Chris Sposato comments on Issues related to International Insurance and Reinsurance . . .

Connecting Again – Awakening after the Economic and Catastrophic Storms

Hamilton, Bermuda – 12 January 2012

It has been quite a while since I last blogged, or indeed felt like blogging. The world, our industry, and businesses everywhere were decimated by the worldwide credit crisis of 2008 and its wave of repercussions. We now know the systemic problems that gave rise to the circumstances and the greed and economic manipulations that were put into play that caused the economic mayhem.

Our company lost numerous ongoing projects and opportunities and were left holding the bag for our time, intellectual property, costs and expenses. However, this is different than losing one’s homestead
and lifetime savings . . . Unfortunately, there were no new projects or opportunities coming forward for what seemed like eons.

So, perhaps, for a while I was the Rip Van Winkle of bloggers – asleep and neither motivated nor inspired to write.

This past year, our industry experienced what looks as if it will be the year with the greatest catastrophic losses in recorded history – the world “blew up” in many fashions: tsunamis, floods, earthquakes, hurricanes, storms, etc. and in many parts of the world not usually understood to suffer such severe damage and destruction.

Today, I believe that the bleakness is dissipating, economically speaking, and from the perspective of our industry
that may be recognizing expansion and growth opportunities; the industry is starting to regain the interest of “money” seeking to invest opportunistically in risk, albeit cautiously and tentatively.

Bermuda has officially announced, through the Bermuda Registrar of Companies and the Bermuda Monetary Authority (the “BMA”), its industry regulator, that this past year saw the number of new insurance and reinsurance company formations grow significantly compared to the prior year (2010) when it was insignificant. See the article in The Royal Gazette: http://www.royalgazette.com/article/20120110/BUSINESS04/701109956/-1

Yes, this is getting better, but let’s look at some of the statistics. Of 54 new “registrations” (or company formations), twenty three were special purpose insurers created to issue insurance linked securities, including cat bonds and ILWs, or to be sidecars. This helps affirm Bermuda’s status as the “go to” jurisdiction for deployment of investment capital into the insurance and reinsurance industry; but none of which adds significantly to the employment of personnel in Bermuda and its attendant spending into the local economy.

With respect to the new special purpose insurers and sidecar structures, I wonder how the investors monitor the selection and risk management diversification of the business put into the vehicle? While many solely depend on the “host” company by taking a quota share of its business, as the use of sidecars increases, I can foresee an evolving structure where more sophisticated investors appoint their own risk “independent” underwriting officer to oversee or supervise the risk selection and diversification of business placed by the “host” into the sidecar vehicle. This may create a new opportunity for retired, talented underwriters, much like the world of “independent directors” on corporate boards.

In December, two class four companies were formed, SAC Re Ltd., established by Steven Cohen, founder and chief executive officer of SAC Capital Advisors LP, to be led by Simon Burton, formerly deputy chief executive of Lancashire Holdings and the Chief Underwriting Officer of its Bermudian underwriting subsidiary; and Third Point Reinsurance Company Ltd., established by Daniel Loeb, the founder of Third Point LLC, which will be headed by John Berger as its Chairman and CEO. John Berger was formally CEO of Alterra Capital, the company resulting from the 2010 merger of Chubb Insurance Company’s Harbor Point Re and the Max Capital Group. These two companies are both likely to contribute to some level of “on Island” employment and expenditure into the Bermuda economy; this will be good for the Island, and its residents; and it will hopefully help to reverse the past years’ trend of corporate job losses, local unemployment, and a shrinking Island economy. Word on the street is that there may be a few new additions looming on the horizon for this year. This in encouraging for us all in the industry.

Best wishes to everyone for a better year in 2012. May you all have a Very Happy, Healthy and Prosperous New Year ! ! !

I will look forward to hearing from you and sharing your ideas.

