Rising to the challenge (AXIS Capital)
What do you perceive as being the main challenges facing your business and the reinsurance industry as a whole?
On the cat side of the business, we had a lot of frequency outside of the United States and Western Europe in 2010, and generally a poor year as a result. On the property side, the challenges relate to the methods and tools we use to price business. And it’s not just the cat tools, but the availability and accuracy of those tools in territories that are relatively small—New Zealand and Chile being good examples— where there hasn’t really been a major driver to develop more robust models due to the size of the economies and limited loss data. As a result, insurers have not typically demanded as much model coverage as they would in Europe or the United States in terms of studies, scientific models or more complete tool building on the modelling side, which has meant that cat risk assessments in those territories have been particularly difficult. With these smaller territories experiencing major cats in 2010, modelling ‘gaps’ have raised evident concerns for the industry.
One of the other big challenges is dealing with all the pricing tools that we need in order to operate functionally across a host of global markets. This represents an ongoing challenge, both for property and casualty. Meanwhile, investment income returns as they relate to longer tail lines of business can represent something of a challenge if you are not as aggressive as others in terms of recognising future investment income. The casualty market has not reacted to the decline in investment income over the last two years anywhere near to the extent that it needs to, and the issue remains an ongoing challenge for the sector.
Then there's Solvency II, and all of the scrutiny and infrastructure demands that brings. This is particularly the case in the Bermuda market where a lot of the liens of business are not the standard, homogenous lines that make up the vast majority of insurance premiums around the world. They tend to be the more volatile and more challenging to price and measure. This puts an additional burden on the Bermuda market in respect to incorporating the products that we underwrite into the robust capital modelling tools set out Solvency II.
Many commentators are talking about the persistence of a soft market. What are your feelings about a possible turn in the market and what do you think might prompt such an event?
I think that when we begin to lose money on standard lines of business, and when investment yields are no longer there and we have to rely on an underwriting side that does not move, then we are going to see demands from investors for consolidation or price increases to justify the capital they have committed to the insurance business.
In all likelihood, a turn will be prompted by a combination of things. It is easy to say that a huge cat event will change the market, but it would need to be an enormous event in order to grab people's attention and drive the property line of business. But there is also an awful lot of non-property business out there that needs to generate an appropriate return as well. That's often driven by investment income, and by changes in social and cultural norms that lead to legal changes and the way the legal code is applied, so there are a combination of factors that need to occcur to prompt a turn.
Looking forward, are you considering greater diversification as conditions improve?
Growth is going to be challenging. At AXIS, we continue to have the perspective that in the reinsurance business, organic growth is the way to go. Acquisitions were carried out by a couple of players a few years ago, but they were in a different position to us and were trying to get their captial base upsized. I don't think they did it specifically for the business they were acquiring.
In most cases, if you have people in place and a reasonable rating, you can acquire the business organically. Frankly, when you buy a company that business does not belong to the purchased entity, rather you will have persuade the brokers and/or the ceding companies that they want to allocate that business to you as a counterparty. I’m not particularly enthused by growing through anything less than organic growth, so we add teams where we see opportunities and try to focus on territories where we still have a relatively small market share but perceive opportunities.
The emerging markets are small, but people are excited by them because they have enormous underlying growth potential. However, you have to remind yourself occasionally that in treaty reinsurance we are basically providing capital to these companies, and in these emerging markets, there is a certain skill-set and willingness to be risk-bearers that is still missing in many territories. Many small companies learn to behave like agencies—they don’t really bear much risk, they cede it away through proportional arrangements or through smaller excess of loss arrangements. At one time, proportional arrangements made sense, when they were tariff-rated markets that maybe had some history of profitability, but as those companies grow and mature, they should be in the position to assume more risk. The proportional cessions will go away, such as happened in the United States and Europe, leaving you with an excess of loss market that requires better and more significant data.
I don’t feel an enormous urgency to have a bigger operation in Asia to write what is not a large market, so I think our growth will be within Europe and the United States, where we still have room to expand our market share. We are not looking to grow just for the sake of growth, but rather are waiting for the opportunity to achieve profitable growth.
How has the role of CEO changed in recent years?
