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Risk & Insurance® Editor in Chief Jack Roberts interviewed O'Halleran in late July, in anticipation of the fall reinsurance meetings in Monte Carlo and Baden Baden. Here's some additional material from the meeting beyond what was featured in our print edition.

Q: Is reinsurance attracting enough young people to the business?

Many of the people who are still with us. I am very proud of the people that started with me. People like Paul Davis, Mike Bungert and Tom Rogers and Dave Kelly, those of the U.S. people. Then there is Bryan Ehrhart has been with us. We basically haven't lost any of our founding fathers.

At the same time, we've made it clear, whether it is the United States or whether it's in London or wherever, you old guys have got to get out of the way. You can continue to be very involved with clients, that's what most of our people do. But the next generation has to lead the charge. I am very respectful and proud of what they have done and continue to do--it's my job with the rest of the leadership to make certain that they rise up and take this company to the next level.

Q: Have we learned the catastrophe lessons of the past?

O'Halleran: If you recall, up to major events like Andrew and obviously '01 and '05 catastrophes ... and the last long soft cycle from '87 to '01 ... prior to that it used to be reinsurers that changed the market. They would say, "Now, that's it. We're picking up our marbles. If you don't like the way the rate is going to go, we're going to get out of this account or that account, or whatever."

After '87, it changed because you had a cycle of strong investment markets with less emphasis on underwriting. Obviously, the results showed from it because the marketplace deteriorated significantly. Reinsurers weren't really changing the market, they were just going along with it.

And in '01 that changed, and in '05 that changed again. The cycles are getting shorter. There has been a dramatic improvement in understanding the business better through the catastrophe modeling and understanding your aggregates. We didn't have that back then, or we didn't have it at the current levels of sophistication.

To me there is a much better understanding today of where you have got to get, in terms of returns. Therefore, reinsurers are willing to walk away from business and certainly reduce their exposures to risks that they think are not as adequately priced as others.

Q: What's going on?

O'Halleran: I think the reinsurers are exercising more discipline. We work on a supply and demand curve. It's always been that way and it will be. The demand curse is still robust because all the risk continues to expand. Things are changing. We have greater frequency of catastrophe. This second quarter just had largest single CAT losses in the history of the business. That was just the United States, it was around the globe. People are understanding that volatility is increasing. But, at the same token, there is a price for capital.

Reinsurance capital is the most economic solution to buyers. They're going into the capital markets space, and they're tying to get debt or equity and it's very expensive. Capital is hard to come by. Reinsurance is a very efficient economic model for people. I do see buyers looking at it with a lot more interest. In terms of the traditional markets, traditional reinsurance is still a lot cheaper than going into other forms of capital.

I think that in listening to both sides of the insurance and reinsurance side, there a level of discipline that is starting on both sides, not that they have been undisciplined but it's the awareness that you're putting out your capital whether you're an insurer or reinsurer and you have to understand the risk/reward ratio.

It's a very risky business, as we know, I think there is a point either as insurance company or a reinsurance company that you have to say, at this level, even though we've had some pretty good years, the reality is that how many of those good years over the past couple of years have been because of redundant reserves? Certainly we've seen a lot of take down of reserves, so how much is left?

You have an investment market that continues to be very problematic. You can't really depend upon solving you return models with your investments. The discipline is really fact-based. If you can't get a certain ROE or ROC, whatever you want to look at, your shareholders are not going to be very happy.

Q: Will the capital markets respond to a major catastrophe with reinsurance capital?

O'Halleran: Absolutely. In fact, we're the largest player in the capital market space of any of our peers. Goldman and ourselves dominate that space right now. We've done more deals than anyone else. We've got our own trading desk. We're looking at the dynamics of it. There hasn't been decreased a desire of the capital markets to participate even in what we consider to be a softer market

There is a tremendous amount of capital available there. People are opportunistic. If a big event occurs, you're going to see what we've seen before. Some of the companies that are legacy companies are going to have issues. They're going to have to reload capital. That takes time. There is going to be a need for additional capital flow.

