Convergence capital proved the talking point at this year’s Rendez-Vous. Bermuda:Re brought together key figures from the Bermuda market to debate its implications for the sector.
Few would contend that convergence capital is not here to stay. Its infl ux into the cat space and forays into non-cat lines suggest that its impact may yet be profound. Bermuda:Re brought together an industry panel in Monte Carlo to explore how traditional players are looking to harness, respond to, and predict the likely heading of alternative capital fl ooding into the reinsurance market.
How much is convergence capital fl avouring conversations at the Rendez-Vous, and how much of an appetite do you expect to see?
James Few: There’s no doubt that the number one topic of conversation is the changing capital supply to the industry, but that’s not anything new. It has been happening for quite some time, but the momentum is increasing and because the amount of capital coming in is sizable then clearly it’s a major topic of conversation. But as it has been happening over a number of years—all of us have been partnering with alternative capital for a number of years—we’re now seeing a broader acceptance of its role in the industry. It’s largely been accepted now that the supply of capital to this industry has changed permanently. In property cat and particularly in US property cat, there is already a considerable acceptance of the role of new forms of capital and innovative products to go with that new form of capital. It’s accepted by us as sellers and it’s what buyers are looking for. Part of the role for us as reinsurers is to bring to customers what they’re looking for with the most effi cient capital that we can.
That’s all very real and relevant, and it’s gained so much momentum that of course it’s the major topic of conversation but it’s not all we do. We’re all broad reinsurance companies that sell many different products around the world and it’s not all equally attractive to new forms of capital. I think we should remember that the new capital benefi ts from the traditional strengths of reinsurance experts such as the companies that are here today. It’s important to remember that that combination will bring the best product to the customer. It’s up to us to help to build the next development in reinsurance by partnering with alternative sources of capital.
Stephen Young: After the last few renewal seasons, we’ve seen signifi cant pricing reductions for specifi c products, including US property cat. That will drive increased interest, specifi cally in collateralised, single-shot type deals, industry loss warranties, even cat bonds where we’ve seen more issues this year than in the past. I expect conversations over the next few days will address this capital integration and the various products being introduced. This will especially be true for the property cat line of business, where these made such a signifi cant impact in our industry during the recent June/July renewal period.
Jed Rhoads: Is convergence capital here to stay? Is it a topic of conversation? Yes. Is it the only topic of conversation? We’re talking about it in part because there is a lack of other things to talk about. We could have had this conversation last year or the year before. More convergence capital has come in the market— there’s no doubt about that. Some of it is very sophisticated capital being deployed in a sophisticated way and some of it is probably naïve capital being deployed in a somewhat naïve way. But, at the end of the day, capital is capital. How is this money any different than that which was historically invested in our five companies? We all had equity investors in the past.
This capital is just coming in from a new source and being deployed in a slightly different way. It’s not as though we’ve discovered a whole new group of investors. Pension funds, hedge funds, and private equity funds have always invested in traditional reinsurers and insurers. That’s not what’s new. The manner in which it’s being deployed is new.
Kathleen Faries: It’s not new, but what is new is the ease of access that these investors have. The fact that we have investment management companies, ILS-dedicated investment management companies, there’s much easier access to the risk. I did think it’s interesting, going back to James’s point, that it is definitely mainstream but yesterday at the AM Best briefing they are still bringing up the fact that buyers are concerned about the long-term relationship they have with direct collateralised reinsurance markets.
It’s interesting that this is still part of the conversation even though it is very mainstream. On most reinsurance panels there is some element of collateralised reinsurance but there still seems to be a sense that in the back of their mind they’re thinking, “What happens if there’s a big event? Where are these investors going to go? Are they still going to be here?” I am of the opinion that there is an element that is always going to be there, that the pension money in the market is going to be sticky money.
