Collateralised reinsurance has proved to be an increasingly attractive proposition. We explore its implications with Tokio Millennium Re’s Edwin Jordan and Tokio Solution Management’s Kathleen Faries.
How are collateralised reinsurers viewed by traditional players—as competition or as an added component of the industry’s offering?
Edwin Jordan: In general I would consider them as competition, although because of restrictions due to risk appetite, aversion to reinstatements, lack of leverage, and collateral release issues, they have a limited impact. In the future as those issues are resolved, they will be a force to be reckoned with.
Kathleen Faries: It greatly depends on which reinsurer you ask. I would think that most would view this capacity as competition, especially as this market starts to move more and more away from industry loss warranties (ILW) and cat bonds and into the traditional ultimate net loss (UNL) market.
However, those of us who have already found ways to participate in this market may view it as a fast-growing part of the reinsurance landscape that can be viewed as an opportunity. Traditional reinsurers are taking a hard look at how they are pricing business in light of the fact that post-loss peaks are looking more like small hills. Will reinsurance buyers really continue to value the services and expertise that the traditional market provides or do reinsurers need to begin to reduce their expenses and services to compete with the lean capital model of collateralised re? Maybe reinsurers will take the position that they should be fairly compensated for the services and long-term stability they bring to the market. Only time will tell how this will all play out with buyers and capacity providers.
How does collateralised re compare with more traditional forms?
Jordan: When a cedant has ﬂexibility to work with the constraints of ‘collateralised re’, its stacks up well and in fact can be difﬁcult to beat. However, outside the current sweet spot for index-linked securities (ILS) investors, traditional is still king. As more investors come into the space and their risk appetite broadens, their sweet spot will expand, which will continue to squeeze out reinsurers, or at least reduce margins.
Faries: The way this capacity is viewed and operates has undergone a shift over the last couple of years. In the early days of collateralised re, reinsureds were sceptical about the longevity of this capacity. Would they be there after a major loss? Buyers are now viewing this capacity as more mainstream and more likely to be committed to the market, especially given the inﬂux of pension fund investors who typically take a longer view on the investment class.
There will always be the opportunistic investment play by some investors but overall, the perception that this capacity is short-term has changed. The big difference between collateralised re, ILS dedicated funds and traditional reinsurers is that they can approach the business with a completely different capital and expense model. It will be interesting to see if collateralised re can maintain the same model as it moves more and more into the traditional UNL space. Claims expertise, administration, multiple vendor models, and analysing unmodelled risks, are akin to writing UNL business.
How are Tokio Solution Management (TSM) and Tokio Millennium Re (TMR) involved in the space?
Jordan: I’m sure Kathleen will speak to our involvement in the past and what we are planning to do. I would like to explain why. Initially it has to do with our parent, Tokio Marine, being an insurance company that gave us the challenge of creating new markets. Now I would say that involvement is necessary to ensure our survival. The reinsurance market will continue to evolve and, to quote a line from the sports drama Moneyball, we have to “adapt or die”.
Faries: Between 2003 and October 2012, TMR has provided fronting and facilitation services to the collateralised re market. We have fronted and transformed billions of limit over that period of time. In October we announced the formation of a completely separate insurance management company called Tokio Solution Management (TSM), in addition to the formation of our own Bermuda Class III segregated accounts company called Shima Re. Both are wholly owned by TMR. This marks a renewed commitment by TMR to the servicing of the collateralised re market. We now have all critical services under one roof, with the backing of TMR and our ultimate parent Tokio Marine. We are excited about the opportunities our experience, strength and risk-taking capabilities will bring to this market.
How can traditional reinsurers get involved in the collateralised space? Are there efforts being made to bring them in?
Jordan: It seems as though every day you hear a reinsurer announce that it is forming an ILS fund. Previously, everyone seemed to be forming sidecars. Stock analysts are expressing negative views on those that aren’t participating in some way, which is acting as a catalyst for recent participants.
Faries: I have heard on more than one occasion that the majority of the reinsurers in Bermuda are exploring how they can participate in the collateralised re space or otherwise maximise their access to third party capital. Most reinsurers recognise that this capacity is not going away so they need to adjust accordingly and, ideally, expand their existing model to include a way to interact with this capital base.
What percentage of the cat market is collateralised and how do you expect this to develop?
Jordan: The percentage is actually small, but it is growing and will continue to grow. I expect some development to take place that will catapult the participation to where it becomes signiﬁcant.
Faries: The latest broker ﬁgures put the entire ILS market at about $15 billion annually. I would expect us to see continued inﬂows of capital into the space. The issue is whether investment managers can ﬁnd enough risk to deploy all the capital. We know that the cat bond market struggles to bring signiﬁcant growth to new offerings; it is $4–$7 billion of new offerings annually.
ILW are a completely opportunistic reinsurance buy for most, so it is extremely tough to forecast how much will be bought from year to year. Traditional UNL is where most of these markets will be looking to deploy new inﬂows. The question is: how much is too much and will the market be able to absorb signiﬁcant pension inﬂows? The other challenge of course is dealing with the capital cost of collateralising reinstatements in a fully collateralised model.
Traditional reinsurers have struggled to prove their worth to investors, with price to book in something of a slump. How attractive are collateralised vehicles to potential investors, what effect are they having on investment appetite in more traditional brick and mortar reinsurers and will they preclude—or become—a future class?
Jordan: Ease of entry and exit, narrow risk appetite, and lack of correlated investment risk are attractive for most investors. The main impact on traditional reinsurers is that they are trying to ﬁgure out how to generate fee income to complement their risk income.
Faries: Clearly there has been a move towards the ILS-dedicated fund structure as an attractive alternative to an equity investment in a traditional reinsurance company. The ability to move in and out of these funds and have transparency around what the investments consist of can be pretty compelling. Investing in a reinsurance company with long-tail liabilities, for example, can lead to surprises and volatility. Although these investors know that in a fund they will be exposed to cat losses, the level of uncertainty is greatly reduced if they are only exposed to cat risk with clearly deﬁned upsides and maximum downsides.
Edwin Jordan is chief underwriting ofﬁcer and chief strategy ofﬁcer at Tokio Millennium Re. He can be contacted at: email@example.com
Kathleen Faries is CEO of Tokio Solution Management. She can be contacted at: firstname.lastname@example.org
ILS, Tokio Millennium Re, Tokio Solutions Management, reinsurance