Singularly Brazilian: Latin re/insurance
Few would deny Brazil’s potential as a re/insurance market. Already one of the two biggest markets in Latin America—with only Mexico anywhere near its scope or potential—it holds obvious attractions for Bermuda players looking to develop a global footprint.
As Andrew Downey, chief executive officer of Validus Reaseguros indicated: “Brazil’s market has enormous potential. The industry is very enthusiastic about being there. Here in Miami we see people wanting to develop a presence in the market on a daily basis. The Latin American region is growing and has weathered the financial crisis remarkably well. There are low levels of penetration and the potential for significant market growth.” The Brazilian market is at the epicentre of Latin American growth, although Downey cautioned that it is a market “not for the faint of heart”.
Philippe Rochaix, president and chief operating officer at XL Re Latin America also spoke of the country’s enormous potential, adding that its re/insurance sector is still in the process of maturing, with still further potential yet to be unlocked. Citing the repeal of the country’s state monopoly in reinsurance in 2007—previously held exclusively by stateowned IRB-Brasil Re—Rochaix said that the process of development since has increased. He explained that local insurers have strengthened their underwriting and improved their reinsurance buying, reinsurers have established closer relationships with cedants and clients, and brokers have brought more technical knowledge to the market.
"As the market and insurance penetration develops and the level of exposure inevitably increases, there may be calls to relax the 40 percent ruling."
Brazil’s potential is tied up in sizeable industrial and infrastructure projects such as the 2014 FIFA World Cup and the 2016 Summer Olympic Games, both in Rio de Janeiro, and in rising levels of individual and commercial risks linked to the growth of the Brazilian economy and the increasing size of the country’s middle class. As Downey indicated, the market has the potential for significant European or even US-sized exposures, that make it an interesting market to write for global re/insurers.
Recent results have been decent, said Downey, although he warned that optimism needs to be tempered with caution. “A lot has been spoken about diversification of late and in that respect writing a Brazilian book of business helps. But underwriters need to be cautious that they are not writing for the sake of it—if they are, the potential dangers of not understanding the market and its exposures mean it could simply be not worth it,” he said.
Brazilian nuances
There are a number of nuances that complicate developing a presence in the market. The first and most obvious is language. Brazilians speak Portuguese, meaning the country cannot simply be grouped with other, Spanish-speaking, Latin American operations. Second, Brazil’s is a highly regulated market. As Downey explained, its classification of registered reinsurers as ‘local’ (entities that are locally capitalised and have preference over 40 percent of placed business), ‘admitted’ (reinsurers that have representative offices incountry and people there) or ‘eventual’, provides some indication of the constructed nature of the market. While the state monopoly on reinsurance was repealed back in 2007, “it remains a highly regulated market”, said Downey.
The monopoly of the IRB-Brasil Re has raised some concerns, but Rochaix said that in the short term, requirements to provide 40 percent of reinsurance capacity locally have not been tested. However, as the market and insurance penetration develops and the level of exposure inevitably increases, there may be calls to relax the 40 percent ruling, he said. Brazil’s emergence as a regional centre for re/insurance—something that is looking increasingly likely—would also encourage a relaxation of Brazil’s present position, said Rochaix. Developments have encouraged a growing realisation regarding the country’s potential position as a regional leader for Latin American re/insurance. Present capital restrictions would inhibit such ambitions. Should they emerge as a significant impediment, it seems likely they will be relaxed.
A competitive dynamic
The level of interest in the market may, however, present issues for those exploring Brazil’s potential. As Rochaix explained “worldwide attention may help mature the market faster, but it also creates a more competitive environment in Brazil”. At some point this will be reflected in pricing, which has of late been buoyant. Rochaix also warned that some re/insurers still fail to recognise the potential catastrophe exposures associated with a Brazilian book of business.