Craig Wenzel: The point that I would draw out is how widely embraced it’s become by the traditional players. There’s a reflection that every one of our companies has had some more formal announcement in the space, or some bigger build-out along the lines of what we’re calling alternative or third party capital in the business. I do think, Jed, it’s a little bit different from what we might have talked about five years ago with extra capital coming in or out because the providers aren’t necessarily our common shareholders in the same form that they’re buying our stock and they aren’t investing in our companies the same way. It’s non-traditional investors investing into non-traditional reinsurance companies. It’s not providing equity capital to a publicly traded company; it’s providing fund capital to a collateralised reinsurance company via a transformer.
That’s a different type of reinsurance competitor. It’s not one of the traditional players coming in with lots of capacity. The value of a rating, the value of the traditional market in some ways will be proven thanks to our partners in third party capital which will draw the distinction a little more clearly. It’s smart capital. But I do actually think it’s caught the industry a little bit off guard because these are non-traditional players and what we would consider a non-traditional product.
Few: The best solution for the buyers—our customers—is a partnership of the new capital with traditional underwriting strengths. This is partly because the business of underwriting risk is much more challenging than just running a model, as we are reminded on sucha frequent basis—although it seems we do need to be reminded on a frequent basis. The traditional underwriting skills can complement technical input from modelling to advising the supply of capital of its likely risk profiles. But also I think from the buyer’s point of view—to Kathleen’s point about whether capital will be there or not be there—I think traditional companies can advise and help on that front.
Traditional companies have relationships, claims paying relationships and track records which our clients find comforting. Particularly if you’re selling multiple products to a customer, not just cat, that strengthens the overall relationship with the buyer. From my point of view the best solution for the customer, which is the way we should try to think about this, is a combination of this new capital with traditional underwriting strengths. That’s what you’re seeing with traditional companies which are responding to these trends in the market.
Are we on the cusp of profound change—let’s focus on the property cat sector—and what opportunities do you think that will usher in?
Wenzel: Profound change feels a little bit grandiose for what is effectively just more capital coming in. People in the financial services industry broadly feel that the landscape is evolving very quickly. The introduction of a different style of capital provider will require all of us to consider how best to set our capital structures and trading relationships with the market. Deciding what the customer wants to buy seems relatively straightforward to most people but actually can be a real challenge in creating an infrastructure and framework to let you do that.
There certainly has been a shift in the last 50 years in financial markets, most profoundly in how people manage capital and risk. That continues into our industry and many of the evolutions have been data-driven. Better data collection, analysis, model-driven analysis, and there’s an increase in the sophistication of the buyers as well as the sellers of protection. We all now are much more aware of the risks we have, in part the good old fashioned way—we lose money and we find out what we insured and what we had—and then in much more sophisticated ways, which I do think have a profound impact on society and how financial institutions manage capital and risk to begin with.It’s hard to say that this industry has gone through a profound change when we still sell protection and buy protection. On the other hand, if you look at what else is going on in the world, it’s very hard to think that that’s not also having an important impact on how we operate.
Faries: It’s been interesting, especially for us, given the space that I’m working in, with dedicating asset managers. Some of them are relatively new to the space so it’s been interesting to hear what they are saying versus what Tokio Millennium knows by virtue of its experience in the market. For example they may be looking at trying to put capital to work in Europe and they’re having to provide reinstatements and they’re saying things like, “Wow! It is really hard to get a return in this business!” Especially when you have to put up capital equal to the limits provided. That’s what’s profound about it—there’s going to be an evolution as investors come to the same conclusions that traditional reinsurers have known for a time: that it can be difficult to make a profit, even when you don’t have the capital model of a traditional reinsurer. So I think there’s going to be an evolution in terms of risk appetite and what these managers are ultimately deploying capital to.
The other side of that is that it’s been interesting to have the amount of competitively priced retro that’s in the market. In terms of an opportunity, a lot of very smart reinsurers have used that capacity to their advantage.
Young: There’s no question that insurers and reinsurers are seeking to take advantage of this capital, which has been around for quite a long time. There was a dramatic change in the property cat space in the middle of this year with significant price decreases in the property cat and retro markets and we saw insurers and reinsurers taking advantage of that. The question for Endurance is alignment of this capital: does is sit side-by-side with a traditional reinsurer? In our case, rather than creating a sidecar or another structure sitting next to us, we decided to buy additional retro within the current Endurance capital structure, taking advantage of the opportunity to use this capacity to reduce our exposure.
