As some readers are aware, Toomre Capital Markets LLC ("TCM") is one of the few Capital Markets consultancies with considerable experience in one arcane sector of the securitization markets called insurance-linked securities. Lars Toomre was originally retained in 1997 by what is now known as Munich Re America, Inc. to help that subsidiary of Munich Re thrash out what strategies to pursue in the convergence of the capital markets and more traditional insurance markets driven by fortuitous loss. Partly as a result of that initial strategy work, American Re Financial Products was established to pursue three major initiatives:

• Finite reinsurance (now much discredited after the abuses exposed by the AIG/General Re finite reinsurance abuse scandal)
• Reinsurance of credit enhancement mono-line insurance companies and other credit enhancement opportunities primarily originating from world-wide project finance needs (now shut down due to Munich Re's downgrade from AAA to A in 2001), and
• Creation of American Re Capital Markets to create, underwrite and trade in various insurance-related opportunities such as future film production securitizations, weather derivatives, insurance-linked securities, guarantees of index total rates of return, insurance swaps, the hedging of Enterprise Risk Management exposures and the secondary trading of various property and casualty, health and life insurance policies (now part of Munich Re Capital Markets operation in New York City).

  Lars Toomre ended up joining Munich Re to help establish American Re Capital Markets where he focused on weather derivatives, enterprise risk management

  and other odd-ball initiatives with "hair on them". One of the odd-ball type of requests that periodically would come across the Capital Markets desk concerned "What would Munich Re want to pay for a particular insurance policy (or sometimes portfolio of insurance policies) in the secondary market?" Some of these requests concerned structured settlements, some concerned viatical insurance and some were marketed as "life settlements". Generally, the insurance broker was looking for a better price than what the leading aggregators of the day (generally JG Wentworth or General Re Financial Products) were willing to pay. The type of policy and details within caused the valuations from various sources to often vary considerably.

  Some people have asked why bother with all the complications of acquiring a portfolio of life insurance policies in the secondary market or a diversified portfolio of P&C risks? In short, the answer is that the returns from such diversified portfolios do not correlate with the returns from more traditional investment sectors such as equity, fixed-income, currencies or commodities. Hence, some of the smartest diversified investment companies (like Berkshire Hathaway, PIMCO, Citadel Investments and Greenlight Capital) have made some very significant allocations to insurance, insurance derivatives and insurance-linked securities, particularly because of how this sector risk increases their risk-adjusted returns (as calculated by such measures as the Sharpe Ratio).

  On Monday, November 26th 2007, The Wall Street Journal published a front-page article entitled An Insurance Man Builds A Lively Business in Death written by Liam Pleven and Rachel Emma Silverman. This article describes in quite some detail how life settlement contracts are acquired and some of the pratfalls of dealing with retail clientele that have primary life insurers and regulators warily circling this rapidly expanding industry.

During the past few weeks, Lars Toomre has been working from a client site (a top-ten hedge fund by size located in Manhattan) together with some members of the great team from G2 Systems, LLC. As a result of the long hours completing this particular project and the additional hours commuting, there has been little time left for writing and then updating this website on a regular basis.

In the financial markets, the week that includes July 4th normally is relatively quiet with many people away for at least some portion of the time. That hardly was the case this year at Toomre Capital Markets. This past week three incoming contacts reminded Lars why it is so important to somehow create time for sharing his thoughts and observations, despite all else that may be going on.

The fallout from the broad probe into a type of reinsurance known as finite reinsurance continues. On September 20th 2006, a superseding indictment was handed up by a New Haven federal grand jury in the case of former General Re and AIG executives, including Ronald E. Ferguson, 63 years old, GenRe chief executive officer from about 1987 through September 2001. A week later, the former CEO of Renaissance Re, James Stanard, and two other ex-RenRe employees, Martin Merritt and Michael Cash, were charged with civil fraud by The Securities and Exchange Commission. The charges accuse these RenRe executives of setting up two sham reinsurance transactions with a Bermuda-based reinsurer in which RenRe had an equity interest for no purpose other than to smooth out and defer $26 million in earnings.

The Boston Globe ran a story over the weekend entitled Hurricane risk data add pressure to insurance costs. This article expands on how the new coastal hurricane loss model from Risk Management Solutions (“RMS”) released in late March for reinsurance loss estimation purposes is effecting home insurance on Cape Cod and its outer islands. In short, RMS “now says its earlier gloom and doom about the cost of potential hurricane damage in coastal areas was far too rosy. The California company is predicting that hurricanes will occur with much greater frequency and intensity over the next five years, and is telling insurers they need to increase their annual loss estimates by 25 percent to 30 percent in New England and the mid-Atlantic states, and 40 percent across the Gulf Coast, Florida, and Southeast.”

The RMS loss estimate model differs substantially from that of one its major competitors AIR Worldwide of Boston, the other major hurricane modeling company. The AIR model takes a more traditional approach, relying on long-term historical data to predict hurricane losses, and sees no need to alter its approach for the greater frequency and intensity of hurricanes now incorporated by RMS.

Until about four years ago, the results produced by both models were similar. However, the first change in the RMS model caused reinsurers to sharply increase the rates that they charge insurers for providing excess loss coverage. According to this Boston Globe article, this increase in projected losses “prompted them to increase their rates dramatically, which forced local insurers to charge customers higher premiums to offset the higher cost of reinsurance. Some regional insurers, including the Andover Cos., Hingham Mutual Group, Vermont Mutual, and Quincy Mutual Insurance Co., went further, concluding the risk of doing business on the Cape and islands was simply too great. The companies scaled back their business in coastal areas or walked away entirely. The exodus has been so great that the market share on the Cape of the Massachusetts Fair Plan, the state's home insurer of last resort, has increased to 33 percent today from 4 percent in 2000.”

In the last two weeks, both Max Re and Fairfax Financial Holdings Ltd have seen their share prices suddenly plunge more than 10% as both announced further developments in how they accounted for finite reinsurance transactions. In the case of Max Re, they announced that both the audit committee and risk management committees of their board of directors were looking into two 2001 and 2003 reinsurance transactions that could have the effect of reducing 2001-2005 net income by approximately $50 million. The Bermuda Gazette has more information on the Max Re announcement here.

The case of Fairfax Financial Holdings Ltd. appears to be more complicated. Previously, Fairfax had received a suponea from regulators about finite reinsurance transactions that started from the probe of a large AIG/General Re probe of industry practices. The Canadian National Post has more details on why now Fairfax, its auditors and an outside investor have received subpoenas in the last two weeks. On Wednesday, March 22, when the information was announced, the Fairfax stock plunged more than 14% on the NYSE. What is particularly interesting from this story is that Federal prosecutors in the U.S. Attorney's Office in the Southern District of New York are also said to be participating in the investigation with the SEC.

This latter fact suggests that federal crimal probes of finite reinsurance remain on-going and Max Re might very well get swept up now in the industry probe. Your thoughts and comments are welcome