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Soft market forecast for near future

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[MADRID,Spain]—Corporate insurance buyers could well enjoy a sustained period of soft insurance market conditions over the next couple of years because investors in reinsurance companies may misread the current market drivers.

Leading European insurance equity analyst William Hawkins, head of European insurance at specialist investment bank Keefe, Bruyette and Woods, says that, at present, investors are bearish about the reinsurance market while reinsurance company executives are bullish.

Mr. Hawkins told delegates at a meeting of modeling experts gathered by catastrophe modeling agency Risk Management Solutions Inc. in Madrid, Spain last week that there is a chance that sentiment could change, ultimately to the benefit of European insurance buyers. Reinsurance rating levels are still near a cyclical high and results reported by the companies are therefore good, said the analyst.

Red shift

But Mr. Hawkins fears that if reinsurance results continue to improve in the short term, investors will see it as a longer term trend and alter their view of the sector.

"The fundamentals are nowhere near as good as executives present them. If I am right and the investment community does misread the underwriting cycle then my concern is that they will jump on the bandwagon at the wrong time," he said.

A decrease in the cost of equity may lead to undisciplined underwriting and exacerbate the cycle, he said.

Mr. Hawkins said that the reason for the current polarization of opinion on the sector between the company executives and their investors is because of a big disparity in information enjoyed by the companies and their investors, the poor track record of the sector in return-on-equity terms and the fact that the basic reinsurance business model is a "systematically-flawed value trap."

Looking glass

Mr. Hawkins said that the business model fails because, just as earnings beat expectations as in 2006, the soft market undermines the outlook.

To solve the disparity in the flow of information, Mr. Hawkins suggests that the reinsurance companies need to disclose more consistent information in areas like reserve development and large losses, show evidence of active capital management and release capital through diversification credits and, above all, show that they can manage their risk effectively.

The analyst said that reinsurance companies need to prove that any capital relief they could gain from diversification credits would not be wiped out by higher operational risk-caused by the longer distance in reporting lines between corporate centre and underwriters on the ground.

He also said that reinsurance company risk managers need to provide more timely and intuitive information, and develop forward-looking tools that provide clear results.

"A risk/capital model transforms the question from 'what can I do with all this capital I've got?' to 'what would be the capital cost of writing my core business and is this attractive?' concluded Mr. Hawkins.