“We’re not at all sure that everyone in the industry is aware of the cat threat, of potential accumulations on sizable property and surety books and that rates need to be paid and charged to account for the cat issues. We need a wake-up call on that front,” said Rochaix. He cited the Thai floods as a case in point. The largest flood event in history in terms of insured losses, the event was an unexpected and unwelcome broadside for the reinsurance industry globally. Brazil has the potential for similar surprises, said Rochaix.
However, recent losses may prompt a hardening of the market, even in the face of an increasingly competitive environment. “At the last renewals we started to see programmes having difficulties being placed at the required price by the client, with losses on property and surety lines beginning to catch primary players and the market up,” said Rochaix. “For those reinsurers with local operations, such losses might not all have been on the radar at head office, but as loss numbers and the scope of exposures and accumulations develop, so the volume of the wake-up call will increase.” Improving data quality—from local insurers, reinsurers (local and global) and brokers—will help to provide ammunition for such calls.
Buying behaviour
While the pricing environment has the potential to increase returns associated with operating in the market as it develops, levels of business ceded into the reinsurance arena are likely to decline. On the surface this will mean less premium for reinsurers, with a resulting impact on their business, but greater insurer retention is part of the maturation of the market, said Rochaix. Presently, Brazilian insurers retain very little of their business—a fact shared by the markets in Latin America—but in order for a developed insurer-reinsurer dynamic to be established, this needs to change.
“Reinsurers bring added value to insurance operations by providing coverage for high severity-low frequency events, while allowing insurers to keep low-severity-high frequency events on their books—an area that is traditionally an insurer’s particular strength. As reinsurers, we are here to help primary players grow by taking those big risks off their book and enabling them to retain more of the manageable risk. By doing this insurers will pay closer attention to their own results, encouraging the development of a sound underwriting approach, an understanding of attritional risk and a solid portfolio,” he said. Strengthening the position of the country’s insurers can only serve to strengthen the market, even if—in the short term—it means a decline in ceded business.
Changes to retentions aren’t the only development likely in the market. As Rochaix explained, the Brazilian market has traditionally been a proportional market. This is likely to change as the industry there matures, with the shift to excess of loss reinsurance likely to reduce still further the ceded premium. That said, an excess of loss approach is “better and cheaper for a good insurance company that works on their fundamental portfolio”, said Rochaix. Again it “allows them to retain the frequency business and make profit on that, while buying reinsurance to protect against peak losses”.
While a shift towards excess of loss arrangements and greater levels of retention suggests levels of available reinsurance premium will decline—and if you factor in increasing international interest in the Brazilian re/insurance market matters look particularly concerning—Rochaix said that rising levels of gross domestic product (GDP) and insurance penetration will more than offset such declines. Brazil might not be able to count on the doubledigit GDP growth it achieved in recent years—and the recent slow-down in its economy will in time be felt, said Downey—but few would bet against its emerging strength as a leading global re/ insurance market.
International expertise
Bermuda players have a lot to offer the Brazilian market. As Downey explained, “The market is still green. Bermuda players that enter the market can bring with them a sophisticated approach to underwriting and capital allocation. They also bring Solvency II-compliant regimes and strong enterprise risk management capabilities.” He added that the balance sheets of Bermuda reinsurers will likewise play a significant role as the market develops and takes on more risks.
"The market is still green. Bermuda players that enter the market can bring with them a sophisticated approach to underwriting and capital allocation."
Rochaix spoke in a similar vein about the expertise and capacity that Bermuda players can bring to the market, adding that XL’s long-term presence and boots on the ground had brought additional benefits to its partners. Being able to have a close view of the market, and to leverage international capabilities as the market looks to develop a more diverse line offering, have been some of the benefits XL has been able to bring to bear, he said. “Bringing specialist underwriters and technical expertise to the market has been of significant benefit to the Brazilian re/insurance market. And international reinsurers have been able to leverage local and global expertise in order to do so.”
At the same time, a presence in-country has played its part. “We have underwriters and actuaries based in Sao Paulo who are client-facing decision-makers. They are able to discuss with clients the technical aspects of the relationship, while at the same time working closely with them and the brokers to strengthen data quality and oversight.” XL is working closely with its partners to understand and better price their exposures—some of which can be found right across Latin America—said Rochaix, and by improving data quality and risk understanding XL also helps to build solid, lasting relationships with its clients.