Christopher D. Sposato

Integrity Resources

You may contact me at cdsposato@integrity.bm

www.integrity.bm

P.S. My Side Bar:

I, as many in our industry do, appreciate automobiles, particularly vintage and classic models, and enjoy their art, engineering, and history. I am particularly fond of Cadillacs, which love dates back to my childhood and warm loving memories of my grandmother, Omey, my Dad’s mother, who had many a model over the years. With this in mind, I have been quite distressed, upset and mortified by the recent commercial advertisements for 21^st Century Insurance, part of the Farmers Insurance Group. That car insurance company seeks to demonstrate its purported superior pricing to its rival Progressive Insurance by a demonstrative commercial in which a vintage 1960s (probably 1962) white Cadillac Eldorado Biarritz convertible is used to forcibly create its own parking space by parallel parking into a small slot between two non-descript mid-sized cars. The Cadillac backs into and rams one of the non-descript vehicles, then goes head first into the other, then back and forth till comfortably parked.

I find it offensive that such a beautiful, venerable, vintage automobile was used and desecrated in this way.

So, let’s say, for the sake of argument, that this bullish activity may have been staged as a dramatization – At a minimum, shouldn’t 21^st Century Insurance be required to clearly state in its ad that “No Cadillacs were damaged in the filming and production of this advertisement” as they do for animals in certain films, cosmetic studies, and documentaries? I suspect that no proper automobile enthusiast will be doing business with 21^st Century Insurance, and even perhaps the rest of the Farmers Insurance Group, any time soon, despite its claim to pricing superiority.

For some historical pictures of vintage Cadillac Eldorado Biarritz convertibles see, for example:

http://www.car-nection.com/yann/dbas_txt/eld56-66.htm

Hamilton, Bermuda – September 2009

Earlier this month, Bermuda’s, and indeed the world’s, reinsurance market saw a major transition which has been unheralded in this arena since its inception. The holding company of International Property Catastrophe Company, Limited as it was originally known, and which has been more recently know as IPC Re, was purchased and acquired by Validus Limited. This followed an initial merger solicitation by Max Re’s holding company to which IPC’s Board jumped at a bit to quickly (possibly without due consideration for its fiduciary duty obligations to IPC Shareholders) and a weak attempt to disrupt the purchase by Validus coming from Flagstone Re’s holding company.

The worldwide reinsurance market only last year recognized IPC Re’s fifteenth year anniversary of service – and, uniquely, the fact that IPC Re maintained its core mono-line discipline, unlike all other “Class of 1993″ Bermuda reinsurers that were formed to create new property catastrophe capacity after Hurricane Andrew in 1992. IPC Re’s shareholders and management recognized the wisdom of this approach although the market and analysts vacillated over time as to the legitimacy of maintaining a mono-line strategy versus that of diversifying among a variety of other lines. Probably, the common sense response may be correct: either and both can be a good approach as long as those executing it understand the strategy and execute it with precision, caution, and hands on and gut level experience and attention.

The undercurrent within the Bermuda market of underwriters, brokers, intermediaries, and clients is that the loss of IPC Re in the market will create a void as IPC Re had a reputation for its responsive, technical, client focused underwriting where old fashioned underwriting knowledge, instinct, and gut were not eschewed but uniquely meshed and integrated with modern day cat modeling analysis and financial structures. In short, “they did it a bit differently, but always effectively!” The senior executives who built up IPC Re and who were asked to leave IPC Re will be missed in the market and by their clients during the upcoming renewal season. Validus Holdings will undoubtedly strive to combine the businesses to produce a “superior” company and to maintain the relationships with IPC Re’s clients and brokers that the “let-go IPC Re executives” fostered over the past sixteen years. Nonetheless, as with all mergers, there will be fallout and we will see how much over the next few months.

I watched and listened to Steve Forbes Friday morning explaining to FOX newscasters and their audience about the underlying and systemic problems that helped cause our financial crisis and that continue to hinder the refinancing and recapitalizing of our banks and financial institutions. While we know there were unforgiveable issues with how loans were originated (say greed.) to borrowers who could not qualify for the loans, and then sold off as securities into the private and public markets, less is said about the Mark to Market accounting rules that served to turn an incendiary event into a self sustaining/self feeding nuclear catastrophe. (see my earlier Blog on the problem “Stimulus Bills – Let’s Get Rid of the Mark to Market Causes for these Disasters” published on 11 February 2009. See: http://cdsposato.wordpress.com/2009/02/11/stimulus-bills-%e2%80%93-let%e2%80%99s-get-rid-of-the-mark-to-market-causes-for-these-disasters/