We actually welcome it and look forward to it. We have built up a tremendous base of support for when big loss hits from wherever it may be.

I don't anticipate that at this point in time, we'd see any sort of shortfall. There will be a lot of capital coming into the market.

Q: What do you think might be some risks that the markets haven't anticipated?

O'Halleran: I don't have any substantial data for what I'm going to say, but I intuitively look at the changing landscape of Europe in terms of litigation. I see the law changes that are happening and tort reform going the other way, becoming more liberal expanding into areas like pollution.

If you think about pollution in Europe, look at what has happened through time. Courts could start interpreting that policies that have been issued 40 or 50 years ago, that, yeah, they really did intend to cover that event. To me, that's a pretty scary thought for what could happen in that world.

We all saw what happened in the United States in the past with asbestos. When you look upon the world, pollution still is one big risk that is lurking out there. It all depends upon what jurisdiction you are in and how people want to interpret it. If you look at the European landscape in particular, which historically hasn't been anywhere near as litigious as the United States, there's a trend there. There's a trend, not just in pollution, but in all lines of liability. I think that's something on the horizon that people have to be very cautious.

I also believe that these catastrophic events are truly something that have far more frequency. Look at the floods that have gone through the Midwest. They go through Europe, they go through everywhere. I know that the interpretation of mold in certain contracts is not as pervasive an issue as one would have thought.

But when these events start occurring and regulators start looking at them in whatever part of the world, they're going to side with the consumer. I see mold because of what's going on across the globe, as something sitting out there that could raise its ugly head. Those two or three are the things that I look at.

If you look at the future, the United States has kind of addressed it. People have been able to sort out what they have and where they have it. Demand for these insurance products are expanding, and reinsurance is involved in it, but it's an issue particularly when I look at the U.K. and Europe. It's a huge issue in Asia, obviously. But I don't see retroactive cover being applied in China, for example. There is not enough legacy there.

Q: Can insurers innovate for changes in the marketplace?

O'Halleran: We have some really intelligent people on the risk management side in the insurance business. There is huge pipeline of innovation that is going on daily. Insurers are willing to take on risk if they can understand it. There are a lot of moving parts. If you look at how many changes have occurred in the D&O world over the last decade, they have been pretty significant and very creative. I think that's true in about every other field. There is no shortage of new ideas coming out, and the ability to do it, it's whether the buyer will pay the appropriate price.

Q: Do the ratings agencies have too much influence?

O'Halleran: This is major sea change from back in the '70s and '80s. The ratings agencies have become so important in our business. Our clients are very dependent upon them so that's why we have a ratings agency practice group that works with the insurers to understand all the things they're going to need.

We literally model out for them economic output to determine if you do this, this is what is going to happen to this rating. If you want to expand, this is the amount of capital the ratings agencies will say you need. This is how your Best rating is going to be impacted. It's become a very important and vital part of the business. If you go back to the '70s or '80s, it was done at the company level, and now it's a major part of our advisory practice.

Q: Are you a bit less involved in the business these days?

O'Halleran: I haven't cut back an iota and I don't intend to. I'm very active in all aspects of the business. I'm traveling all the time and very client focused and market focused. The good news is that my partner, Andrew Appel, has taken on the heavy lifting in terms of the infrastructure. But I'm still actively involved, as are all our executives, in doing god's work for our clients. I'm still very involved in the overall strategy and execution of the company. As the chairman, it's my responsibility to make sure it all gets done.

I love my job. It's a terrific (one) with a terrific company.

Q: Do you have any more acquisitions planned?

O'Halleran: Last year we did the facultative team. That was a big investment. We acquired Gallagher Re, which is turning out to be a great acquisition. We'll continue to look at things that fit strategically, finically and culturally. We're obviously in a great position with a lot of cash on our balance sheet from the sale of Combined. We'll deploy that judiciously on behalf of our shareholders.

(Four weeks after this conversation, Aon announced it would acquire Benfield, the third largest reinsurance brokerage firm).

September 1, 2008

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