How Gio Took On The World And Lost

The Age

Saturday August 21, 1999

Jill Ferguson and Malcolm Maiden

Eight years ago the New South Wales Government was on the brink of committing to Australia's first major privatisation. The float of the state-owned Government Insurance Office was to be the first of a decade-long wave of national and state sell-offs.

But within the insurance industry there were growing concerns about the business the NSW Government was grooming for sale. Some believed it contained a time bomb.

Senior industry figures sought private meetings with Mr Nick Greiner, the NSW Premier at the time, to air their concerns. One of them was Mr John Cloney, the then chief executive of the QBE insurance group, who spoke on behalf of the insurance industry's representative group, the Insurance Council of Australia.

He told Mr Greiner that GIO's reinsurance division, launched in 1986, had significantly increased the risk profile of the GIO group, in a way few outside the arcane world of reinsurance understood.

Those who met with Mr Greiner also told him that GIO's earlier decision to gate-crash the sophisticated and insular London-based global reinsurance market, which insures the risks of insurance companies, had resulted in the Sydney-based group becoming a ``reinsurer of last resort".

According to sources, representatives of Lloyd's of London, the group that sits at the centre of the reinsurance market, also flew to Sydney and told the NSW Premier that GIO had plunged into the high-risk reinsurance business as it attempted to establish a beach-head.

The move by Mr Cloney and his colleagues to alert Mr Greiner to their concerns may have inadvertently accelerated the sale of GIO to the public. Sources say Mr Greiner relayed the industry concerns about the reinsurance business to GIO's board, and questioned whether the NSW Government should be exposed to risk. The board probably sealed the privatisation sale when it defensively told the Premier that it would not jettison the risky reinsurance business.``They said it was part of their strategy, they were handling the risk and the business was profitable," the source, who was close to the events, told The Age this week.

GIO made its debut on the Australian Stock Exchange in mid-1992, weeks after Mr Greiner had stepped down in favor of the man who is now federal Finance Minister, Mr John Fahey. The $1.2 billion sale was a huge success, oversubscribed by $1 billion, and GIO's reinsurance business was a key profit earner for the group in its first five years as a listed company. At this stage shareholders were left in the dark, having no idea that they were investing in a high-risk company.

But last year reinsurance cost GIO $189million, and this week's news that the division had lost a staggering $759million in 1998-99 confirmed that reinsurance is a marathon race, where it can take up to 10 years before profits are fully realised. Year-to-year paper profits are meaningless unless the company has set itself up to survive the inevitable convergence of catastrophes that periodically punish the industry.

Reinsurance runs to a cycle that favors the deeply capitalised AAA-rated giants such as Munich Re and Swiss Re, which between them cornered 25per cent of the $US125billion of reinsurance premiums written in 1997.

The cycle consists of three phases: a period of unusually high catastrophe claims that eliminate weaker players, a period when the survivors earn super profits by raising premiums, and a period where margins are progressively squeezed as new cut-price competitors enter.

This week GIO's directors admitted the company had been unable to stay on course in the face of the $743 million loss in 1998-99 caused by a succession of disasters - both natural and man-made - that ravaged the industry. This led to an astonishing $1 billion shortfall against the $250 million profit GIO confidently tipped only last December, when the group was doggedly resisting a $3.5 billion takeover by the nation's biggest insurer, AMP.

So what happens now in the wake of the GIO calamity? The newly appointed chief executive officer, Mr Peter Corrigan, said this week that GIO's reinsurance book would be run down or sold, and a run down is most likely: the investment bank that advised AMP in its bid, Credit Suisse First Boston, has the sale mandate but is considered long odds to find a buyer.

But questions are being asked about how the GIO fell into this perilous state. The huge loss came after a series of internal reviews and reorganisations of the reinsurance arm that involved some of the nation's premier advisory organisations. The entire, convoluted, process is now being investigated by the Australian Securities and Investments Commission, which this week expanded and upgraded an earlier inquiry.

The Australian Stock Exchange has also been asking hard questions of GIO, including what happened between its 12 May announcement that reinsurance losses would top $300 million and this week's revelation of the full $759 million reinsurance disaster.

On Thursday, GIO told the ASX that preliminary estimates of the loss exceeded $600 million on 3 August - a surprising two weeks before the $759 million deficit was disclosed. The expanded ASIC inquiry centres on the AMP's bid for GIO late last year and GIO's spirited defence, which was based on a due diligence process that one insider says was criticised by some as being extraordinarily thorough.

In the end, the holders of 43 per cent of GIO's share capital, most of them individual shareholders, heeded their board's advice that the AMP's offer of $5.35 a share undervalued the company, and held on to their stock.

They have been punished for their loyalty: GIO shares slumped by 93 cents, or almost 26 per cent, to $2.70 after the loss was announced this week, and hit their 1992 float price of $2.40 during the day. AMP shares lost 59 cents, and between them the two groups shed $1.2 billion of market capitalisation. AMP's 57 per cent stake in GIO will have to be written down by about $400 million and the group will also have to support a $400 million-plus recapitalisation of GIO.