This issue continues to affect efforts to refinance and recapitalize banks and financial institutions worldwide. Indeed, just yesterday a leading Bermuda Bank was given government assistance to help raise capital. See: http://www.royalgazette.com/siftology.royalgazette/Article/article.jsp?articleId=7d933af30030000&sectionId=60

Mr. Forbes validated my concerns and thinking about these accounting rules when he opined that until they were suspended or nullified they would prevent private investors from investing in and recapitalizing our banking and lending companies. As an example, he highlighted the continuing problem for these lenders and their borrowers when he described the situation where the lenders made properly verified loans to qualified borrowers who have to date, and are expected too continue to, make their regular loan servicing payments. BUT, since the sub-prime crisis, almost all home values have declined significantly and in our example, the homes of our qualified borrowers who continue to pay their loan obligations have been devalued to less than the loan balance. Now, since these homes are valued at less than the loan balance as a result of this market dislocation and shock, their loans may be called and their homes foreclosed. Common sense says these people will continue to pay their loans and in time the valuations of the homes will correct and stabilize. Mark to Market Rules, however, say the bank must immediately recognize the devaluation of the collateral asset, pronounce that the loan is under-collateralized, repossess the house, and admit that their balance sheet is insolvent (liabilities exceed asset value). This is idiotic and turns common sense and ordinary life into a surreal horror show.

This phenomenon applies to all businesses including insurance companies and manufacturing companies. Insurance companies must mark down the value of investment securities even where the issuer is making all payments of interest and principal just because the “at the moment” market price is reduced because of interest rate fluctuation or a market hiccup. This is true notwithstanding that the issuer is paying its obligations and will do so until maturity. What a travesty.

IPC and MAX Re – What the Investment Bankers and Merger Advisors did not (publicly) predict (but they collected their checks!)

We saw an absurd reaction to the big deal orchestrated by the all knowing investment bankers and merger advisors this week. On Monday, IPC and MAX Capital (MAX Re) announced that IPC was buying and merging into MAX in a combination that “all parties and their advisors” expected to be value additive, where in fact “one plus one” would be greater than two! Well, I’m not sure I understand the math: On Monday, IPC was valued by the market at more than $25 as share; but at the end of the week it was below $21; likewise, MAX was above $16 when the transaction was announced and was flirting at $13.50 at week’s end.

Let’s see – 25 + 16 = 41 before the announcement. 21 + 13.50 = 34.50 after the announcement. I think that’s a 16% decline?

We can see some obvious synergies with this proposed combination but do not understand the economics based on the market reaction. The only ones who have made money so far with this transaction are the investment bank/merger advisors, the lawyers, and the accountants. Mere shareholders (who pay the fees of those superstar advisors and hard working service providers who are just doing their job) have seen their interest, at least this week, decline significantly. Should we blame this performance on the market which went down with continuing (bad) news out of Washington – boats sink as the tides drop? This seems too easy and it begs the question of value and validity. We hope this improves for the companies and their shareholders as the year and the amalgamation move forward.

Please see:

http://slabbed.wordpress.com/2009/02/05/slabbed-lets-the-cat-out-of-the-bag-is-allstates-reinsurance-program-worthless-ask-the-weeping-willow-tree/#comment-6054

If you have some additional information or thoughts, let us know. Thank you.

While we watch the spectacle of representatives and senators designing laws, cajoling agreement with, and working toward passage of the “stimulus plan” we need to be mindful of how we came to find ourselves in this predicament. People who could not afford to buy homes were sold houses by charlatan brokers collecting fees for themselves as they wrote mortgages on behalf of banks who earned other fees but didn’t take on any credit risk because these loans were then bundled and sold as high yield investments to purchasers who didn’t understand the underlying risks they bought; and those who packaged and sold these securities – the wall street bankers – didn’t think they had to understand the credit risks either nor had to bother to investigate any underlying credit reports. . . . .

At the same time, these same investment bankers were making odds on the presumptive defaults of sound (and unsound) corporations worldwide and were selling discounted bets at the craps table as to whether those companies might default. For a cost or premium of a few basis points you could bet on the financial collapse of any significant (or insignificant) company – and then pray for its demise.