Rhoads: It’s a fairly significant change, but has been evolving for the last 20 years. I worked with Morton Lane of Lane Financial and we were talking about cat bonds 20 years ago. I don’t share Craig’s view that it has to do with data capture. Convergence is now developing at a faster pace as a result of worldwide economic conditions. In our lifetime, we have not seen interest rates this low. That is the real difference here. The pension funds are reaching for yield. In reaching for that yield, they’re looking for new places to deploy their capital. We haven’t used collateralised capital for the last 300 years because it’s an inefficient use of capital. We have surpluses and we can use that surplus many times over to write and support new deals.
So what we’re talking about here is really an untested product. It’s untested by losses; by meaningful frequency and severity of losses. So are we on the cusp of a profound change? Yes. Is it a permanentchange? I think the jury is still out. As Kathleen said, some portion of this will remain. And I agree that large amounts of new capital will continue to be invested. But will it ebb and flow over time? If we trace the history of capital invested after 2004 and 2005, when we had seven events, we see some has stuck around, while some has been disinvested. What investors are really interested in is the recycling of capital and they can’t recycle capital when it’s being used directly to collateralise obligations. On the other hand, it’s very easy to recycle it when a company has a traditional surplus and is able to keep writing on that.
Few: There are some profound changes to property cat which have come about recently. This is partly due to lower investment returns in other asset classes but also due to a couple of other factors which are just as important. One is that the benefit of diversification of the property cat asset class in particular was really well illustrated by the 2008 credit crisis, where it was obvious to the investment community that virtually every asset class they invested in was correlated except for investments in property cat. The benefit of that diversification has been a key driver for why there’s so much interest. We’re already seeing that interest spread into other insurance and reinsurance classes, particularly short or medium tail, but you could even argue it’s going towards long tail now because alternative capital is more prepared to lock up its capital in illiquid ways than it was initially. A real key driver of this interest in our sector is not just low competing asset class returns due to low interest rates, it’s the attraction of the diversification.
One of the other profound changes is that because there is so much supply there’s pressure on price and rate. There has been a commoditisation of cat which I think has gone too far—actually cat underwriting is quite difficult to get right and it’s not something you can outsource to a vendor model. There is a real risk that the rates have gone to a level where some of this capital can find returns very uncomfortable for them. But do I think that would lead to a significant exit of capital from our sector? Unfortunately not.
It might be the case that if there are some shock losses, some players who have come into the market could leave. Perhaps there is some naïve capital. But a lot of the capital that’s coming in is not naïve. It does understand volatility. It may not appreciate the finer points of price, but instead of leaving would say, “I still like your diversification but now I want a higher price.” If capacity does leave there will be at least that much and more prepared to double down after an event. That could be Aspen doubling down or it could be new third party capital, hedge funds suddenly become more interested again. There’s profound change in the selling of property cat. It’s increasing commoditisation, it’s probably a change to the shape of the cycle and it’s a lowering of price, which at the moment I’m concerned about.
Rhoads: Some smart people on the capital markets side looked at the reinsurance industry and determined where the best profits been made historically. And it’s clear they’ve been made on the cat side. Brokers have changed their model to focus less on casualty over the last 10 years or so and focused more on property cat, because that’s where the margins are. The same thing is true with reinsurance companies. They haven’t been on the specialty side or the casualty side and smart money figured that out.
Wenzel: I take Jed’s point about how it’s not just models and data, although I think the perceived commoditisation of cat has come in part because we’re all using very similar vendor models and holding capital and reporting capital to rating agencies—and now our equity analysts use our reported PMLs to determine what our capacity is to write post event or after a model change. That creates a pretty level playing field as investors. They have very similar access to the models and are using pricing mechanisms that aren’t that dissimilar to how we may be looking at risk and return. It’s on us to figure out the correct capital structure and how best to play with all of the different parties there, but some of the commoditisation has come about because of that technology change.
