Bermuda:Re spoke with leading figures from the market and asked their views on five key issues challenging the market from rising convergence capital to the value of emerging markets.
Is convergence capital likely to be—when all the chips are down—a ‘marriage of inconvenience’ for the industry?
Jerome Faure: We’ve seen an influx of capital this year into the property cat market, particularly for the June 1 Florida renewals, that is starting to impact on the pricing of the reinsurance product. This is very different from past experience where the capital markets had limited impact on the price of the product itself, even where they had substantial participation. We are now observing a divergence between what reinsurers consider the correct price of the property cat product to be and what the capital markets believe it to be. One of the reasons is that the capital markets deploy capacity in a very different way than reinsurers use capital, and reinsurers demand higher minimum returns.
At Endurance, we are always keeping an eye out for opportunities to make the most of the convergence capacity that’s available. In fact, we’ve used that capacity recently, buying more retrocession than in the past because we felt it was at an attractive price and the timing was right. Some other reinsurers have decided to form sidecars or invest in insurancelinked securities (ILS) managers. We think that can create a conflict where reinsurers compromise their underwriting principles for the benefit of fee income. That’s not something that Endurance is willing to do.
The question, of course, is whether this capital is going to be here for the long term or if it’s going to be a short-term allocation. Quite frankly, for some of those institutional investors managing trillions of dollars, a few hundred million dollars allocated to property cat is quite a small investment. Even if there were a big cat event and they lost that capital, the downside would be minor whereas the positive yield is quite appealing, especially if rates were to increase after a large loss event.
There appear to be two types of investors. First are the more sophisticated institutional investors who have made this allocation very carefully and will continue to become more knowledgeable about the risk. They will stay in this market for the long term. And then there are others that are more opportunistic and may be surprised by a large loss event which could cause them to pull out of the market. But on the whole this capital is here to stay, particularly on the property cat side.
Guy Hengesbaugh: In general the non-traditional investors we see in today’s market have return targets that can be compatible with a flat oreven a soft reinsurance market. Many investors these days are probably looking for anything from 7 to 12.5 percent return in this market and that is over a longer time horizon than most investors expected in the past. We don’t need extreme hard market conditions in order to satisfy a non-insurance investor’s return targets like we did in the past. My view is that the chips don’t have to be down—we don’t have to ha ve a dearth of capacity for these investors to find the returns they’re looking for.
Paul Markey: No, I would describe it as an opportunity for the industry. It may not necessarily have appeared that way at the outset, but then access to capital has always been an issue of timing. The fact of the matter is that convergence capital has very defi nitely entered the reinsurance business in a signifi cant way, and it is a situation to which the industry needs to adapt. While it may not be, shall we say, perfect timing for existing reinsurance capital, it is something that our clients welcome. At this stage, while the reinsurance business is in a fairly robust position fi nancially, it is actually helping to make it more efficient.
"We don't need extreme hard market conditions in order to satisfy a non-insurance investor's targets like we did in the past."
Thomas McKevitt: Many reinsurers with sidecars or other vehicles to manage outside capital do, to some extent, cannibalise their own traditional portfolios. I doubt there are many companies who deployed all of their allocated cat capital and thus used the additional outside capital strictly for ‘overfl ow’ or new opportunities. That would be a nice situation for a company to be in but I’m not convinced it’s actually happened in this market.
Jeremy Pinchin: Third party capital has been part of the insurance industry for a considerable period of time. Hiscox has evolved from an organisation which began managing such capital back in 1901 and we continue to manage substantial sums of capital on behalf of others. We still manage capital on behalf of Names in our principal Lloyd’s syndicate; we have been a major player in the sidecar market and we support substantial quota share capacity on behalf of capital providers from around the world. There is no doubt, however, the more aggressive recent activity from pension funds and other investors in the reinsurance arena has forced the industry to evolve.
The ILS market is here to stay. The winners will embrace this change, but we believe it is unlikely to fully replace the conventional market; rather it will complement it. The ILS market has clearly reached a critical mass given the rating impact we saw in the June 1 renewal season and, as an industry, we can expect to see further material growth in the coming months—whether or not we have a loss event. As the market continues to evolve, such structural changes will only be fully tested by a material loss event—or series thereof.
What more can reinsurers do to strengthen their value proposition in the face of rising insurance retentions and convergence capital?
Hengesbaugh: Reinsurers in general, and specifi cally in Bermuda, have already strengthened their value proposition. Bermuda companies are servicing those investors that want an entrée into the reinsurancemarket. Just about every reinsurer on the Island has some sort of capital markets vehicle or can offer some type of alternative risk transfer solution which leverages capital markets capacity.
