Bermuda: weathering all storms in an improving market

In attendance:

1) Brad Adderley, partner, Appleby

2) Neville Ching, managing partner, Capsicum Re

3) Robert DeRose, senior director, global reinsurance ratings, AM Best

4) Christian Dunleavy, chief underwriting officer, Aspen Re

5) Peter Dunlop, partner, Walkers

6) Kathleen Faries, chair, ILS Bermuda; chair, RICAP Bermuda

7) Peter Gadeke, executive vice president, Willis Re Bermuda

8) John Huff, president & CEO, Association of Bermuda Insurers and Reinsurers

9) Dan Malloy, CEO, Third Point Re

10) Andre Perez, chairman & CEO, Horseshoe Group

11) Adam Szakmary, director of underwriting–Bermuda, Hiscox Re + ILS

12) Arthur Wightman, Bermuda territory leader, PwC Caribbean

13) