Strategic change inevitable
That is the view of Bill Dubinsky, head of Willis Capital Markets & Advisory, who argued that the convergence market, which had for many years been viewed as a sideshow, has now entered the main tent.
“Previously the convergence space did not have an impact on the strategy of reinsurers. But over the last eighteen months—and certainly over the last six—that has changed in a clear and decisive way. There are now parts of the market where frankly traditional reinsurance simply isn’t competitive”. As a result, reinsurers will need to re-examine their position and involvement in the convergence space, said Dubinsky.
Craig Redcliffe, insurance partner and insurance-linked assets (ILA) markets lead in the financial services office of E&Y concurred, adding that, “the reinsurance industry is undergoing fundamental change. A famous Austrian economist, Joseph Schumpeter, would call this shift a process of “creative destruction’”. It remains unclear what the final form of the market will be, but it is apparent that a change is occurring.
Redcliffe mused on a recent report by Willis Capital Markets & Advisory as to whether the reinsurance industry is “being transformed by the capital markets in the same way as the Internet and cell phones have transformed the publishing industry.” Evidently, the industry needs to think carefully about their strategic response to the rising participation of the capital markets.
“While the extent of impact ILAs has had on the reinsurance industry is up for debate, I do not believe many would disagree that the ILA market has a growing influence”, said Redcliffe. “According to a recent Morgan Stanley report, alternative capital makes up approximately 15 percent of the reinsurance market, and some believethat alternative capital could capture as much as 30 percent of the mid-year renewal business.”
Although not a zero-sum game for the market, “reinsurers now have to engage with this issue at a strategic level”, argued Dubinsky. He said that they face a number of alternatives, including “managing investor money alongside their own equity holdings, joint ventures with specialist investors, or accessing investor capital as a form of retrocession”, but what is apparent is that they will have to adapt to a new norm.
Dubinsky added that reinsurers may also consider becoming net underwriters, accessing the capital markets directly. Rather than leaving the market to insurers, he said that if reinsurers are able to access convergence capital and deliver solutions to primary players in an efficient and cost effective manner, they will be able to establish a valuable position for themselves within the space.
Redcliffe added that as demand for ILA products increase, there will inevitably be pressure on reinsurance rates and traditional reinsurers to respond to these competitive pressures. “We have seen many traditional reinsurance companies unveil their strategy for managing third party capital alongside their traditional reinsurance product offering. Others are likewise looking to the capital markets as an efficient source of capital. As Redcliffe explained, “while some companies are ahead of others in adopting their business model, there is a growing realisation that the management of third party capital is fast becoming a necessary product offering.”The competitive advantage of traditional reinsurers is their underwriting expertise and data analysis, not their capital. Those that use this competitive advantage in diversifying their revenue streams to include fee income from management of third party capital, may be the leaders in this new normal. In addition, stable fee based income could result in higher market valuations, as fee income removes some of the volatility associated with a traditional reinsurers’ earnings.
Locked out
Dubinsky said that reinsurers will continue to prove their worth in terms of their understanding of risk, their underwriting capabilities and claims handling function, but added that in “some parts of the market they won’t be able to get paid purely for their capital”.
He said that traditional rated and regulated reinsurers will continue to be the most efficient capital structure in diversifying geographies, but that for peak perils, convergence capital will become increasingly attractive.
Dubinsky concluded that investor interest in the convergence space is unlikely to tail off any time, with brokers increasingly considering “blended solutions” for their clients, extending the “best solutions to clients, whatever form they may be”.
