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MORE OFTEN THAN NOT, all good things come to an end. We suspect that this will be the case with the domestic reinsurance business over the next year or so.

Primary insurers have been increasing their retention levels, mirroring management efforts to satisfy investor premium growth demands and to make use of a burgeoning capital base.

We also are getting a sense that "working-layer" treaties are being replaced by excess-of-loss covers in order to further reduce premiums paid by primary companies to their reinsurers. There also appears to be rising interest in the use of multiyear contracts and finite risk covers, which in essence seek to further optimize the cost of traditional risk transfer. Finally, it is quite clear that Lloyd's of London is back with a vengeance and has been aggressively seeking to regain lost market share.

All of the aforementioned factors have been pressuring the premium growth prospects of reinsurers and are likely to continue to do so. This is all occurring against the backdrop of numerous efforts to develop securitized products that could move risk away from reinsurers and would clearly be a competitive threat to the business, except for perhaps the strongest and most nimble participants.

Globalization also has become a buzzword within the industry. On the surface, it would seem that the drive to become a global entity rests in the desire of reinsurers to spread their risks both geographically and by line of business. The geographic dispersion is of particular significance where property and property catastrophe covers are involved.

Having said this, there is no question that there is also a drive to find other sources of revenue growth, given the increased competitive nature of both the domestic and numerous foreign insurance markets. One other factor fostering the need for globalization is the desire of many cedents to find reinsurers offering significant capacity. Over the years, there clearly has been a flight to quality within the reinsurance industry as cedents have reduced the number of reinsurance entities on their approved lists.

Reinsurance, like primary insurance, is cyclical. Furthermore, reinsurance underwriting cycles tend to be more volatile than those of primary insurance because of the greater volatility of the business reinsurers write. For the most part, reinsurance is purchased to cover commercial risks as opposed to personal risks, because of the potential for larger losses. However, well-positioned reinsurance companies typically have produced better profit dynamics than most primary insurers.

This is particularly relevant for those reinsurers whose books of business are dominated by excess-of-loss covers. Excess-of-loss covers permit a reinsurer to uncouple its pricing from the vagaries of the primary market. Proportional reinsurance is more closely correlated to primary industry pricing trends.

The reinsurance industry in general tends to fare better than the primary sector, in part due to the wholesaling nature of the business and to somewhat less regulatory peer review. Put another way, reinsurance entities generally have leaner infrastructures and greater operating flexibility. While we believe that conservative reinsurers will continue to be among the most profitable segments of the property/casualty industry in terms of return on equity, there is clearly an interim squeeze on margins due to the slowdown in written premiums and some deterioration in reinsurance pricing.

Traditionally, conservatively run reinsurers suppress their profitability during the good times and pull down some doubloons when things get a bit tight. We expect this modus operandi to continue. Hence, returns on equity should still average in the 12% to 15% range over various time frames but could slip a little from this range on an interim basis.

The most likely way for either direct or broker-oriented reinsurers to produce strong premium growth in the years ahead appears to be through consolidation, combined with an ability to carve out business segments that heretofore might have been primarily the province of primary insurers. For 1997, we would not be surprised to see the premium growth for the Reinsurance Assn. of America group of companies to be flat or down from the year-end 1996 figure, given continuing shifts in primary retention levels, price cutting at both the primary and reinsurance levels, and the increased competitive threat from Lloyd's. Hence, if a company can achieve a high-single-digit pace of growth for a while, it may compare well relative to industry numbers.

"Critical mass" factors such as capital, global girth and premium growth will remain important. However, the torrid pace of M&A activity that was evident during 1996 is not likely to be repeated, due to valuation disparities and a clashing of management styles. Logic suggests that the slowing of premium growth and a squeeze on margins should result in some multiple compression. However, in specific instances, speculation about a reinsurer being caught up in the industry's consolidation can quickly add a premium to an average multiple. We note that the lofty multiples paid for the acquisition of direct writers are not likely to be obtained for broker-market reinsurance acquisitions.

We would not be surprised to see consolidation further reduce the number of reinsurance industry participants by a third over the next three to five years.

While there always has been a subtle caste system in the reinsurance business, recent activity seems to have produced a sharper tiering of the industry participants.

The top rungs of the ladder are clearly occupied by reinsurers that have a dominant position in the U.S. market, have exemplary balance sheets and have positioned themselves as global players. The middle of the ladder is occupied by reinsurance underwriters that have a strong U.S. presence, possess solid underwriting capabilities and good balance sheets and have differentiated themselves via their service and market specialization.

This specialization, which involves an above-average understanding of a client's book of business and the challenges the client faces, enables the reinsurer to offer customized solutions in addition to various services. These services run the gamut from risk management, alternative risk transfer mechanisms and actuarial analysis to capital-enhancing services.

Finally, the reinsurers hanging on to the bottom rungs of the ladder are entities that have a modest presence in the domestic market, and for the most part they have not differentiated themselves in the marketplace. These entities' long-term existence is questionable.

Myron M. Picoult is a vp and senior insurance analyst at Wasserstein Perella Securities Inc. in New York. Mr. Picoult is the past president of the Assn. of Insurance & Financial Analysts and a member of the New York Society of Security Analysts.