1993 but had kept a very low profile in the industry since then.
The Exor bid was not only a surprise because of its origin but what it represents causes the current conventional thinking to turn on its head..
Before the Exor bid conventional thinking was that only two types of reinsurers would prove successful in the future. One would be very large multi-line writers with worldwide geographic risk spread who were, ideally, in control of a primary insurance business flow. The global scale and resources of such leviathans are thought to be able to better serve clients who demand such a breadth of service as well as provide the reinsurer with the necessary insulation to have as diverse a risk portfolio as possible to generate income in times of lean investment returns.
The other type of reinsurer poised for future success were the so called "hedge fund reinsurers" which would derive maximum return from higher investment income managed by hedge funds while the underwriting income provided the necessary "float" needed for the investment portfolio. The lower capital costs of these carriers allows for competitive underwriting which generates increased float and thus increased returns.
The Exor bid turned all this on its head when Exor's Elkann said that he thought PartnerRe was already as big as it needed to be; that he saw no need to acquire a primary insurer to obtain both business and higher premium at risk levels closer to the insured risk; and that the $15.9 billion in PartnerRe's investment portfolio was just fine the way it was --with 88% of it invested in fixed income or cash.
You could have heard the proverbial pin drop in London, New York, Bermuda, Munich, Zurich and Paris after those remarks. After all, as Insurance Insider noted just last week an unnamed reinsurance CEO had told the publication that "reinsurance is dead".
The silence didn't last too long. A number of stock analysts came out in favor of the all cash Exor bid and even some of PartnerRe's largest shareholders publicly said they supported the Exor bid. PartnerRe's management, which was due to play a secondary role to Albert Benchimol and Axis Capital, was lauded publicly by Elkann who said that "Once permitted, we will interview the internal management (of Partner) and we believe that we will be able to find a CEO candidate" to replace Costas Miranthis who left when the Axis proposal was made public.
The smoke is slowly clearing on this murky scene. Axis has reiterated its determination to move ahead with the merger and presumably another bid will be forthcoming. The real story though is that in the midst of this current constant debate about whether "size matters", or if "ILS carriers" will eclipse traditional reinsurance, one of the wealthiest private entities in Europe, if not the world, wants to take PartnerRe private and have it stick to its knitting as a reinsurer and leave its investment portfolio as it is --in very low interest liquid assets.
Elkann was clear. By taking PartnerRe private he would remove the quarter to quarter pressure from investors and Wall Street and allow the reinsurer to do what it was set up to do --reinsure risks at a price that would make a profit. He stated that he wasn't particularly interested in increasing PartnerRe's size ("In the case of PartnerRe scale is absolutely not a constraint.") and he strongly dismissed the idea of buying a primary insurer ("We don't like competing with our customers".)
He went on to note that Exor's all-cash deal would provide "certainty and continuity for management, employees, customers and clients, in contrast to the Axis transaction, which he said relied on synergies that would cause disruption (The Axis deal proposes to wring $200 mm in savings from redundancies and efficiency gained from the merger).
As of this moment there is no new Axis proposal and each day sees a new analysis as to why the Exor bid is better for Partner than the original Axis deal. There is that little matter of a $250 mm "break-up" fee that Partner would have to pay Axis if the deal falls through but even with that payment factored in the Agnelli bid is still superior.
It would be tempting to dismiss the Exor bid as foolish and one which ignores the current trends in the industry. But just maybe it is not foolish precisely because it's ignoring the current industry trends. The Agnellis are serious people and they have a lot of money. As Elkann said Exor is a "big advocate of the pure reinsurance model" and that it had been a "student of the industry" for the past three years.
You can bet that news of the Exor bid was read with some satisfaction in CEO suites of traditional reinsurers throughout the world. There is no better validation of value than the market and here was a very legitimate investor proposing a cash on the barrel deal for a reinsurer with plans to keep it just as it is.
No doubt more will be revealed in the coming days but for right now anyone putting the nails into the coffin of traditional reinsurance has quietly put away their hammers..
John Charman's Endurance looks to buy Montpelier Re
Endurance Specialty announced that it would acquire Montpelier Re for $1.83 billion in a combination cash and stock deal. Montpelier Re is a property CAT specialist which is a market which has been under, to put it mildly, some pressure of late. Montpelier also has three very attractive other assets.
Montpelier has a Lloyd's syndicate (Syndicate 5151) as well as a Lloyd's Coverholder authorized to enter into insurance and reinsurance contracts on behalf of Syndicate 5151 and which places business into 5151 from MGA's and brokers.
A Lloyd's platform is worth its weight in gold these days (see Hamilton Insurance), and with the accompanying wholly owned coverholder channel, Montpelier certainly has a valuable structure in place at Lime Street.
Harris did go on to say that he expected the NWP for the first quarter of 2015 to be flat versus the prior year "with planned growth in Individual Risk and Other Specialty lines offsetting the impact of targeted reductions in Property Catastrophe."
There are several nuggets here but it could be argued that Montpelier Re was not nearly as ready for the emergency room as pundits had suggested about the monoline CAT reinsurer when rumors of its sale were swirling.