Now you have ways for investors who previously weren’t able to take advantage of the asset class being able to do so. The broad strokes are that retirement assets need to deploy into alternative assets and property cat happens to be one of the lower correlated alternative assets out there with a pretty straightforward way of getting into the space.
Rhoads: There’s a perceived levelling with the models and the data. But models are a little like handguns. You can give one to a five-yearold boy and an identical one to a 50-year-old man. They can both fire the guns, but one generally fires with a little more accuracy than the other. Right now we’re giving handguns to five-year-olds—they believe they can use the models and the data with some level of sophistication. That belies the underlying fact that, as experienced underwriters, we bring something more to the table. We know how to use the models as baselines, benchmarks, and not just blindly accept them, because we know they’ve been wrong in the past.
Young: We have spent a lot of time analysing models and really working to understand the exposures we underwrite. It’s not just about plugging a set of data into a model and spitting out a number. It’s about bringing our underwriting, claims and analytical knowledge and experience to bear to really understand the underlying risk.
Faries: But here’s the thing: all of those things cost money. The concern is how do traditional reinsurers survive the next few years, especially if there’s not a big event. The capital model is completely different from a traditional reinsurer’s. Deloitte came out with the estimate that Solvency II is going to cost European reinsurers $9 billion. These are costs that traditional reinsurers have to bear which dedicated ILS funds and investors don’t incur. I guess I’m asking a question: what’s the plan, right? Because you have to survive. You have to somehow compete in that environment.
Young: Traditional reinsurers have to use this alternative capital in different ways. We need to adjust our capital structures and balance sheets to take advantage of it.
Few: We need to do a better job of selling the strengths of traditional reinsurance, providing much more than just the bare modelled outcome. It’s about understanding the overall relationship with that customer and all of the other products that customer is looking for, and the ability to pay claims, to advise on claims, to advise on loss trends in the industry or new risks in the industry. The traditional reinsurance market has done a fabulous job for buyers of protection and has proven it time and time again. However, we’re not very good at marketing ourselves, perhaps because we haven’t particularly had to.
The reality today is that the traditional reinsurance market needs to step up and make very valid points that the buyers will hear about why combining the strengths of traditional reinsurance and alternative capital is the right way forward. As Jed said earlier, we’ve always drawn from the capital markets to run our businesses. If the capital markets are now interested in supplying a cheaper form of capital then we need to work out how to harness that. And that’s what we’re doing. We all have asset management businesses and that’s a trend that needs to continue.
"One obvious place that product innovation might take place or where this captial might find a home is with foreign governments."
Rhoads: Part of the reason the traditional market has been around for so long is that it seems as though every time we have a major event there are contract interpretation issues that lead to parties wondering whether the losses are covered or not. The traditional market has done a good job of being flexible and saying, “You know what? Maybe by the letter of the contract that wasn’t covered but we’re going to pay it. We have a relationship.” Our experience with some of this convergence capital is that the approach is pretty legalistic. If an event is technically not covered, why would they pay the claim? With convergence capital, we’ve got to be a little bit careful about how it gets deployed, because if a lawsuit is filed every time a loss isn’t covered, convergence capital is going to have a very short shelf life. When buyers have a loss, they want it covered if it falls within the spirit of the contract, even if not strictly within the letter of the contract.
What about potential opportunities to bring new risks into the commercial insurance and reinsurance space? What role do you think the capital markets can play in working with traditional reinsurers to do this?
Young: We did see an interesting new structure—a storm surge bond [MetroCat]—among the many cat bonds this year. I expect we will see new risks being covered, as well as some new views on the risks that we currently cover, although less so in the casualty lines.
Few: One of the weaknesses of traditional reinsurance is that it’s perhaps a little complacent in terms of product development. One thing newer suppliers of capital have shown is that they can be very innovative in terms of product design. We might say that it’s been overly broad or under-priced and we could argue about the details, but what we can’t argue about is that it has been more innovative and customers find that attractive. From a traditional reinsurance point of view it would be good for our industry to try to think of ways in which we can continue that strain of innovation to help grow demand. Demand for reinsurance is not growing as fast as we would like. Therefore innovative ways in which we can increase demand for our products is a good thing. One of the positives that has come out of new capital is that it has probably shaken the traditional market into thinking a little more deeply.
