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

Warren Buffett has released the annual 2006 investor letter for Berkshire Hathaway. As usual, his folksy writing style makes for a great read and the letter itself contains considerable information about the diversified portfolio of operating companies that Berkshire Hathaway has become. Insurance and reinsurance operations remain a considerable portion of Berkshire’s portfolio. The letter highlights on pages 7 and 8 changes in Berkshire Hathaway’s approach to mega-catastrophe insurance underwriting:

Was this onslaught of more frequent or intense storms merely an anomaly? Or was it caused by changes in climate, water temperature or other variables we don’t fully understand? And could these factors be developing in a manner that will soon produce disasters dwarfing Katrina?

Joe Brandon, Ajit Jain, and Warren Buffet don’t know the answer to these all-important questions. What we do know is that our ignorance means that we must follow the course prescribed by Pascal in his famous wager about the existence of God. As you may recall, he concluded that since he didn’t know the answer, his personal gain/loss ratio dictated that an affirmative conclusion.

So guided, we [Berkshire Hathaway] have concluded that we now should write mega-cat policies only at prices far higher than prevailed last year – and then only with an aggregate exposure that would not cause us distress if shifts in some important variable produce far more costly storms in the near future. To a lesser degree, we felt this way after 2004 – and cut back our writings when prices didn’t move. Now our caution has intensified. If prices seem appropriate, however, we have both the ability and the appetite to be the largest writer of mega-cat coverage in the world.

Both the Royal Gazette of Bermuda and A.M. Best have updates this week on the 2005 class of Bermuda reinsurers. In the article New Reinsurance Companies Could Merge or Go Public written by Lilla Zuill, the Royal Gazette reports that

one can’t necessarily count on the 2005 companies following the same path as the earlier Bermuda insurers, because of the unprecedented influx of capital. About $20 billion came into the Bermuda market both to back the new companies and to replenish the coffers of established companies hit by storm losses last year. “Some may be surprised at how quickly capital entered and some may be surprised at how quickly it exits.” Ed Noonan, chief executive of Validus Re, a $1 billion reinsurer formed last year by Aquiline Capital Partners, a new private equity fund run by former Marsh & McLellan chief Jeffrey Greenberg and partners, said he expects the new reinsurers will eventually pursue initial public offerings. “One of the things that seems clear after the events of 2005, if you are in this sector you need access to the public markets,” he said, citing how quickly Bermuda’s established insurers and reinsurers were able to raise in the region of $9 billion to replace the losses from Hurricane Katrina and other 2005 catastrophes. “The existing companies proved that to be a necessity (to be able tap capital markets quickly). Most of the companies at some point will look to become public,” he said, speaking generally.

The Boston Globe is reporting on February 9, 2006 that American International Group Inc., one of the world's largest insurance companies, has agreed to pay $1.64 billion to resolve allegations that it used deceptive accounting practices to mislead investors and regulatory agencies.

The deal -- believed to be the biggest concluded by regulators with a single company -- also requires the New York-based firm to adopt changes in its business practices that will ensure proper accounting procedures in the future. AIG said in a statement that the settlement was approved by its board "in the best interest of the company." The pact announced Thursday settles a civil lawsuit filed last May by New York Attorney General Eliot Spitzer with backing from the New York State Insurance Department and the U.S. Justice Department. The Securities and Exchange Commission, which also worked with Spitzer on the investigation, filed and settled allegations of accounting fraud with the company simultaneously. The settlement does not cover Maurice "Hank" Greenberg, the company's former chairman and chief executive who was named in the suit but who has pledged to fight it in court. While acknowledging the civil misconduct and facing a huge fine, AIG at the same time escapes the threat that a criminal case could have been brought.

Allstate Corp., the largest publicly traded company that insures personal property and automobiles in the United States, continues to try to reduce its fortuitous loss risk exposure to the greater New York City region. Allstate took huge losses in the 2005 hurricane season when Hurricane Katrina devastated New Orleans and the state of Louisiana, where the insurer had no backup coverage from reinsurance, and Hurricane Rita hit Texas. Together the two storms cost Allstate more than $3 billion in losses. As a result of new underwriting guidelines put into place as a result of such 2005 storm losses, Allstate previously announced that it would cease initiating new home insurance in Westchester County, Long Island or the five boroughs of New York City since it felt was over-exposed to possible major hurricane losses with a 26% market share along the southern New York shoreline. Throughout New York State, Allstate is reported to have an 18% market-share.

Now on February 6, 2006, according to the Newsday article entitled Allstate pullout elicits rebuke, Allstate is going a step further. It has announced that it would cease renewing some of its homeowners policies in the greater New York City area as a method of further reducing its risk exposure to the region. This action received a rebuke from New York State Insurance Superintendent Howard Mills who has called for a public fact-finding hearing on February 27th. "It's fair to point out that Allstate has a large concentration of risk, and that is the reason they are taking this action," Mills said. "But that doesn't mean I approve of it." Spokesmen for two other large insurers, State Farm Insurance and Nationwide Insurance, said they have no plans to reduce coverage in the New York area.