Markey: It is not the fi rst time that reinsurers have faced this challenge, and I think the answer is that they perhaps need to examine the current situation in the market, take a close look at the competition, and then define—or perhaps redefi ne—their value proposition. In terms of convergence capital, while it appears to be competing with traditional reinsurance they are very different product offerings and this needs to be articulated.
Whether reinsurers need to emphasis their class experience and claims paying records is perhaps something they are asking themselves. Further to this, reinsurers need to clearly understand the specific needs of their existing and prospective clients, helping them to achieve their objectives and being very proactive when it comes to further developing client relationships. There’s no question that there are certain areas in which insurers have shown an appetite to retain more of their own business, so finding ways structuring other types of business with those companies is a key aim.
That’s where the new business opportunities are actually going to come from: new products, emerging territories in particular, and innovation have to be some of the most important longer-term planning propositions for reinsurers, and rank alongside making savings through increasing efficiency and reducing expenses. Those that can better manage expenses are going to have more fl exibility to react to opportunities.
McKevitt: There is not a lot we can do against rising insurance retentions. Fluctuating retentions have always been part of the re/ insurance cycle.
As regards convergence capital, I think fl exibility on the part of reinsurers is the key. It’s hard to say to what extent, but convergence capital is here to stay. Traditional reinsurance must have the fl exibility to restructure programmes to allow clients to access this new capital if they want to do so. Structures are becoming more complex and it’s important to adapt to these changes.
Pinchin: Traditional reinsurers already provide a strong value proposition. They provide clients with confi dence that, when an event occurs, claims will be paid effectively and efficiently; they understand the often complex needs of their clients and act not just according to very strict legal interpretation of wordings. While new ILS playersmay provide ‘value’ in terms of rating, the traditional industry offers long-term players a level of continuity, service and confi dence that is impossible for the pure ILS industry to match. Price is key—we all recognise the importance of achieving value for our reinsurance spend. However, advantageous pricing is not always achieved without some risk and does not always represent true value.
There is a risk of ‘contract uncertainty’ as collateralised wordings are pushed in an attempt to mirror the traditional market, leaving collateralised funds potentially exposed on a multiple basis. There must be a concern that in a ‘perfect storm’ the true integrity of the collateralise product will be tested. It is in all of our interests that the regulatory authorities are able to provide proper oversight.
Faure: To the buyers of reinsurance, convergence capital has been attractive from a pricing standpoint. How do we compete with that? It’s not on the pricing side—it’s on the services that we bring to our clients.
A company such as Endurance has strong relationships with our clients around the globe and in many more lines of business than just property cat. Our clients appreciate having an underwriter in front of them who truly understands their business rather than someone who is just providing capacity at a price. Reinsurers can offer a host of valueadded services including sharing our knowledge on claims, audits, actuarial, technology and other areas. Capital markets players have not yet been able to establish that level of relationship with a client.
And of course there are other lines of business that the capital markets are not able to participate in at the moment—for example, casualty, marine, and a few others—although I think they will try to get into those lines in the near future. They offer a pure commodity, whereas reinsurers bring much more in terms of partnership.
Has investment in emerging market opportunities proved its worth? Is the future likely to be brighter for re/insurers?
"Reinsurers need to clearly understand the specific needs of their existing and prospective clients, helping them to acheive their objectives and being very proactive."
Markey: Yes, it has proved its worth but it remains a very long-term proposition. You have to determine how, if you’re a reinsurer, you will access emerging markets business, commit resources to that plan and then stick to it even if the returns are not immediately apparent. In due course, the emerging countries and regions will require more and more capital assistance via reinsurance, and reinsurers need to be ready to react to that demand. In the interim, you’ve got to be prepared tonavigate a fairly expensive and a fairly low-return environment. It’s not easy—the investment is substantial and it’s a long-term proposition.
McKevitt: I don’t think there is a yes or no answer. There have been areas of the world that received a lot of attention, such as China and Brazil. For some companies who spent large amounts of time and resources trying to develop those markets, perhaps the results have been slower coming than they expected. Speaking from a reinsurers’ perspective, we still feel the future is bright for a number of emerging markets.
Pinchin: We have consistently seen greater opportunity in the established markets, where we already have signifi cant and established relationships. Our existing international operations mean we are well placed to serve these markets.
Our work within emerging markets comes through our broker partners from our underwriting hubs in London and Bermuda, and this has proved to be a very effective approach so far.
The real emerging market for reinsurers is as much about risk as it is about geography. Non-modelled perils, cyber risks and other so-called ‘emerging’ risks mean reinsurers have the opportunity to develop new products and create new demand in areas less obviously tackled by ILS markets. In many ways this marks a return to the traditional role of the underwriter, which has always been a core value for Hiscox.
