After the recent series of mergers and formations in the re/insurance market, Jason Carne from KPMG in Bermuda tells Bermuda:Re+ILS what he thinks lies ahead for the market and why a transformation could be coming.
With the re/insurance industry watching the recent string of merger and acquisition (M&A) and formation announcements from Bermuda’s market carefully, thoughts are turning to what the implications are over the long term.
According to Jason Carne, managing director and head of insurance-linked securities (ILS) at KPMG in Bermuda, the traditional reinsurance market is currently being squeezed on both sides of the balance sheet with yields on government and investment grade debt at historic lows and rates softening in both the short tail and casualty lines.
“For some time now third party capital has been coming into property-catastrophe and short tail lines through cat bonds, ILS funds and so on, and that capital has softened rates significantly,” he says.
In addition, traditional reinsurers are now under pricing pressure on their casualty books of business, partly due to good loss experience, and partly from new hedge fund reinsurer entrants into the market looking for a certain type of casualty business. Generally these reinsurers are not looking to make significant returns on their underwriting book but rather are looking to make money for investors by taking more risk on the asset side of the balance sheet.
“Hedge fund reinsurers have been around for a long time,” says Carne. “Recent growth in the hedge fund reinsurer sector has initially been driven by large hedge funds forming reinsurers to take advantage of premium ‘float’ on casualty business and to provide certain US investors with some tax deferral benefits.”
These types of companies are typically looking at writing low volatility casualty business, using the ‘Berkshire Hathaway’ model of taking insurance premiums on day one and earning investment returns in the hedge funds held by the reinsurer until the money is needed to pay claims that arise on this type of business (typically over a five to ten-year period).
All this is a backdrop to the current consolidation in the Bermuda market. “The rate softening on the underwriting business together with low yields on the asset side of the balance sheet are driving these players to come together,” says Carne.
“They want to achieve cost efficiencies, but also the greater economies of scale possible from a larger organisation, which provides them a number of quite interesting, flexible options going forward.
“A larger reinsurer, for example, has greater scale, so when they’re negotiating terms with counterparties they’re able to take larger lines of business and to demand better terms than perhaps they would have when they were smaller.
“CONSOLIDATION ALSO GIVES THE ENLARGED ENTITY SOME INTERESTING OPTIONS ON BUILDING OUT ITS THIRD PARTY CAPITAL PROGRAMMES ON BOTH THE CASUALTY AND THE PROPERTY-CATASTROPHE SHORT TAIL SIDE."
“With consolidation there’s arguably fewer mouths to feed in the market, and maybe that can stabilise rates across various lines of business. M&As can also produce greater diversification in a combined book of business and may allow them to produce better, less volatile underwriting results over the long-term with a more capital-efficient structure.
“As a result this would allow them to return excess capital to shareholders and/or pursue further acquisitions.”
However, Carne feels this is not the end of the opportunities for these entities. “Consolidation also gives the enlarged entity some interesting options on building out its third party capital programmes on both the casualty and the property-catastrophe short tail side and enhancing return on capital by earning an underwriting fee on managed business.
“They could also potentially go down the route that we’ve seen recently with ACE when it helped form ABR Re, which is essentially a hedge fund reinsurer sidecar for the group. ACE is able to provide the right kind of casualty business for this vehicle and gets paid a fee for doing so.
“That’s an interesting model that I think a number of other re/insurance groups will explore over the next few years. Having increased scale and the ability to secure a distribution channel for the right type of casualty business, either on a reinsurance or a retro basis, could be very attractive to entities that want to merge,” he continues.
“Initially it was the hedge funds forming reinsurance companies but more recently they have been joint ventures between traditional market players and hedge funds.
“The insurance companies, as opposed to reinsurance companies, are also in an interesting position, because they control the customer relationship. The larger ones may have the ability to form a hedge fund re sidecar and potentially I can see hedge fund reinsurers buying insurance companies as part of their strategy to secure the flow of low volatility casualty premium that they want.
“All of this has the potential to further disrupt the traditional reinsurance market and put pressure on the reinsurance brokers, because they could see quota shares coming out of these insurance companies direct into hedge fund reinsurers and other forms of third party capital.
“I’m not saying that they’d move all of their reinsurance spend into this kind of vehicle, but you could certainly see a meaningful portion of their business going into these kinds of structures because it would increase their fees and help their return on capital.”
Possible changes such as this will make life interesting in the future. In a merger situation a company such as KPMG can act as a trusted adviser to both entities, helping them with strategy and advising on issues such as capital modelling and integration issues that emerge when two large organisations come together, such as tax planning, internal control optimisation and actuarial advice.
Another integration issue is one of technology—will the combined entity still use its legacy computer systems and, if so, will the two be able to communicate? Or will they instead move to migrate their data on to a new system? How best to analyse the combined data to result in a real business advantage? What are the cyber risks arising from integration, especially in the insurance book of business? Issues like that sound simple enough but can sometimes be complex.
Asked whether he foresees any further M&A and formation activity in the Bermuda reinsurance market Carne replies immediately: “I do. We’ve still got the Partner Re, Exor, Arch and AXIS situation happening and ACE has recently announced its intention to purchase Chubb.
“There’s potential for additional M&As, and not just between traditional reinsurance companies. We may see some of the ILS funds being either acquired or targeted by the traditional reinsurance market and I do think we are likely to see further formations of hedge fund reinsurers.”
Jason Carne is a managing director and head of ILS and third party capital at KPMG in Bermuda. He can be contacted at: email@example.com
KPMG, Jason Carne, Bermuda, Mergers & Acquisitions, ILS