on catastrophe reserves to improve domestic insurance and international reinsurance markets, Bermuda's insurance industry was told yesterday.

Mr. Ian Heap, head of Bermuda's new $350 million property catastrophe reinsurer Mid Ocean Re., said: "Fresh thought on these issues of catastrophe reserves is critical to the commitment of both existing capacity and to the attraction of new capital and capacity.'' There was currently a chronic lack of capital in the market and a severe imbalance between supply and demand of catastrophe reinsurance, said Mr. Heap, whose company was formed as a direct result of this shortage of capacity.

"It is an imbalance greater in 1993 than it was in 1992 and there is no good reason to believe that the situation is getting better,'' he told guests at a Bermuda Insurance Institute luncheon.

"In a free market with an ability to price a product fairly, there should eventually emerge a balance between supply and demand, all other things being equal.

"But other elements need to be changed in the property catastrophe market with new capital being a necessary ingredient.

"The negatives of volatile annual earnings subject to taxation and the accounting prohibition on contingency reserves are deterrents to the commitment of capital to a business which has been and will be inherently profitable.'' An insurance product with loss frequency and large volume can be priced on an annual premium basis, he said.

However, a product without frequency but with a random severity needed to be priced over a longer period and there was a need to provide reserves for the random severity.

"Accounting principles do not allow the creation of tax free contingency reserves and absent a reserve in a catastrophe loss-free year the apparent underwriting profit falls into tax,'' he said.

"This is a business which historically has had more years free of loss than years with loss. So Bermuda becomes an attractive domicile for a property catastrophe reinsurer because short term underwriting profit in the catastrophe free years will not be taxed here.

"And while Mid Ocean Reinsurance Company will use US Gaap accounting and will not post contingency catastrophe reserves, there will be retained earnings as a surrogate for those reserves.'' Insurers in the US needed to get stronger prices for their product and tax and accounting issues must be addressed before the inflow of capital and capacity grows and ceding companies' needs for protection are met,'' he said.

The worldwide capacity for property catastrophe in the broker market has gone down by 20 percent over the last two years, with the important London market being drastically reduced by 40 about percent, said Mr. Heap.

"A contributing element has been a drastic reduction in retrocessional capacity, which is about half of what it was two years ago,'' he added.

"This underwriting retreat in the US market has occurred notwithstanding an increase in ceding company retentions of 200 percent and an increase in property catastrophe reinsurance premium income of over 220 percent in the last decade.

"The average increase in property catastrophe reinsurance premiums for a unit of exposure has been even greater in some other markets, with a 400 percent increase in the UK and a 700 percent increase in Japan over the last two years.

"These are terms which should produce underwriting profits over time and which should be attractive to new capital investors.'' Mr. Heap added: "All one can say at a time like this is that the property catastrophe market does have problems -- but someone's problem is usually someone else's opportunity and, at Mid Ocean Reinsurance, we certainly see these times as our opportunity.''