European exposures
The cold Europe contracted back in 2008 lingers wilfully on in Greece and southern Europe, despite a lengthening procession of EU bail-outs. Europe’s capital markets remain jittery and the prospect of a renewed crisis in Europe still looms large. However, despite precarious European macroeconomic conditions, Bermuda reinsurers remain bullish about their exposures to the crisis in the eurozone. As Marty Becker, chief executive officer of Alterra, and James Few, president of Aspen Re, indicated, neither company has significant exposures in Europe—and this appears true of the wider Bermuda market.
Charles Dupplin, chief executive officer of Hiscox, Bermuda, said that “for Bermuda, most of the business is focused on US catastrophe risk and is US dollar-denominated, so looking at it narrowly, events in Europe are not a huge concern for Bermuda reinsurers”. He admitted that there were exposures related to European windstorm, but added that European re/insurers faced far greater exposure on such lines.Becker concurred, adding that recent price competitiveness in Europe had proved fortunate, with many Bermuda players having shied away from business that had simply been “too cheap”.
On the investment side, Bermuda re/insurers find themselves, again, far better positioned than their European counterparts. “Domestic European re/insurers naturally have a high concentration of bonds from their home market and surrounding territories, so have a much bigger asset concern than Bermuda companies,” said Becker. For their part, Bermuda reinsurers such as Aspen Re have only a “relatively modest exposure to eurozone investments, with Aspen’s sovereign debt holdings within the eurozone limited to the stronger participants, including France and Germany”, said Few. Becker spoke in a similar vein, indicating that the bonds Alterra holds “are in the larger, more stable economies”. Such a situation would suggest that European concerns, while troubling, are unlikely to have major implications for Bermuda reinsurance.
Counterparty concerns
For those European and global reinsurers with exposures to debt issued by one or more of the GIIPS countries (Greece, Ireland, Italy, Portugal and Spain), however, there are significantly greater risks. Dupplin indicated that there is considerable ongoing research regarding the exposures of financial institutions’ balance sheets to GIIPS sovereign debt. And it seems that a number of major European insurers—Allianz, AXA, Generali and Mapfre—all find themselves caught in the firing line. Mapfre and Generali both hold more than 100 percent of GIIPS-exposed shareholder equity, while Allianz and AXA hold 80 and 70 percent, respectively, said Dupplin.
The situation is grave for those concerned and a matter of some concern for their reinsurance partners. “We trade with these people and they are old and trusted clients and friends,” he said. Nevertheless there are opportunities: the situation is likely to oblige some European insurers to buy more reinsurance. “It is a fascinating world,” Dupplin said, and undoubtedly the dynamic will be watched with interest.
Meanwhile, the threat of counterparty risk remains a significant concern. As Becker indicated “we are monitoring counterparty exposures very closely”. Much will depend on how the crisis develops. Should it deepen, there are likely to be more “situations where collateral may be imposed, and greater scrutiny of the underlying security in a stress test scenario will occur”. Few added that reinsurers face indirect exposure to sovereign debt “through their holdings in European banks, themselves large lenders to national governments”. Attention needs to be paid by re/insurers to with whom their euros are banked, and when there is a significant amount of the currency, that it “isn’t all in the same bucket”, said Dupplin. The Aspen group, for its part, has adopted a policy that limits its exposure to debt issued by eurozone banks to existing holdings which European re/insurance business and is currently “against further investment in these instruments”.
Dupplin added that reinsurers need to be cautious about counterparty relationships, suggesting the industry would be prudent in taking a “gunshy approach to those companies not regarded as being in rude health”. Nevertheless, within the wider context of counterparty exposures, Bermuda reinsurers remain well-positioned. As Dupplin made clear: “I would be surprised if any of the Bermuda players were having quite as miserable a time as some of the European insurers and reinsurers.”
An underwriting challenge
Conditions have encouraged reinsurers to take a more cautious approach to underwriting. Dupplin said that the industry will have to pay close attention to the payment of premiums, because if the particular position of a company deteriorates sufficiently “you might find you aren’t being paid”.