The company's increase in book value (Warren Buffett has historically used the same metric as a valuation measure) beat the S&P 500 for 2014 and it has a potentially potent operating mix at Lloyd's that would allow it to offset reliance on CAT business. You may note Harris's reference to "targeted reductions" in Property CAT. Translation: they are exercising underwriting discipline and not reinsuring CAT at inadequate premium prices. When you add in the $790 million collateralized insurance fund (ranked 17th in size out of 43 listed ILS funds) you can see that Montpelier's management seems to have been covering as many of the bases as it could --and not doing too bad a job of it at that.
Would Elkann say that in any event Montpelier Re has the Lloyd's infrastructure in place to pivot nicely to individual risk and specialty while exercising underwriting discipline in the CAT area? And would he finally say that with the nearly $800 million in collateralized funds available to it Montpelier has enough access to low cost capital to structure CAT deals which its own capital might be too expensive to support?
The answer to these questions posed by John would seem to be yes --although in this case it wasn't John Elkann asking them. It was John Charman and obviously the answers were more than enough to satisfy him and the Endurance board.
Much has been made about how Charman's decision to buy Montpelier is contrary to his prior statements about CAT reinsurance, a Lloyd's platform and ILS funds
. We suppose that technically if you compared his previous comments with his current plan there may be a contradiction but so what?
Smart people have been known to change their minds when confronted with facts -it's part of being smart. (The people who won't or can't change their minds are not called "smart" but something else.) Having an ego big enough to not be worried about what reaction will be to changing your mind is the hard part.
It may just be, based on the little analysis we can do from our distance, that Endurance shareholders are fortunate that their CEO has a big enough ego that he made the decision to buy Montpelier despite anything he might have said in the past. We'd like to think we'd have made the same call.
Higher premiums can be found closer to the original insured
Reading between the lines so far you have probably, once again, picked up on the interest of reinsurers in insurance. You saw John Elkann categorically state that he saw no need for PartnerRe to acquire a primary insurer. You read of Montpelier Re's Lloyd's operation and Christopher Harris's plan to generate premium in the individual risk and other specialty lines since CAT premiums are unprofitable.
Since reinsurance premiums have decreased reinsurers are looking further down the origination line for higher premiums. This next paragraph is about as succinct as you can get in describing what's going on. It's written by Artemis' Steve Evans referring to a report issued by the financial management firm Bernstein.
"The disparity between falling prices in the property CAT reinsurance line and a continued pricing momentum in the homeowners line, in light of low catastrophe loss levels, demonstrates the principle that in insurance, being closer to the customer and controlling distribution is the most valuable part of the value chain."
Naturally, as one gets closer to the original payer the risk of loss increases. Reinsurers are usually shielded by the retention maintained by the primary insurer cedent and aren't reached until a loss or losses exhausts that band. But as you do get closer to the original payer the possibility of getting more premium increases. The coverage is priced so that more likely or frequent claims, which occur in that primary level, are compensated for by premium and whatever risk bearer is taking that risk responsibility will expect the commensurate share of premium.
With the ongoing declines in reinsurance premiums these lower attaching level risks, and their corresponding higher premiums, are looking attractive to reinsurers. This attraction is bolstered by the fact that these lower level lines such as homeowners insurance have enjoyed pricing increases at the same time that reinsurance premium prices are decreasing.
The Bernstein report notes that US homeowners coverage saw insurers miss-price low-frequency,high severity losses over the last few years but "with the proliferation of vendor catastrophe models across even the smaller and regional players driving more rational pricing." This more rational pricing leads Bernstein to conclude that high-margin growth opportunities exist in this class.
In the casualty space reinsurers are well aware of these downstream juicy targets which is why they have historically paid ceding commissions to ceding primary insurers on quota share reinsurance although the ceding commissions are negotiated based on the notion of acknowledging the original insurer costs of business acquisition, claim management and administration.
This time honored "acknowledgement" notion has been unmasked of late as primary insurers are increasingly pushing for higher ceding commissions on quota share deals. It's not as if their expenses have increased but more a recognition they have come to that they want more of premium they are delivering to the deal. The only way to do that in a quota share is to push for a higher ceding commission.
Some cedents are dispensing with the fiction entirely (it is a tough sell within the confines of a QS) and are attempting to restructure quota share programs to excess of loss cover where they can name their retention and keep more premium.
Of course the driving force motivating the so called vertically integrated risk bearer is to capture this lower level risk and obtain the higher premium before ceding excessive exposure off to the vertically integrated risk bearer's reinsurer. If it's done internally you can avoid the reinsurance broker fee and the transfer of underwriting information should be relatively straightforward coming from one subsidiary to another.
There are a few such risk bearers who are big enough to be doing this now and are very good at it. You can guess who they are.
We'll see what happens here but there is no doubt that for as long as reinsurance premiums remain low that primary insurance premium is going to be attractive.
Roger Crombie writing for CATEX Reports takes an off-beat view of the world of insurance
The Truth (Or Maybe even a Story) will set you Free
It is a truth universally acknowledged that soccer referees suffer from an absolute inability to perform their job correctly. A referee cannot possibly see everything that takes place during a game, even with assistants running the lines on either side. As a result, far too many games feature errors by the officials that directly affect the outcome of games.
