Sirius adapts to the new normal
Sirius Group is on the brink of a big change. It revealed earlier this year plans of a merger agreement with special purpose acquisition firm Easterly Acquisition, which will result in Sirius becoming a publicly listed company.
It has made several strategic announcements around that including reshuffling its management team, and revealed plans that show ambitious growth strategies towards potentially doubling the size of its reinsurance book of business. It has also entered into equity subscription agreements with various private equity funds ahead of being listed.
The deal will transform the company; but at its helm will remain Allan Waters, chief executive officer of Sirius Group. Restricted in discussing the impending deal at the moment, he suggests that, along with most carriers, he is more interested in market conditions—which are refreshingly positive.
After five or so years of seeing all the insurance market indicators pointing down to a soft market, it is now heartening to see most of them pointing upwards instead, says Waters.
He is cautious in his optimism. “The increases aren’t a lot, but increases of 2 or 3 percent are better than 5 percent declines in prices, so that’s good. Everyone wanted more obviously, but this is the world that we operate in now,” he says.
“We may be entering the new normal, where rate movements continue up and down, but we don’t get the big cyclical swings we used to see; this might be a long-term development.”
On the other hand, Waters points out, the unexpected can change everything. He cites Berkshire Hathaway chairman and CEO Warren Buffett’s claim that every 50 years the market will see a $400 billion event. According to Waters that sounds about right, because there are so many non-modelled losses.
He suggests that something like a solar storm can cause huge damage to infrastructure and that it may take that type of event to a trigger a true hard market. Such a tail event would hit insurance companies the hardest as they do not have the benefit of contractual limits in the same manner that reinsurers do.
“If something like that does happen then we will see a significant increase in demand for risk spreading,” Waters explains. “That could spark quite a market opportunity for reinsurers. But when is that going to happen? Who knows?”
He also points out that where rates will go in the near future is difficult to predict and that the strength of upward rate movements has historically been dictated by the level of pain in the industry—and the market has indeed seen increasing pain of late.
Market discomfort
“We’ve seen some companies taking reserving actions on longer-tail lines, and even shorter-tail lines on the catastrophe side,” Waters notes.
“We’ve seen Lloyd’s reporting underwriting losses. When you start to see things like that, eventually we will achieve better pricing for our products. Whether premium rates will continue to strengthen is hard to say, but there isn’t much room left for them to go down. We’re at a place where all the excess profits have been flushed out.”
Waters adds that the market is also seeing a merger of the two capital approaches to the business, in terms of traditional capital and insurance-linked securities (ILS)-based capital. He considers sidecars to be a form of ILS, as they have a limited amount of capital supporting a risk set; once that capital is extinguished the residual risk comes back to the sponsor’s balance sheet.
The limited amount of capital in each sidecar is similar to ILS. According to Waters, the market is now seeing all companies using a mix of traditional and ILS capital—it’s becoming an increasingly grey area in the middle.
“Some insurance carriers, however, are becoming a bit skittish about using too much ILS protection,” he adds. “They certainly don’t want to use exclusively ILS capital. After a big cat loss, when the bills come due, traditional reinsurers pay up.
“ILS funds are often held up in trust; you get hedge funds complaining after the fact about the cat modelling used to sell the bonds they are invested in, so they’re going to arbitrate or litigate.
“ILS don’t get triggered too often, but when they do there’s a fair amount of uncertainty as to when or even whether funds will be released from trust. As a result, insurance carriers want to retain access to traditional capital as well.”
The sting in the tail
Waters concludes by stressing that the other thing the market may see is an eventual recognition by ILS investors that the property cat business is not as short-tail as it used to be. Hurricane Harvey in Texas, for example, was principally a flood loss, a type of event which often results in coverage disputes.
Additionally, Florida has become a litigious venue when it comes to insurance coverage—something that will greatly extend settlements for Hurricane Irma.
Waters has a warning for the market. “As a result of this litigation, we’re going to see a lot of ILS funds locked up in trust for years.
“This may not bother pension funds too much, but after a couple of years I suspect hedge fund managers will hate having their clients’ money sitting on the sidelines for so long,” he says.