Few added that “aside from the obvious impact of weaker demand, an economic downturn can produce certain effects which re/insurers need to be careful to monitor and mitigate.” For example, owners of commercial property may be tempted to reduce investment in risk management and risks of “moral hazard” may arise, he said. In its efforts to manage the cycle and Europe’s stiff economic headwind, Few said that Aspen Re has “cut back on lower-attaching layers in order to avoid higher-frequency losses in our property reinsurance excess of loss book—a prudent approach, particularly when a soft market is combined with a weak economy”. Dupplin was more reflective, arguing that the “risks of European windstorm are the same regardless of economic circumstances”, but it seems clear that Bermuda reinsurers will have to watch closely as conditions develop.
Greek drama
At the same time, euro-denominated business places its own particular demands on global re/insurers, with Dupplin and Nicolas Papadopoulo, president and chief executive officer of Arch Re, arguing that asset-liability matching presents a particular challenge in the current environment. Papadopoulo said that there had always been an assumption by the market that all euro bonds were equivalent, but that the new economic reality had revealed this to be untrue. Whereas in the past some euro-denominated assets had been matched “indiscriminately to reserve liabilities from any other European country”, he suggested that the prudent approach today is to “match reserve liabilities with assets from the more secure European countries or corporate risks within the eurozone”.
Addressing a possible Greek or other GIIPS exit from the euro, Papadopoulo said that the resulting “likely devaluation of that country’s currency could have a significant and unpredictable impact on liabilities assumed by reinsurers under contracts covering risks or cedants in that country”. He said that devaluation would “not be likely to translate into a one-for-one reduction of the ground-up liability for the risk reinsured”. At the same time, there would also be the potential for exposure to “more frequent losses than contemplated when the contract was underwritten”.
On the flipside, Papadopoulo suggested that “reinsurance premium paid prior to the devaluation would be worth more, counterbalancing the impact somewhat”. Nevertheless, he argued that reinsurers would need to consider asset-liability matching on a case-by-case basis. “What is striking is the lack of any contract clauses dealing with the possible situation discussed. This is not a new phenomenon, but unfortunately our industry prefers to deal with wording interpretations post-loss as opposed to ahead of time,” Papadopoulo concluded.
Not all bad news
Despite wider economic concerns and the risks presented by counterparty risk and euro-denominated business there are, nevertheless, opportunities in the eurozone. Asked whether the crisis had dampened the appeal of European business, Papadopoulo said the answer is “clearly ‘no’”. Becker concurred, indicating that current conditions “may force a re-pricing of risk in Europe and make it more attractive for reinsurers to write European business”. Another positive dynamic will be that of insurers purchasing more reinsurance—“a theme that was already beginning to emerge with the implementation of Solvency II”, said Becker. He said that many firms—Alterra included—had opened up offices in Europe in anticipation of such opportunities and that should there be a “deterioration on the asset side, it is only going to amplify that discussion”. Papadopoulo spoke in a similar vein, arguing that with limited access to the financial markets, many cedants would be obliged to pursue reinsurance in order to reduce regulatory and rating agency capital.
"Another positive dynamic will be that of insurers purchasing more reinsurance-- 'a theme that was already beginning to emerge with the implementation of Solvency II.'"
Another current discussion is whether the timing is right for further engagement in Europe. For Dupplin, “with casualties in euroland possible, entry into Lloyd’s or Europe might look like a potential opportunity for some Bermuda players”, although he admitted that the precise timing of entry might prove troublesome. Becker, likewise, indicated that for those that “aren’t heavily involved at the moment, present conditions would probably encourage more involvement”. For those concentrated in Europe, much will depend on how their “particular capital adequacy situation ends up”. For those particular players, the eventual outcome of the eurozone crisis will be pivotal.
Few indicated that the attractions of European business in the present environment “very much depend on the line of business concerned”. He said that diverse specialty players agile enough to switch between profitable segments can find themselves a “profitable niche”, citing trade credit reinsurance—a line where conditions rapidly adapt—as a case in point. “Aspen Re saw an opportunity to support a small number of specialist insurers with credit reinsurance at a time when few of our peers shared our risk appetite for the line”, with the reinsurer benefiting from a string of hard markets in 2009, 2010 and 2011.
There was, however, a note of caution. As Few made clear, following recent rating actions “the definition of ‘risk-free’ is ever-changing” and the threat of contagion from Greece remains a very real prospect. And despite the relative detachment of Bermuda reinsurers, Becker was clear that “should the eurozone deteriorate as radically as some people forecast, then everywhere in the world will be impacted to some degree, so Bermuda may well not be immune”. Despite Bermuda’s position, eyes are unlikely to shift from developments in Europe.