Toomre Capital Markets made a post back in November 2005 entitled Civil Fraud Charges Likely Coming in General Re / AIG reinsurance probe?? that speculated on the probable imminent indictments of Ronald E. Ferguson, General Re’s former chief executive officer, as well as Elizabeth A. Monrad, General Re’s former chief financial officer, in the General Re / AIG reinsurance case that led to the resignation of long-time AIG CEO Maurice R. Greenberg. At that time, Colgate-Palmolive Co. said in a regulatory filing that both Ferguson, who served as head of that company’s audit sub-committee, and Monrad, who served as the head of another sub-committee, had resigned from Colgate-Palmolive’s board of directors. Previously both had received so-called Wells notices from the U.S. Securities and Exchange Commission and it was curious that both should resign from the board of directors at the same time seemingly out of the blue. Ms. Monrad, who had taken a leave of absence from her position as the CFO of TIAA-CREF after receiving her Wells notice in May 2005, formally resigned from TIAA-CREF in mid-November which made the joint resignations from Colgate’s board seem even more curious. After an initial flurry of visits around when the above post was made, the TCM web server log files reveal that general interest about this story was insignificant – until this week that is when activity markedly increased! Tonight the public now knows why…

The Bermuda Royal Gazette reports that the principals behind Castellum Re, one of 11 major reinsurers licensed to operate in Bermuda since the first of November, have decided against proceeding with formation of the company in an article entitled “Castellum principals scrap plans to operate in Bermuda”. “Appleby Spurling & Hunter, the law firm hired to handle the group’s incorporation process, told The Royal Gazette the parties behind Castellum had decided not to proceed with their plans. It is not known who was behind Castellum’s bid to join the Island’s burgeoning reinsurance sector, or why they decided against it. A search of Castellum’s share register, something that is generally available for public viewing, was not allowed because the company is to be struck off the Bermuda register. Parent company Castellum Holdings Ltd., and reinsurance unit Castellum Re Ltd., were added to Bermuda’s register of companies in mid-November.”

The Boston Globe reports in an article entitled "Insurer to drop coastal policies" that a relatively small insurer Hingham Mutual is retreating from underwriting homeowner policies on Cape Cod and the offshore islands of Nantucket and Martha’s Vineyard, blaming the 2005 hurricane losses for its retreat in Massachusetts. While this news is not particularly noteworthy since it only affects approximately 6,500 homeowners, the article contains a couple of details that are worth noting. This insurer states that it is facing a rise in reinsurance rates of 20% to 30% despite the fact that New England did not have any significant losses from the 2005 Atlantic storms. The article further reports that the state’s insurance pool of last resort has seen in its share of the Cape Cod market rise from 4% in 2000 to 28 percent today as other companies have pulled out or scaled back because of high reinsurance costs related to new storm damage estimates.

If this pattern continues for the rest of the costal eastern United States, there will be substantially more insurance premiums paid in 2006 and entering the short tail catastrophe property reinsurance may well turn out to be profitable if the 2006 Hurricane season returns to historic norms. The interesting question that no one knows for sure what the future natural catastrophes will be. As a side note, consider for a moment, if a hedge fund invests in property catastrophe exposure and those “reinsurance” options are not “exercised” due to a normal season, what percentage of the option (or reinsurance) premium return should be considered Alpha return and what portion is Beta???

The article “Swiss Re Steps up Risk Shift” by Charles Fleming in the December 8, 2005 edition of The Wall Street Journal offers a short summary of the continuing convergence of the fortuitous loss (insurance/reinsurance) markets and the capital markets. While this convergence has been a process that has been on-going for several years in fits and starts, the recent increase in retrocessional pricing (i.e. reinsurance for reinsurers) due to the massive 2005 storm losses has finally brought the traditional reinsurance market to a level close to an Insurance-Linked Securities (“ILS”) execution. As a result, the negative arbitrage from an ILS issuance has narrowed and the market is likely to see more issuance in this securitization sector. These ILS securitizations and insurance-linked swaps are alternative forms of capital raising for replenishing the 2005 storm losses (in addition to the capital raised by existing and new reinsurers in Bermuda and the Cayman Islands).

According to the article “Five more class four insurers licensed” in the December 7, 2005 article of The Royal Gazette out of Bermuda, four more highly capitalized (re)insurance companies have received licenses in Bermuda to start writing (re)insurance for the January 1, 2006 insurance renewal season. The new companies are:

• Ariel Reinsurance Company, Limited;
• Castellum Re Ltd.;
• Flagstone Reinsurnace Ltd. and
• New Castle Reinsurance Company Ltd.

These companies join those approved in October 2005 including

• Amlin Bermuda Ltd.;
• Arrow Capital Reinsurance Company, Limited;
• Harbor Point Re Limited;
• Hiscox Insurance Company (Bermuda) Limited;
• Lancashire Insurance Company Limited and
• Validus Reinsurance Ltd.

It appears that there is more than $9 billion in new capital backing these start-ups as well as much as $9 billion more replenishing existing companies through equity, hybrid capital and debt securities. Coupled with activity on-going in the catastrophe insurance-linked securities market, the rise in catastrophe reinsurance premiums is likely to be somewhat tempered. While different insured properties have differing risk profiles and hence differing rates of premium increase, the “general” cat policy appears poised to increase by at least 10% over 2005 rates. Will that level of premium be enough to satisfy the return on capital sought by the new companies being formed? Time will tell…

Reuters has more information on the new start-ups here.

Around Thanksgiving 2005, according to this press release on Securitization.net, Munich Re announced that it privately placed 110 million Euro ($129 million) of risk-linked securities to provide protection against severe Western European windstorms. BNP Paribas acted as lead manager on the deal and Risk Management Solutions modeled the underlying risk. Munich American Capital Markets, the capital markets unit of Munich Re, worked with BNP Paribas in structuring and managing the transaction. The bonds have a coupon of 475 basis points over three-month EURIBOR. "This transaction complements our existing retrocession program for one of the peak natural catastrophe exposures and improves capital protection through collateralization at economically favorable terms," said Munich Re management board member Thomas Blunck, who is responsible for retrocession and capital markets solutions.