I don’t think the function of the CEO has changed much except perhaps for the demand that you become more technical. You can overcome that with a strong enough personality—someone who is a super coach, cheerleader and manager—but it also depends upon the type of business you have. If your business is all about process, or more of a ‘machine’ if you will—versus a historical Lloyd’s model, which was much more of a trading floor model—a more technical skill-set will prove an advantage. For a lot of companies here, the starting point was the trading floor and, as the companies matured, the trading floor became a component part of the business, not its entirety. Here at AXIS, we are in the process of gravitating from a trading floor mentality to one that’s more machine-like and process-driven.
What’s your feeling on the possibility of M&A activity in the Bermuda market?
I hope it happens, frankly. It would be healthier to have fewer players here. There are a few too many people chasing what’s certainly not been a growing pie over the last year or so. We could do with a few of the smaller players consolidating. Typically, this means that they will be stronger in their underwriting discipline and that’s good for all of us in the marketplace. While I do want it to occur, I don’t see any particular role for AXIS in the process. I think it is other players whoneed to consider such a move and who need to make sure that they have sufficient critical mass to continue to trade through.
How are your preparations for Solvency II faring and what have been the major lessons from the process?
I think the major lessons have been that it has been more work than we thought. And as I said before, the general complexity of the Bermuda market is fairly high—particularly for those in the broader global business covering a range of lines. A lot of things need to be built, not just to satisfy your own internal demands, but also to satisfy Solvency II. I wouldn’t say that we underestimated the regulatory demands—we have thrown a lot and continue to throw a lot of resources at it—but it’s a big process and anyone who’s waiting until the last minute is going to have a nasty surprise. It is not just building the models, but it is integrating the process into everyday decision-making. Depending upon where you are in that transition from trading floor to process-driven ‘machine’ will make it harder or easier to implement these measures.
What is the major value-added in Solvency II beyond the capital requirements themselves?
The biggest benefit is that everybody in the organisation has to think about taking, managing and pricing risk, because it all gets wrapped up in the capital models that are drivers of a lot of what we do. And we need to be able to show that the decisions we make are driven by the results of that model. There is an education that is going on for all of the underwriters regarding thinking about risk. Ten years ago, the word ‘capital’ was almost never used outside the chief financial officer’s suite, whereas now it is a common part of the language used in the underwriting areas—what’s the return on capital, what’s the capital you are putting at risk. The way people are talking about risk all comes back to this concept of leveraging capital and how to do it efficiently. People may have been doing that in one way or another in prior years, but now it’s all starting to crystallise.
Everyone needs to understand how the capital base is put to work, both on the investment side and the underwriting side, what the implications are of writing new lines of business—down to how much capital it consumes or why certain loss ratios are acceptable or not— based not just on instinctive underwriting decisions, but on the returns and the longevity of associated reserves. There’s a whole myriad of things that were handled in the past in a less robust way, but we are now going to have more robust tools that are going to force us all to understand such demands within a more technical framework.
Does this nudge companies in the direction of the more ‘process-driven’ approach that you were talking about?
Absolutely. I don’t see how you can get around it. The whole process is pushing everyone towards such an approach and there is a downside to that. The machine model that can be criticised on the cat side does aim to capture the extreme detail and complexity of such events, butat the same time, they are regularly proved wrong after an event. Maybe the problem is that no one should have considered them right to begin with. They are just directional indicators.
We will have to continually update our assumptions as the cat models themselves develop, based on new findings and the frameworks within which we operate. The risk is that the creativity historically associated with the Lloyd’s approach, this willingness to try to assess any type of risk that might come your way, might disappear and that’s not necessarily a good thing.
How is AXIS looking to utilise its excess capital?
If you look at what we have done for the last year and a half, it is buy back shares in the open market at prices well below our book value. We are a conservative company and are confident that our book value is sound and that repurchasing shares is a wonderful investment of capital, especially when the underwriting climate is more challenging.
Others have suggested that share buy-backs might cause problems in the future if there is a major catastrophe in the market and there is a need to acquire capital quickly from the market.
You can’t have everything. Certainly by using your capital to buy back shares, it makes the capital less available should you need it, but you have to balance who your stakeholders are. If we had thought there were immediate opportunities to put that capital to use on the underwriting side in a more robust way than what we are getting from buying back shares, we would have done so. But remember, in the Bermuda market, shares are trading at, in some cases, 60 percent of book value—in our case, in the eighties and nineties—and that is a tremendous guaranteed return on buy-backs that I don’t think we could replicate elsewhere. Yes, if you take it too far and you have very little additional cushion to work with post an event, it could be problematic, but it’s just as problematic if you do nothing and sit on excess capital that you have not returned to your shareholders. It seems there’s no easy answer.