Young: Certainly from a structuring perspective that’s happened. In this last renewal cycle, we saw several new structures introduced into the market. While some of the features included this year were replicated from prior years, they proved a little more challenging for traditional reinsurers. Some of the funds or collateralised reinsurers were able to take advantage of that, even though traditional reinsurers were very much in the mix.
Wenzel: Capital flows to opportunity. The more we’re able to innovate around our products and bring underwriting skills and distribution and knowledge to capital then we’ll have success in bringing more products to the capital markets providers. Third party capital has advantages in scale, in credit quality and potentially in speed of access that the traditional market may not be able to match. There are plenty of risks out there that the traditional market doesn’t cover well. That’s a fantastic opportunity. More capital to provide cover for risks is out there. If structured intelligently and where the buyers are interested in buying that protection, capital providers can help solve the big problems out there that we may not be well equipped to deal with ourselves.
Rhoads: One obvious place that product innovation might take place or where this capital might find a home is with foreign governments. This is an area underserved by traditional reinsurers, but there’s a huge demand. A lot of foreign governments are susceptible to natural perils, and they are major concerns for fragile economies. I could see convergence capital fi nding a home there. Granted, the available exposure data is not always as good as we are used to and the demand is not there from the consumer, but the demand is there from governments. Governments need stability. When they get hit with cat events on a regular basis and need to keep rebuilding homes, schools and hospitals, they need a source of capital to fall back on. Convergence capital may be able to fulfi l this need, fi nding a new home and meeting demand at the same time.
Faries: There are many in the structuring side of the business that have been trying to do this for a long time. There’s been talk about how we increase the uptake on earthquake in California, how do we get more governments to purchase parametric or index covers? It’s going to be diffi cult to keep up with the demand from investors. Certainly if they were able to do it they would have done it. There are a lot of people working hard on it, but it’s a diffi cult nut to crack.
Few: One issue we can look at further is those areas of our industry where governments have become involved and where in some cases, this is not always in the best interests of the buyer. Flood is a good example. Governments have provided solutions for a variety of reasons but when it comes to actually paying claims to the ultimate customer it doesn’t always work very effi ciently. The industry is in a good position to go out and make a strong case for why private re/insurance solutions should return to that space and provide customers with a more robust, workable solution. That might be in partnership with new forms of capital but I think the source of capital is less relevant than the fact that the private solution can be provided.
We don’t have to go to emerging economies—although Jed’s point is valid—there are large opportunities in highly developed markets where government solutions have proved to be inefficient or not the best solution for the ultimate customer. The industry should be more forceful about making the case for a private solution for those perils. That could result in material industry growth, but it requires political will.
If you look at the US as an example, the results of the NFIP service provided by the government have not been good on any level,whether that be through providing support to ultimate customers or providing risk management advice and trying to manage risk or about simply funding the claims through adequate payment of premium. The NFIP’s current balance is tens of billions in the red and we’re still looking at multiple exposures which we all know are facing signifi cant fl ood risk with inadequate premium. This isn’t in anyone’s interests, and certainly not the taxpayer’s. The private solution is a compelling argument, but it does take political will and we need to work with governments to try and make the case.
Young: Yes, it will take political will on both sides. Traditional reinsurers need to step up as well and indicate that we are prepared to analyse and understand this risk and government needs to actually be willing to make changes which they’ve pulled back from, even since Sandy. Both sides need to come together in a more collaborative way.
What approaches are reinsurers taking to positioning themselves to maximise their competitive position in the current environment?
"We view third party captial as a partnership and are focused on marrying underwriting with investment management expertise."
