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The rules of the game for what was once a sort of insurance buying afterthought have changed and changed fairly recently. Reinsurance buyers in general have become much more circumspect about what they buy.

Driving that change in facultative is that its cousin, the treaty reinsurance market, has softened somewhat from where it was two years ago.

"Yeah, it was almost like we'll auction it off to the highest bidder. Things are easing off a bit now and assuming we don't have a desperate wind season this season I think a bit more choice will come into it on catastrophe purchasing for the wind buyers," says Whyte.

That slight increase in treaty flexibility, coupled with a softer market overall, has made for a much more enlightened consumer of facultative reinsurance, Whyte says.

"On the facultative side, funny enough, in previous soft markets a lot of people propped up their results on the back of what some would call naïve, some others might have a sort of slightly ruder description for it, but there was facultative capacity out there that people would buy cheap to sort of help themselves ride the soft market. What there is in the facultative market around now, there is nobody to go to get those really silly cheap done to sort of prop the whole thing up kind of deal. The guys writing fac now, they're not dummies, they are quite smart, they know what they are doing and they have chosen to play in the facultative arena," he says.

"It's an interesting dynamic in the market now because in the past the fac market was much softer, which helped fuel it, and this time everything is softening quite rapidly because there is no naïve fac market out there. But to be honest with you, I don't know whether it's good or bad. Yeah, there is less choice around and there are fewer reinsurers, but, yeah, they are all pretty professional and that can't be a bad thing long-term for everyone," Whyte adds.

In the macro view, in the way reinsurance is purchased--and this goes for facultative and treaty--the emergence of enterprise risk management, along an ever broader corporate horizon, is leading to changes in whom is making reinsurance purchasing decisions and what kind of analysis is leading to their decisions.

Reinsurance is no longer looked at as a layer of defensive protection to be purchased but for what it really is--a piece of capital, a financial chess piece if you will, to be employed in the battle plan that we now call ERM.

"That is a major change. It has changed completely the way in which we talk about it. The people with whom we are talking about it," says Chris Klein, the London-based head of business intelligence for Guy Carpenter.

"The real issues are what are they writing, what are they doing, how are the underwriters behaving, how is the reinsurer protecting itself? And that is where you are getting into more extended detailed conversations with companies. Understanding their strategy, where they are going, how do they manage their capital, what their risk management is like," says Klein.

It's become a part of strategy, in other words. It's not so much a defense mechanism, as it is a piece of your offense.

"You can use reinsurance to alleviate your business strength if you want to grow. So, it has a number of uses, but it is now firmly a part of the whole capital management aspect. And people will flex their reinsurance to meet all of those goals," says Guy Carpenter's Klein.

"You've got the ratings agency, the regulator, the insured, or reinsured. They want to see security, they want to see a nice big cushion. They want to see lots of E, lots of equity."

That's why reinsurers have such a part to play in corporate strategy, at least right now. They have something not a lot of people in the world markets have right now do they? It's called cash.

According to Guy Carpenter's 2008 Reinsurance Market Review, capitalization of the Bermuda Reinsurance Composite increased by 20.4 percent in 2007 to stand at $129 billion at the end of the third quarter of 2007 due to strong retained earnings. Reinsurers returned $9.4 billion to shareholders in 2007, up nearly 200 percent from 2006. That's what we call strength.

And all this is happening in an environment where the overall faith in the stability of financial institutions is nowhere near what it was even 10 years ago. Banks that once prided themselves on their AAA ratings don't even bother to operate with that kind of blessing anymore. And the same is true for reinsurers, according to Guy Carpenter's Klein.

Years ago, according to Klein, 40 percent to 50 percent of the net reinsurance premium was written by companies with AAA ratings. Now, only one of them, Berkshire, retains that rating.

"The others are AA-, and in those days AA was probably the weighted average rating in the bulk of the reinsurance sector. Today, it is around about the A+ or on the cusp of AA-. Is it a bad thing? No. We've got a fair balance between the security wishes and the ability to generate satisfactory return," says Klein.

September 1, 2008

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