And on top of all of that, let us clearly identify the real issue that has caused the foregoing problems to turn from “burning’ serious economic issues into nuclear bombs . . .

Mark to Market accounting was the accelerant tossed onto the fire to turn these incendiary situations into nuclear meltdowns in the financial landscape The so called brain-trust promulgating generally accepted accounting principles who have insisted that valuations of assets must be determined instantaneously have created a nuclear storm for real value over time. We know the value of many of those subprime properties value will come back to normal and the corporations against which credit default swaps were sold will recover The failure to view values over time – as opposed to instantaneously – has proved to be a sick and poisonous potient for the worldwide economy.

I’m not an economist nor an accountant, but I can say with confidence that the accounting rules of mark to market need to go as they contributed far too much to the devastation experienced recently by the US and also foreign banks. They do not reflect the reality of the real world and only create turmoil and confusion in their profession’s own synthetic view of the world. These rules have only served to be an accelerant thrown on the fire of bad situations. Things go bad, throw more gas/kerosene on the fire!!! Let it burn. Let it burn hot and have higher flames. Let it burn.

Shakespeare used to say (and I paraphrase): the first thing to do is to kill all the lawyers …….

Today, perhaps, one should say: banish those accountants who promulgated mark to market rules!

As an American, my heart swelled, as it did for all previous Presidents during their inaugurations; but it swelled so much more today because this days marks such an historical occasion in our history when, without reserve, our citizens exercised their freedom to elect one of the most qualified American to the office of President, no matter what race, creed or political party. This makes me proud.

If this is the case, it is excellent news for our industry, and those companies in Bermuda, especially. Mr. Slayton has worked hard for the benefit of both the U.S. and Bermuda. The Consul General has strived to ensure open and frequent communications between the two governments on important matters, including anti-money laundering, monetary and tax, and terrorism issues. He has been a pragmatist and a passage maker whose efforts demonstrate that political rhetoric should not obscure, or worse, bury, the reality that there can be a commonality and mutuality with respect to certain shared common purposes even when typically there are significantly differing views.

For our industry members which operate outside the U.S. in so called “tax-haven” jurisdictions, and particularly for those that are Bermuda based companies, Slayton has helped demonstrate that their existence and means of operations are beneficial to the U.S. and its citizens because they provide much needed insurance and reinsurance coverages at reasonable prices that are not otherwise available from U.S. companies at economical prices, if available at all. The Consul General has garnered respect from government leaders both in Bermuda and the States as well as from a cross range of industry leadership and related organizations.

We congratulate Mr. Slayton on his job well done; and we hope that the reports of his tenure being extended are true so that we may welcome him for an additional few years of service in Bermuda.

Our industry apparently has some good news for the New Year in that reinsurance rates are rising not only for property catastrophe contracts, but for casualty as well – perhaps not as sharply as after other major crises, but enough to help put smiles on industry leaders and underwriters. While reinsurers have not often been the “darlings of Wall Street,” they have faired much better this past year than those “far (intellectually) superior” financial services participants known as investment and commercial bankers! Who could have thought that???

Happy New Year everybody!

It was reported this week in our local newspaper, The Royal Gazette, that Florida CFO Alex Sink was in Bermuda to meet for a series of important meetings regarding the Florida Hurricane Catastrophe Fund. Florida is looking at alternatives to enable it to address concerns that its catastrophe coverage facilities are significantly underfunded and that it may not be able to close the gaps through the further issuance of bonds due to the turmoil and uncertainties in the financial markets. Florida recognizes that it can protect itself from any deficiencies through buying more reinsurance and Ms Sink’s mission was to explore those options in detail and determine how much capacity would be available to the Fund from the Bermuda market. Ms. Sink had meetings with Bermuda reinsurers, local industry representatives, the Finance Minister, and the Bermuda Monetary Authority, Bermuda’s insurance and reinsurance regulatory body.