Faries: As you know Tokio Millennium has been in the space for quite a long time, since about 2003, but more on the service side. So we haven’t really been managing capital but we’ve been facilitating capital coming into the market by fronting and providing certain types of leverage for investors. There is certainly pressure, given what a lot of the other reinsurers are doing, to at least look at managing capital. We are exploring this topic internally, but there are challenges. For a reinsurer, confl ict of interest is a real issue. For a conservative company like Tokio Marine and Tokio Millennium Re those are issues that there’s been a lot of discussion about and they have to be handled properly before we would move into the space. It’s really more about a partnership for us right now. The theme I’m hearing is that in order to be successful there needs to be a mix of the resources of a traditional reinsurer and the capital.
Rhoads: I’m working under new ownership at Markel and the mandate is very clear, which is don’t change what you’ve been doing. Access the capital and manage the capital, whether it’s our own or someone else’s. But at the end of the day the message that’s also very clear from Markel is, don’t compromise underwriting integrity. Because at the end of the day, whether you’re competing in the traditional market or the new convergence market, if you produce poor results, it reflects on the firm, it reflects on your credibility and your underwriting ability as well. Their view is that we should be competitive in both spaces. Well, how do you do that? In a traditionalmarket, you can be competitive by offering multiyear contracts. The new convergence capital hates long-term tie-up. This is a way you can compete against it on the traditional side.
The new capital hates to cover man-made perils. They like natural catastrophe perils, because allegedly that’s the non-correlating part with their own portfolio. So you can expand the coverage a little bit to include terrorism and other things that the capital markets don’t like. Reinstatements: the capital markets don’t tend to focus on the same economic metric as we do. Traditional reinsurers like to focus on return on equity and return on capital (ROC). New convergence capital likes to focus on internal rate of return (IRR), which hinges on the time value of money; so they’re competing on very different performance metrics. So, to be good at what we do in the nontraditional space, we have to be focused on IRR and, in the traditional space we have to focus on ROC.
You try to be the best-in-class in different spaces, utilising the particular strengths and weaknesses of those capital providers that bring the business to us. Clearly where we provide collateralised cover, one of the ways you compete there is security. Collateralised security is better than AAA security. The client has the ability to draw down that money any time that they think they’ve got a contractual loss. That provides a very meaningful source of cash flow. The client doesn’t want to get into a debate with a reinsurer about whether something is covered; they can draw the cash down from the convergence capital and ask questions later. They may end up in a suit, but they’re holding on to the capital that’s covering their immediate needs. That’s a huge advantage for the capital markets.
Young: From our perspective, it’s really about maximising the capital that is coming into the market. We see an inherent conflict in having multiple underwriting structures, and instead have elected to align this capital within the company. Endurance is bringing capital in behind us, not just the alternative capital but multiple quota shares as well so that we present one unifi ed face to the customer and our long-term partners. This year, we also made some signifi cant retro purchases for specifi c perils which we felt were good deals, from a price perspective. Our approach is to maximise this alternative capital coming in, align it within our company and take full advantage of the opportunity this capital offers.
Wenzel: We view third party capital as a partnership and are focused on marrying underwriting with investment management expertise. We’re acutely aware of concerns around conflict of interest. There’s a focus on our relationship with the market as well as with our investors. That’s why we’ve chosen to partner in the way we have, to make sure that we had independence and validation with the capital. We felt that was a really important component in managing some of those confl icts both internally and externally and that it was a superior proposition.
Our language also needs to change in terms of how well we describe the value proposition. It needs to emerge in our relations with our shareholders, ratings agencies and equity analysts. We don’tnecessarily do the best job of differentiating how we’ve built our businesses and the value they provide. How do you do a good job of managing IRRs as well as underwriting? And how do you make sure you partner with capital that fits in your structures? It will be interesting to see how we learn to communicate this message. It’s how we all execute and bring that capital into that partnership and that dialogue that will be the competitive advantage.
