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Letter from Tal Piccione

"TO SEE THINGS CLEARLY IS TO FORESEE THEIR CONSEQUENCES"...William Blake

This statement was made more than 200 years ago by Blake. Having recently marked my 37th anniversary as a reinsurance broker, I increasingly ponder how our business has migrated over the decades to where we are today. Perhaps of greater interest is what lies on the horizon as a corollary to the cause and effect relationships leading to today's dynamics. To do justice to this topic would require authoring a novel of sorts but the little space afforded here only permits a skeletal commentary.

In the early to mid eighties, there were more than 100 risk takers of varying sorts assuming reinsurance from America's cedents and many were based in the States. Today, consolidation has cut the number to a much smaller universe of players the world over. In those earlier years, shareholders of reinsurance companies were content with more moderate annual returns on their investment. Under the principles of continuity and payback, on which the industry functioned successfully for decades, reinsurers could adhere to strategies designed to smooth results and look to long term profitability in lieu of significant price rises following catastrophic losses. Strong consideration was given to the build up of the so called bank (sic, profits/losses) that was in place on a particular reinsurance program prior to losses and the perception of the relationship between the cedent and reinsurer.

Beginning in the mid-to-late eighties, the culture started to change and by the early nineties, the principles of continuity and payback were heavily watered down. Indeed, the Financial Accounting Standards Board, prodded by the Securities and Exchange Commission in 1992, promulgated new rules dealing with accrual accounting and risk transfer standards culminating with strictly defined rules in 1993 and 1994 that put the nature of long term relationships between cedents and reinsurers under close examination. The word payback became immediately suspect. I well recall a senior luminary in the accounting sector voicing an opinion to me that even a handshake commitment by a reinsurance buyer to the reinsurer, to put the latter whole over time after a loss, was a no no! The changing dynamics underway coincided with Hurricane Andrew after which venture capital firms began partnering with some industry players to launch reinsurers. The new investors entered the fray based on business strategies that focused on delivering ROE's north of 20%. After Katrina in 2005, private equity and on other types of investors sought exit returns in the 30 percent range. One should easily understand that reinsurance has evolved today more as a commodity with prices driven by short-term objectives particularly where cat perils are focused on. The evolution of catastrophe models has also promulgated today's pricing culture. Near-term models, often pointing to greater exposure, are increasingly factored by reinsurers as they consider terms of coverage. Contrary to some opinions that standard models are no less accurate, this stance plays an important role in today's higher pricing levels. And we can't ignore the influence that rating agencies implicitly, if not explicitly, have in fostering today's culture versus yesteryear, particularly where their influences on deleveraging capital has fostered greater demands for short term profitability.

It would be unprofessional to not point out, however, that among other things, the good news about models and the role of rating agencies as a corollary to same, is their collective role in facilitating billions of dollars of commitments over recent years from the capital markets for cat bond and sidecar capacity.

My concern from a big picture perspective is that the growing awareness of higher reinsurance rates for catastrophe protection on the part of policyholders, regulators, and politicians is morphing into ever increasing calls for government intervention. Proposals for a national catastrophe fund to backstop private sector reinsurance are being introduced to Congress at an even greater pace. Unless structural changes come about, the trends will continue to point to federal involvement in our business going beyond the present national flood and terrorism risk programs.

Politicians and regulators are now more closely following the underlying dynamics which foster market conditions. Some of them noted the rationalization put forth by some quarters late last Fall that rates had to go up in 2009 because of the falling stock market and that the economic meltdown would make it difficult, if not impossible, to raise capital after major losses. On the other hand, a few of the same folks have cited their awareness that new capital is filtering into our industry, and that despite views to the contrary expressed late last year by a certain constituents in our industry, the capital markets are continuing to play a meaningful role in 2009 and likely ahead. While it may be foolish to attempt to reverse the flow of a large river, the fact of the matter is that unless more consideration is prudently afforded to the dynamics which have come to characterize our industry, or where further meaningful competition is not engendered, there should be no surprise to major consequential developments on the horizon. More to the point is the need to facilitate new forms of private sector involvement by way of a combination of added capital to our industry and newer creative products. Ideally, the latter engendering greater commitment between ceding companies and reinsurers to the objective of achieving long term profitability in relationships while attempting to mitigate heavy spikes in reinsurance costing.

While it may be inevitable that governmental intervention is a reality, we as professionals should be focusing on how the private sector's growth through innovation could position government further away from the ground than would otherwise be the case and be proactive in facilitating same.

Tal Piccione
Chairman & Chief Executive Officer