Link to The Royal Gazette article:

http://www.royalgazette.com/siftology.royalgazette/Article/article.jsp?sectionId=65&articleId=7d8c7b73003000a

The “off-shore” insurance and reinsurance industry is once again in the firing line of “patriotic” Americans who want every company doing business with, or providing services to, “on-shore” U.S. companies ,to pay “their fair share” of U.S. income tax. While the accusations of tax avoidance may be appropriate for certain people and entities that are off-shore, they are patently untrue for the companies in our industry that provide efficient, solvent protection at an economical and effective cost.

The Americans making these charges, including some U.S. based insurance and reinsurance industry leaders, condemn “off-shore” companies by accusing them of being tax evaders and, thus, anti-American. The gist of the political rhetoric is that these companies are established in, or have re-domesticated into, an offshore jurisdiction for the sole or primary purpose of avoiding paying “their fare share” of U.S. federal income tax.

The term “off-shore” includes any domicile outside of the U.S. and is not limited to Bermuda, the Cayman Islands, etc.; it also includes Switzerland and possibly other European and Asian countries whose market participants provide necessary protections to the U.S. “on-shore” marketplace and their interests worldwide. Some may argue that “off-shore” also implies and limits the definition to those jurisdictions that are “tax havens.” A tax haven is to be defined (simplistically) as any jurisdiction that does not charge the equivalent rate and amount of tax that the U.S. would charge. Well, Germany is thought to have a heavy corporate tax structure; this is perception as they also have reasonable and effective reserving policies that effectively protect much on the insurer’s and reinsurer’s premium and investment income from taxation so they can build-up and grow their reserves in anticipation of catastrophes and the payment of other significant losses. Germany may be a tax haven in disguise in certain respects!

Many of the off-shore insurance and reinsurance companies were established and licensed in places like Bermuda, the Cayman Islands, Switzerland, Dublin, and other offshore jurisdictions so as to be able to operate economically and efficiently. For an insurance and reinsurance company, the most vital aspect of their operations involves their ability to pay substantial amounts of claims when policyholders have catastrophic losses. To do this fundamentally requires theses companies to accumulate income and hold assets until the funds are needed to pay claims. Given the current regulatory and tax environments of operating on-shore, insurance and reinsurance companies choose to set up in and operate from off-shore jurisdictions to permit their capital and surplus to grow and accumulate at a faster pace than could be achieved in a jurisdiction with significant taxation and restrictions against building and holding catastrophe reserves.

The beneficiaries of this growth are the insureds and reinsureds who most often are in jurisdictions with significant taxation. For example, depending on which resource one consults, the insured damages from Hurricanes Katrina, Rita and Wilma totaled approximately $65-$75 million, of which over fifty percent was reinsured to U.S. and other foreign reinsurance companies. It is expected that Bermuda companies will pay more than thirty percent of the total loss amount, somewhere in the vicinity of $18 – $23 million. Today, considering the risks insured and reinsured in Texas, it is expected that Bermuda insurers and reinsurers could be responsible for approximately forty to forty-five percent of the covered damages caused by Hurricane Ike.

While the average U.S. voter and taxpayer may not know it, a good amount of their personal and business insurance coverages is likely reinsured to a Bermuda or other foreign reinsurance company. Even large behemoth U.S. insurers, such as State Farm and Allstate, buy meaningful amounts of reinsurance from these companies. Without this important resource, they could not continue to offer the levels of coverage they provide to their customers at the price they offer it. If the income and profits of these off-shore companies had been subject to U.S. federal income tax, they could not have offered to provide as much coverage as they did and it would have been significantly more expensive. U.S. companies would have been hard pressed to make up the shortfall and maintain economic pricing.

In conclusion, while labeling offshore insurance and reinsurance companies as “tax dodgers” and the “anti-American” may make for a nice political sound bite to attract press coverage for politicians and stir up emotions among those who do not understand the reality of the situation, it would be harmful and wrong to America and its voters and taxpayers to interfere with the operations of off-shore insurers and reinsurers by subjecting them to U.S. federal income tax or otherwise hampering their ability to conduct their businesses. Those in the insurance industry in the U.S. whose companies depend on offshore and foreign reinsurance, together with those who understand the immense benefits that offshore insurers and reinsurers provide U.S. individuals and companies, need to speak out to educate their government representatives and leaders and their fellow citizens about the harmful consequences that will result from such types of interference.