Few: We’re in the business of providing professional reinsurance solutions to buyers of reinsurance. We are trying to keep up with a trend of what customers want and to provide the most efficient forms of capital to support those products. Our first partnership with alternative capital was in 2007, where we invested in and provided services to a managed fund for fees. The fund provided collateralised ILS products. That was a nice move for us, not just to keep customers happy but also to generate fee income. But the world has changed dramatically since 2007. So this year, we formed Aspen Capital Markets and we’re now building a fully-fledged asset manager to help us partner with all sorts of sources of capital. It seems to me that over time reinsurance businesses are indeed going to be asset managers, if we’re not already.
A more professional approach to managing capital through an asset management structure will be part of the reinsurance solution. The asset management part of our business won’t be everything Aspen Re does, but it certainly is an increasing proportion of what we do. We’re selling expertise, added value services and distribution. The way in which the capital is supporting all of that expertise is changing, hence we’re building an asset management business which is itself a valuable asset. When supply and demand are out of kilter—and I think they are at the moment for property cat—as experts in this space we’re more likely to become a buyer ourselves. To Stephen’s point, utilising retro, where coverage has become too broad or prices have become too low, makes sense. We can switch from being a seller to a buyer. That can sometimes be a short-term hedge but it can’t be sustainable over the long term if we’re correct in thinking that the price is incorrect. Our role is to help that capital get the product offering right and a fair offering for both the buyer and the seller.
Do you think that alternative capital will make itself into longer tail lines?
Few: It wasn’t long ago that we were talking about these new forms of capital only for named peril peak zone property cat. In recent times that has rapidly developed, not just to named perils peak zone US property cat but into a much broader approach to cat risk in general, multiple and different ways of accessing it, multiple and different products. We’re now seeing considerable interest in other classes in insurance and reinsurance, driven by the diversification benefit and the fact that the supply of new capital is bigger than the cat market can meet. There’s more interest in diversification than the cat market alone can supply, so it’s naturally asking what else we’ve got. That is already evidenced in short tail, medium tail, specialty risk, which is attractive to certain capital providers.
It’s not impossible for longer tail business to become a part of this trend and we’re keeping a close eye on that. It’s harder in the short term because of the illiquidity of supporting something with a long tail. However, we are increasingly seeing that alternative capital is prepared to tie up its resources for a longer period of time, whether that be through supporting an actual rated entity or in other ways. They’re attracted by the diversification and the fact that if you’re a pension fund it’s still only 0.5 percent or less of your assets. It would be overly optimistic to say that our long tail business is not also at some point going to be affected by this market change. But it’s going to take a bit more time.
Young: It will happen, but it will take more time as the lockup for long tail lines is going to be difficult for some investors and capital providers. Some of them want to be on risk only for the hurricane season and are providing capacity only for that six month period. Longer tail lines will take more time for them to understand, but I definitely see them getting into specialty short tail and medium tail.
Rhoads: Some companies would claim that convergence capital has already come to the long-tail space. The question here is whether there is a direct or indirect impact to this convergence capital. The indirect impact is for all of us with traditional multi-line business, some of the traditional capital is getting refocused on specialty and casualty lines as we see our property returns starting to get dumbed down with the imbalance of supply and demand for capital on short tail lines. The direct impact will develop over time. But if you think about time value of money and IRR, it’s a much harder nut to crack on the longer tails side. This convergence capital likes the flexibility of getting in and out quickly. That’s one of its advantages, but also one of its weaknesses.
Faries: There are investors in the market that are looking to use their existing assets which are not all AAA treasuries, and use these assets as collateral against these long tail risks. This speaks to what the chairman of Lloyd’s was saying about potential systemic risk. What they’re trying to do is convince people to take these baskets of assets, which could very well lose their value—think Lehman and total return swaps—against long tail line limits that could be exposed over many years. I tend to agree with John Nelson with regard to casualty lines, there could be a detachment building.
Wenzel: Many could argue that long tail lines are already in a direct or indirect reaction to alternative capacity. A more formal entrance into the space is going to take a lot more time. There are a greater number of complexities involved, not least of which is figuring out how to package it.
Bermuda:Re Roundtable, Kathleen Fairies, Stephen Young, Craig Wenzel, Jed Rhoads, James Few, Aspen Re, Markel Re, Tokio Millennium Solutions, XL Group