At the 2010 FIFA World Cup finals, giant screens were in place at many of the 64 games, to offer spectators a better view of events on the often distant field of play. The screens neatly delineated the referees' ineptitude when their decisions were repeatedly viewed in slow motion by everyone in attendance, as well as by the home audience. Those who had paid small fortunes for seats at the matches were vocal in their outrage.
FIFA dutifully sprang into action to correct this awful state of affairs. After all, what's the point of a game if it is not played in accordance with the facts and the rules?
FIFA acted neither to improve the standard of refereeing, nor to install technology to overturn bad decisions. It simply turned off the giant screens. The truth, FIFA argued, was an obstacle to the fans' enjoyment of the game. Those of us at home could still see the awful refereeing, but couldn't threaten the operation of the games.
In the real world, not just in soccer, the truth is a despised commodity. The insurer Zurich might agree with that view. In 1998, an English claimant won a £135,000 ($200,000-plus) settlement from Zurich after claiming that a workplace injury to his back left him incapable of working.
Zurich had been doubtful about the claim from the outset. A judge who subsequently unpicked the settlement said that the man had 'dishonestly exaggerated the effects of his injury,' and ordered the claimant to repay the majority of the award. One might imagine that a jail term would have followed for this particular cheat.
The fellow appealed the decision that forced him to repay his award. His attorneys readily admitted that their client was a swindler and a liar. They argued that the truth is of no relevance in legal matters. The Court of Appeals agreed.
I might, perhaps, restate that: the Court ruled that what is true has no relevance in matters of law.
The man found to be a crook was not required to repay so much as one cent of his winnings. Nor has he spent even one day in jail. The earlier judgement was final, the Court ruled, and the truth irrelevant, so that neither repayment nor jail time was necessary.
Charles Dickens, in Oliver Twist, wrote in the late 1830s that 'the law is an ass', so this will hardly come as news. Whoever coined the phrases 'cheats never prosper' and 'honesty is the best policy', were clearly barking up the wrong tree where the justice system is concerned.
Another legal matter in the UK this spring took the same approach to the truth. A man and his wife had divorced 30 years ago. Both were at the time extremely poor, so no great financial settlement was necessary. Years later, Al Gore invented the Internet, and the divorced man created an app that earned him millions. A few months ago, his ex-wife sued for half of everything he'd earned since the divorce, happily agreeing that she had in no way contributed to the development or success of any of it. She won.
Again, no great surprise. Justice is the last thing one expects from a court of law. My question is this: how may the public rely on the financial statements of an insurance company (or any other company), if matters long dead may be reopened and the truth excluded from the findings?
Surely every set of financial statements requires a footnote to the effect that 'the above numbers must be considered at best a wild guess', since that is all that they can be, given the accepted futility of the Law.
The argument that everyone knows this to be true and doesn't care, won't do. The casual reader of financial statements, unversed in the ways of the Law and its disinterest in the truth, would assume that the phrase used by auditors in the UK (and implied by auditors in other jurisdictions) that the statements provide a "true and fair" view should mean something. It does not; indeed, it is palpable nonsense.
And that's the truth.
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 firstname.lastname@example.org.
Copyright CATEX Reports
April 24 2015
Aon Benfield says that the ILS, collateralized reinsurance and CAT bond space will hit $150 billion in capital by 2018...Speaking of Aon Benfield the company was selected as the sole reinsurance broker by the Florida
Hurricane Catastrophe Fund to place a $1bn risk transfer to the private reinsurance market....A few months back RSA's Stephen Hester said that risk bearers had allowed space for brokers at their own expense. Some followup on that from Intelligent Insurer which found that more than 85% of respondents to a survey believe there will always be a place for brokers in the market but 15% said that clients may cease to see value in paying an intermediary as technology continues to advance at an ever increasing pace...the California Earthquake Authority said that it hasn't received any quake claims citing human-caused activity like fracking or deep-well injection as a cause...Unfortunately for SCOR the Japanese
Sompo bought into the French reinsurer. Sompo competitors Mitsui Sumitomo and Aioi Nissay Dowa have all but dropped SCOR from their April 1 reinsurance renewals...KPMG foresees a day when retail investors will be allowed to invest in reinsurance risk. Retail investors can practically do this already by investing in publicly traded ILS funds...Believe it or not the long, cold US winter of 2014/2015 has generated an
than last winter according to Munich Re...Tom Hutton is back in the news having
emerged as the director of a venture capital initiative called XL Innovate launched by XL to invest in companies with a strategic focus on developing new capabilities in the insurance sector...Finally there was a great article in the Bermuda Royal Gazette about piracy and how the shipping industry is responding. One response is the creation of so
A "Citadel" courtesy of Marine Insight
called "citadels" deep within a ship to which the crew can retreat to and actually control the ship. The citadel is impregnable and has communications links and enough provisions for the crew to subsist on until the ship is guided to safety or help arrives. Amazingly the "citadel" idea has been successfully deployed "many" times in the past.... Too bad Captain Philips didn't have a "citadel" but then there would have been no movie....