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Identifying the victims
Everyone knows individuals, organisations, markets who - at one time or another - have been open for business with the word "victim" tattooed across their proverbial foreheads. In business as in life, it is human instinct for the strong and ruthless to sense foolhardy innocence, for the sharks to smell an injured fish from miles away.

The wounded and naive get teased, stripped and finally plundered. That's how the food chain works - that's life. Enter the world of reinsurance; garnish the innocent with an ego, the predators with greed, and a veritable bloody feast is inevitable!

Recall the early 1980's  - about the time the first glut of innocent capacity flooded the London Market. Those blissfully unsuspecting reinsurers blinded by the pound signs and lured, perhaps in the underwriting room, perhaps in the local hostelry, to sign up for a risk, a treaty or to a delegated underwriting facility which should never have been touched. Instincts were ignored, questions were not asked. Cedants and brokers smelt blood and moved in.

The dilemma
Sooner or later, the inevitable happened - the underwriter fled, the losses mounted, the balance sheet haemorrhaged - and the "cleaners" moved in; run-off managers, accountants, lawyers, consultants. The cleaners screamed "foul", usually asserting that cedants and brokers alike had knowingly stitched up their clients.

The usual questions were posed - was this a case of let the buyer beware - (such as failure to ask the right questions) or did the predators overstep the mark (perhaps by not volunteering materials facts at placement). The truth was all too commonly an unhealthy slice of both!

Asking the right questions
I recall advising a Lloyd's Action Group in the early 1990's. The "Names" were members (unlimited liability stakeholders) in syndicates writing almost exclusively London Market Excess of Loss (LMX) business. Some were tempted to subscribe by potential returns on equity of as much as 50% - annually! In the good years they achieved this.

A series of natural catastrophes in 1988 and 1989 however generated market losses in the hundreds of millions, which the incestuous, enclosed LMX spiral "churned" into billions. Many, many Names faced financial ruin and scrambled together lawyers and consultants to try and prove they were improperly induced to invest in a scam that enriched brokers, underwriters and professionals - at their expense.

My advice was that there was no fraud. Yes, the brokers had salivated, as they took cut after cut of brokerage, as retrocession upon retrocession churned back and forth within the LMX spiral. Yes, the syndicates concerned had negligently, even recklessly, failed to evaluate aggregate exposures (or acknowledge their inability to calculate these because of the opaque nature of the business). Clearly some level of culpability existed.

But how truly "innocent" were the Names? The vast majority absolutely understood the principles of business, money, risk and reward. So surely - surely there was a critical question to be asked when the 30%, 40% and 50% returns were promised? Of course there was - the principal of risk/reward meant there HAD to be a massive downside - what might happen in a poor year!

Blind optimism? Greed? No matter, they chose either not to ask the question, or if they did so did not press hard enough for a realistic answer. A clear case of contributory negligence in my view - a sentiment ultimately reflected in the dispute settlements that followed.

Arrogance and ignorance - a fateful combination!
The Australian reinsurance industry took a severe beating in the 1990's and the casualties duly followed - New Cap Re, HIH, GIO and REAC. How did this come about?

Innate confidence (some might say arrogance) inspired a belief that a profitable book of London and U.S. reinsurance business could be written out of Sydney. They overlooked that the best business would be swapped amongst those on the inside track - the A-list; the established; the "old school" companies. That tip offs as to poor business circulating the underwriting rooms of London would be exchanged at the bar in the East India Arms in Fenchurch Street, not in a fax to Australia.

By the time the penny began to drop, so did the losses. The Australian companies had been "picked up" - no question. The many disputes that naturally sprouted centred around whether they had been picked up fairly or unfairly. Had key information been withheld or misrepresented, or was it simply poor underwriting judgement?

I can recall some examples of the former and many examples of the latter. It has often been my job as a "cleaner" to make that distinction!

Facing Reality
Why is my company so familiar with these patterns? Sure, we have spent what feel like lifetimes problem solving on behalf of international reinsurance clients, but we also once failed to sense a storm brewing and developed cataracts of innocence and ignorance - an extremely costly cocktail of ills!

We allowed a division of our company - which once successfully complimented and promoted the core reinsurance consultancy in its early years - to grow a life of its own and alter the focus and culture of the company. It became a highly visible, well-respected but significantly loss-making luxury. We "hung in there" almost two years longer than we should have.

After one last textbook mistake of contracting out its management to a third party whose interests were its own bottom line not ours, finally we faced reality, made the necessary changes, swallowed the losses, focussed back upon our core consultancy business - and returned to making profits!

The lesson!
The parallels of our own experience to the reinsurance innocents are uncanny - moving away from core business, delegating authority but not accountability, refusing to acknowledge the warning signs - and perhaps most frustratingly - failing to act speedily enough once the writing is on the wall!

Those who remove the scales from their eyes in the nick of time - as we did - survive. Those whose heads remain lodged in their rear passages inevitably fail - often spectacularly. Be you an individual, a company, a market - the underlying principles and fates are common to all!

© Julian Ward, JTW Reinsurance Consultants, 11^th October 2007