Faure: There are two aspects to that. There is defi nitely potential for growth in emerging markets even though it’s probably overestimated by some. I don’t expect we’ll see exponential growth in insurance penetration in the next few years given that the cultural factors that are driving the growth in some of those markets don’t change very quickly.
At Endurance, we see opportunities, particularly in Asia, where we have plans to upgrade our capabilities. At the beginning of next year, we will move part of our property cat underwriting operations from Bermuda to Singapore to improve the service to our clients in the region and build on the synergies of the lines of business we write there. We see Asia as a potential growth area for reinsurers and for Endurance particularly, but we are also very careful about understanding the risks.
There are also some specialty lines of business which Endurance will focus on going forward—for example, trade—where we see potential growth in emerging markets such as Latin America.The other side of the coin is that with the growth of emerging markets, new risks are emerging. A good example is the fl oods in Thailand a couple of years ago which caught the industry off guard. Reinsurers now recognise the need to understand and model these emerging risks appropriately.
How do you view present conditions for growth, both organic and through acquisition?
McKevitt: The current conditions for organic growth, while still adhering to disciplined underwriting standards, are challenging but achievable. There are so many factors that go into determining growth opportunities. A company’s current geographic footprint, line of business mix and market penetration will play a large part in determining if opportunities for growth exist.
As far as growth through acquisition, the conditions continue to be favourable and I would expect that more companies will at least consider their options. I wouldn’t be surprised if M&A activity heats up a little but I feel as though people have been thinking that for a few years.
Pinchin: We have traditionally focused on organic growth given the long-term value it brings; growth by acquisition has never been a preferred Hiscox strategy. With the growth of alternative capital, buying market share in the traditional market adds little clear value, so acquisitions are not on our agenda in this area. Opportunistic added value in areas outside our traditional skillset are of value and we are open to broadening our client offerings in this manner.
Faure: While we see pricing improvement on the primary insurance side of the business, this has been offset by increasing competition on the reinsurance side. Particularly at the July 1 renewal, we saw deteriorating treaty conditions for several lines which we attribute to excess capacity. Unless there is a very large loss event, we expect the reinsurance pricing environment to remain very competitive for quite some time. While this limits profi t potential, these market conditions also create opportunities to grow through acquisition, more so than through organic growth. That’s something we will continue to monitor very carefully, because we expect there may be some very good opportunities in the future.
Hengesbaugh: There’s no doubt that conditions for growth in the reinsurance business in general are diffi cult. We don’t have a lot of new demand and as long as primary rates stay fl at and demand is stagnant growth can be difficult. Being nimble and innovative especially with leveraging the convergence capital to enhance our clients’ returns is key to growth in this market.
Markey: We’re pretty positive about the current conditions. Again, the reinsurance market has shown a high level of resilience through fairly diffi cult economic times. The key is being able to identify correctly the areas for organic growth, and for reinsurers, and probably insurers as well, the opportunities for acquisition of new talent may bebest achieved through M&A. Consolidation appears to be something that will increase going forward.
Do you regard social media as an opportunity, a distraction or a potential pitfall for the re/insurance industry?
Pinchin: Social media have their place. Their place in our retail operations is growing apace. In the world of reinsurance, social media can certainly complement our face-to-face interaction with brokers, but are not currently having a material impact. While social media already work very well in terms of breaking news and for retail brands, in the world of re/insurance you simply can’t build relationships in 140 characters.
Faure: Social media don’t appear to be a focus for the insurance and reinsurance industry, with the exception of personal lines companies. That is likely due to the nature of our distribution model which does not lend itself to rapid uptake of social media. Having said that Endurance, like most of our peers, is using social media to disseminate information about our company and collect information, primarily as we recruit new talent.
Hengesbaugh: Love it or loathe it, social media will continue to grow and be an important part of social interaction. The insurance industry and the reinsurance industry should always benefit from the advancement of shared information in terms of amount and speed.
Markey: It’s got to be an opportunity. Initially, the opportunity seems best aligned to the insurance business as it provides an additional— and effi cient—means of interacting with potential customers. I would say the younger generation, who have grown up with social media, are fi nding it an integral part of the way they run their lives, and that has to led to opportunities in sectors such as personal lines business and life insurance. As far as the reinsurance business is concerned, the impact of social media in terms of helping to achieve growth seems less obvious and is further down the chain.
Some reinsurers would say that social media, if anything, are a distraction. If you look at the emerging economies, one thing that seems clear is that almost everyone is going to have access to a cellphone, which generally confers access to social media, so in these regions it could potentially be a driver for new business, again, particularly in the insurance sector.
Jerome Faure, Endurance, Guy Hengesbaugh, Towers Watson, Paul Markey, Aon (Bermuda), Thomas McKevitt, Allied World, Jeremy Pinchin, Hiscox