For XL, it enables the reinsurer to better manage the cycle because “having a more technical relationship with clients and a more technical understanding of what they are doing enables us to manage the size of a portfolio based on market conditions. It’s not emotional; it’s not pure commercial—such an approach technically explains why we are in the market.”
Broadening lines
Addressing the lines that show the greatest potential in the market, Downey said that property and casualty reinsurance are the most significant lines at present, “although as the market matures so the opportunities for line development will grow”. Rochaix said that for XL property lines associated with engineering and industrial projects such as the FIFA World Cup and Summer Olympic Games showed the greatest potential, coupled with products that serve Brazil’s growing middle class. Surety is another significant line, playing a significant role in the development of major infrastructure projects—many of which are projected well beyond Brazil’s hosting of the two major international sporting events—with premium on the line buoyant, said Rochaix.
Other lines with potential include agriculture, aviation and marine, all of which require very specific expertise. Rochaix suggested that much of this would draw on underwriting expertise from locations such as Bermuda and London, with international players evidently able to bring this knowledge to bear. Casualty, for its part, remains nascent, but there is evident potential there in the mid-term, said Rochaix.
The Brazilian market has developed apace, particularly post-2007, but as Downey made clear, it is a market that requires dedication. “Facing regulatory, pricing and foreign exchange issues, your horizon needs necessarily to be long when developing a presence in Brazil,” he said. The market still has some way to go before achieving maturity, added Rochaix, with data quality a particular concern, although he did add that the industry is working towards resolving data shortcomings.
Regulatory restrictions remain something of a concern, although there is an expectation that as the market develops, the state monopoly on reinsurance will be relaxed. Pricing also remains a challenge, although matters look likely to improve—as does market discipline as greater retentions become the norm. Nevertheless, Rochaix concluded that “the blind interest of past years has cooled, replaced by a more steady and controlled market. And greater discipline and technical underwriting can only be a good thing for the market”.
An end to its monopoly
An examination of the Brazilian reinsurance market would not be complete without a discussion with the state reinsurer. Daniel Veiga, commercial director, and Jose Farias, underwriting director, at IRB-Brasil Re, give their thoughts on the end of the state monoploy and developments since 2007.
What were the reasons behind ending the state’s monopoly in reinsurance in 2007?
The objective was to encourage new reinsurance companies to enter the Brazilian market and provide Brazilian insurers with alternatives in terms of coverage and products, increased reinsurance capacity and competitive pricing. Additionally, the change in the legislation sought to create the necessary conditions for the establishment of a reinsurance market in Brazil with the participation of local reinsurers.
Have the reasons for the decision proved to be right?
We understand that the transition from a monopolistic to an open market was necessary and the numbers are proof that it was the right decision. In 2009, there were 74 reinsurers qualified to do business in the country. By May 2012 this number had risen to 100 (11 as local reinsurers, 29 as admitted reinsurers and 60 as occasional reinsurers). Other benefits include the increased level of capacity offered to insurance companies and a reduction in pricing. On the negative side however, there has been an absence of new products in the market.
What benefits has IRB gained from ending its monopoly in the market?
For IRB-Brasil Re, a natural consequence of the market’s opening was the implementation of a restructuring process and reassessment of operational policies, which aimed at making the company more competitive. Furthermore, the new rules applicable to the Brazilian market have enabled IRB-Brasil Re to operate with the prerogative to underwrite risks according to more selective technical underwriting policies.
In which lines of reinsurance have been the most marked increase in reinsurance take-up and profitability?
Besides property, the lines of business that have most benefited from the opening up of the Brazilian reinsurance market are ones associated with infrastructure projects. They have gained additional capacity and experienced reductions in price. However, there has also been a reduction in profitability as a result of greater international competition in insurance and reinsurance.