Few of those involved in the GIO disaster are speaking on the record, because of fears that the loss will trigger a complicated round of lawsuits and counter-actions.

The abrasive American chief executive of the group, Mr George Trumbull, who is quitting early at least partly because of the damage caused by the GIO misadventure, says legal action is being contemplated and firms that specialise in class actions are also circling the company.

The risk of a litigation chain reaction is high because so many firms and individuals have had parts in the takeover. The defence against the AMP offer was led by the chairman, Mr David Mortimer, and GIO's newly appointed chief executive, Mr Nick Steffey, both of whom have since departed as part of AMP's restructuring. Advisers to GIO during the defence included Macquarie Bank (strategy), PricewaterhouseCoopers (financials, including the review of director's profit forecast), and Atanascovic & Hartnell (legal). Grant Samuel & Associates provided an independent valuation of GIO that buttressed the board's rejection of AMP's bid, and after AMP took control Ernst & Young provided advice that led to the warning that reinsurance losses would exceed $300 million.

The huge loss announced by GIO this week comes as the entire industry is being battered by claims for a series of catastrophes ranging from the Canadian icestorm to a series of satellite failures. But GIO management has also conceded that its reinsurance division had been afflicted by ``management processes and disciplines (that) were historically poor" and handicapped by reinsurance exposures that were ``out of line with reasonable risk tolerances".

Analysts say those comments are euphemisms for a poor-quality reinsurance portfolio, inept risk management, including a failure to adequately limit the group's exposure to infrequent large disasters, and inadequate reserves and provisions. Separately, each problem will maim a reinsurance business, but combined their impact was devastating.

From a standing start in 1986, GIO was making up for lost time and hoping to create a Sydney-based reinsurance market in a world dominated by London. Whether this was a strategically clever move is open to question. With business flowing largely from the pen of key underwriter Mr Volker de Chelard, who worked with a tight coterie of insurance brokers, GIO managed to corner most of the business coming into the Australian market. Rival QBE preferred to write its business in the key reinsurance centres of London, New York and Bermuda.

``The further away from the centre of activity, in this case London, the higher the loss ratio of your business," says one analyst, who adds that much of the reinsurance business that finds its way to Australia has already been passed up by other reinsurers in London, the United States and Europe.

``An ex-GIO executive once explained to me how he was going to make more money out of reinsurance than QBE ever could," a rival insurer said this week, adding that he described a system whereby GIO would take far bigger bets on a fewer number of contracts than QBE and its more conservative risk models would allow, thus exponentially expanding the profit.

Reinsurance profits buttressed GIO during the lean general insurance years of 1994 and 1995, but the group was operating at the point in the industry cycle when margins are fat. ``That was the Indian summer, it takes seven to 10 years in a reinsurance book to know if you've made a profit or not," one insurance executive said.

Mr de Chelard's departure marked the introduction of a new team-based approach in GIO's reinsurance division and a significant diversification into two new reinsurance areas, marine and aviation.

While industry pundits have always been concerned with GIO's Sydney-based operation, it is the business written over the past three years that has savaged GIO's bottom line. Sources say much of the aviation, marine, satellite and property exposure was written without adequate ``retrocession" cover, which is high-cost insurance cover for reinsurance. ``The attitude was `retro's for wimps'," a stockbroker to the original GIO float said this week. GIO in the early years used retrocession cover to cap its exposure to any one catastrophe at $20million, other sources said. But as time progressed, retrocession programs increasingly focused on protecting GIO from a one-in-10 or one-in-20-year disaster, rather than a continual dribble of claims.

In latter years, one of GIO's specialities was as one of the largest writers of property catastrophe retrocession cover for other reinsurers in the Lloyd's of London market. Analysts say it was a dangerous strategy for a small Australian company.

GIO shares closed yesterday at $2.50, less than half the exit price AMP offered shareholders nine months ago. Those who stayed on for the ride will now look to ASIC in particular to tell them whether they knew everything they were entitled to know nine months ago, when they took the board's advice and rejected the chance to accept the AMP's takeover offer.

Another person associated with GIO's original float in 1992 said: ``These mums and dads investors had no idea they were stakeholders in the highest risk, most speculative reinsurance company in the world."

GIO'S INTERNATIONAL DISASTERS*
Coming home to roost
1997-98         Canadian icestorms              $20 million
Aug     1998    Galaxy 10 satellite             ?
Sept    1998    SwissAir crash          $25 million
Sept    1998    Zenith satellite                ?
Sept    1998    Hurricane George                $166 million
Oct     1998    Hurricane Mitch         $33 million
Mar     1999    Sydney hailstorm                $43 million
May     1999    Oklahoma tornados               $20 million
Aug     1999    Turkish earthquake              ?
1997-99         Shipping losses         $48 million
1997-99         Property damage         $80 million
* The cost of the disasters to GIO
Source: GIO

© 1999 The Age

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