The conundrum of scale


Roger Crombie

While smaller players may face the heavy attention of even-handed regulation, their larger contemporaries are obliged to contend with greater— and often unflattering—scrutiny.

Insurance is considered counter-cyclical. The industry has certainly performed in a rather different manner from that of other financial sectors in recent years. It’s only natural, therefore, that with regulators around the world fully focused on ‘too big to fail’, insurance remains more intimately concerned by companies that are ‘too small to succeed’.

Smaller insurance companies have less margin for error, no matter how well they manage their daily business. An event of magnitude might knock a quarter’s earnings off a major re/insurer; the same event might altogether take out a less well-capitalised company writing property cat business. (This is the as yet largely untested danger with cat bonds, which can be seen as relatively tiny standalone insurance endeavours.)

Examples abound in reinsurance of companies that were too small to succeed. Or, if they did succeed, they did so briefly and on a scale that forced them to live permanently in the shadow of acquisition by a larger organisation.

For an insurance company, survival is the primary goal, or sometimes the only goal. Non-existent companies can’t deliver on the promise to pay that is the very essence of insurance.

"The punishment AIG suffered was massively disproportionate to its actual behaviour. But then, it's always good to have someone to blame."

Regulatory costs that merely irritate the financial statements and forward motion of major insurance companies can cause smaller entities to lose focus and direction. If Solvency II is indeed doomed—as we are beginning to hear this autumn—the wasted time and effort will be more keenly felt in the lower divisions, even if their executives might grudgingly admit that it was money well spent, overall.

While the world of finance fell apart, only one major re/insurer felt acute pain when the credit windows closed back in the Great Recessionof 2007/08. That was AIG. Contrary to the chorus of assertions that AIG ‘failed’, or was on the brink of doing so, the truth is that the company ‘only’ had a severe liquidity crisis, brought on by the banks’ and governments’ inability to keep the lights on. The punishment AIG suffered was massively disproportionate to its actual behaviour. But then, it’s always good to have someone to blame.

Smaller companies, in this regard, are perhaps less likely to suffer. No need to make an example of the shareholders of a small company that made the dreadful mistake of assuming that the banks would be open on Monday.

The price of what Don Kramer once famously referred to as ‘the ticket to the dance’, ie, the capital required of a start-up reinsurer, rose from a couple of hundred million dollars in, say, 1993, to a billion and a half today. That in itself has changed the dynamics of the market. A billion and a half is serious money, too serious for many of the parvenu brigade who now see insurance as not correlated to their other economic activities. ILS instruments are generally much smaller and easier to jump in and out of and are therefore likely to remain popular until, like the mini-skirt, they fall out of fashion.

Roger Crombie, regulation

Bermuda Re