The industry is on the cusp of profound change, with the rise of the reinsurance manager part of this substantial evolution. Rick Miller and Michael Popkin explore the new landscape.
Within two to three years, it will become diffi cult to distinguish between a traditional reinsurer and an insurance-linked security (ILS) manager. The distinction is becoming less relevant as both ILS managers and traditional reinsurers become reinsurance managers. For the most part, both license catastrophe models and have dedicated staff to run those models. Both are populated with people who have been long-standing members of the reinsurance world, whether they are underwriters or actuaries. Both are managing other people’s money—albeit historically in different forms.
Traditional reinsurers manage via debt and raising equity capital and then write on a traditional rated balance sheet. Some of them also have sidecars to expand capacity and generate additional fees. ILS managers deploy money from pension and other funds, and enable them to assume reinsurance risk. As ILS managers establish numerous pockets of capital via various mandates, use fronting institutions for rated paper, provide collateralised reinsurance, participate in industry loss warranties and own Lloyd’s entities, they become reinsurance managers, which are active in all forms.
Similarly, traditional reinsurers that have multiple sidecars, third-party asset management platforms, separate accounts for pension funds, listed vehicles in London and investments in asset management platforms have also become reinsurance managers, active in all forms. Therefore, in the near term, what will distinguish one reinsurance manager from another is what distinguishes most companies: history, culture and constituents.
The market’s reaction to this evolution is surprisingly analogous to thereaction to the rise of corporate-based Lloyd’s syndicates, the Bermuda Class of 2001 (post-9/11) and the Bermuda Class of 2005 (post-Katrina). Underwriters will always complain about the supply of perceived excess capacity provided by new market entrants. All new markets will be ignored and dismissed until they prove themselves, forcing incumbent markets to react.
What does a reinsurance manager look like?
Before exploring the implications, it is instructive to briefly describe the new reinsurance manager. The epicentre will be occupied by those with a balance sheet or mandate for each sub-segment of risk, whether categorised by expected loss, peril restriction or line type. Reinsurance managers will have capital available for different perils and different geographies.
Accordingly, reinsurance managers will be relatively agnostic regarding form (paper, collateralised reinsurance, bond or other) since they will have mandates that allow them to participate in any or all of these. Cedants (and brokers) will interact with reinsurance managers, which will then sub-allocate to various funds, balance sheets and mandates. The marketplace will broadly comprise reinsurance managers that will compete by either servicing most of the cedants to become a core top-tier partner, or specialising and being extremely competitive on a narrower risk band. There will be room for both along the continuum.
As this continuum develops, the market will enter an era of greater pricing along an efficient pricing frontier. Cedants will shift risk in packets that are most efficient for the various buyers, both in terms of risk and form, since this will yield cedants the best overall reinsurance rate. Similarly, reinsurance managers will have upstream investors (such as pension funds) for each sub-segment of risk. We won’t necessarily see someone offering cheap capacity and mispricing risk. Rather, capital with different risk/return requirements will be available in greater granularity, taking into consideration attributes such as liquidity. Innovation will be required to parse the risk more finely and to package it correctly for an optimal risk transfer. Brokers and cedants that view the market in a holistic fashion will be the beneficiaries.
Hot money versus committed capital
Some have argued the current marginal supply of alternative capacity is all ‘hot money’ that will flee after the first big event. Others have argued the money fleeing will get trampled by the money entering to capture hardening rates. We feel the reality has developed into a phenomenon with reduced volatility.
Those that have tried to raise pension fund money (such as traditional reinsurers and ILS managers) realise quickly—sometimes to their own dismay—that pension funds are very slow to become comfortable with an asset class and new managers. It takes many months, even years, of courting, education and due diligence. In short, they are slow to commit and slow to exit. Most ongoing change is one of upsizing or downsizing allocations based on relative value. The argument for diversification and uncorrelated assets will only get stronger.
"Remaining outside the convergence zone will offer less to upstream investors and downstream partners. Going back to the old landscape is not an option."
One of the main lessons from 2008 was that few asset classes are uncorrelated and perform well in a global market crisis. While there has been some hot money, substantial amounts of the assets under management and new mandates represent more permanent capital. When large events come and prices widen back out, it is very reasonable to expect that at least some of the permanent capital providers will increase their allocations to capture the higher spreads. As history has shown, others (both permanent and opportunistic) will enter. What has fundamentally changed is that the reinsurance asset class and its new forms have become more mainstream. Provided the markets avoid past mistakes—such as introducing credit risk into collateral—they will prove resilient. Model and underwriting risk will remain for all parties.
Not surprisingly, price remains the main transmission mechanism. In the current, relatively benign catastrophe environment, it is not unexpected that prices have fallen and deal size has increased to absorb new capital. Invariably, when large events happen again, the market will reprice and widen back out. However, the degree and duration of widening is likely to be less than before convergence. Previously, new companies were needed to provide fresh post-event capacity; now, the capital markets can react quicker, with a pension fund just upsizing its mandate. This increased speed to recapitalisation will help keep an upper boundary on the price widening and bring pricing back to an equilibrium level, similar to other asset classes post-dislocation.
The broker’s role in convergence
One critical area is the growth of risk to be transferred. If the convergence market remains the domain of only the largest cedants and a limited number of perils, growth will be stymied. New cedants need to come to market. Private placement deals are allowing new cedants to access the marketplace. Equally important is the need to bring new perils and new layers of risk. In sum, new cedants, new perils, new geographies and new layers are all part of the formula to increase the supply.
Bermuda’s role in convergence
Bermuda is well positioned to capitalise on the changing environment. It houses a significant number of reinsurance managers coming from both ends of the spectrum. It has access to considerable expertise for all the forms of risk transfer, including service providers and fronting parties. It is both a provider and a consumer of risk. The special purpose insurers legislation and the Bermuda Stock Exchange have shown themselves to be compelling to reinsurers and issuers. Overall, there is critical mass, which means the reinsurance community can participate in all the various changes underway and continue to be at the forefront of them.
There is no single strategy for how to become a reinsurance manager and no uniform single configuration of the various components. What has become clear, however, are the parts of that constellation. They include the ability to write reinsurance in all forms. Having diverse sources of upstream capital to write different types of business (whether category, form or risk type) is an essential ingredient. Having a culture that is open to the changes underway is vital. Buying businesses, hiring convergence executives, creating third-party vehicles, having private equity/venture capital arms or even—as was done recently—tapping the capital markets as issuers, are all part of the new constellation. Other platforms that have been active are opening up their business to outside investors.
Even the sources of capital are expanding, with some listing in London while others go the IPO route. Some have taken more of a mutual fund approach, while others buy Lloyd’s businesses or establish a hedge fund-driven reinsurance strategy. Some have new owners or investors ranging from private equity, to insurance companies, to global asset management platforms. Seen in its totality, we have been a very dynamic industry, particularly of late.
While there are many paths, the epicentre of change is clear: become a comprehensive reinsurance manager, or remain a very specialised player. Remaining outside the convergence zone will offer less to upstream investors and downstream partners. Going back to the old landscape is not an option. Just as each generation complains about the younger generation, the old guard suggests that the next generation isn’t permanent and has a more superficial treatment of risk. With each new class, however, some of them become the leaders of the establishment as the next phase and new crop come through. The same will be true as ILS managers and reinsurance underwriters become reinsurance managers and overall market leaders. This is already happening.
Rick Miller is co-head of insurance-linked securities at Towers Watson Capital Markets. He can be contacted at: email@example.com Michael Popkin is co-head of insurance-linked securities at Towers Watson Capital Markets. He can be contacted at: firstname.lastname@example.org
Rick Miller, Michael Popkin, Towers Watson, insurance management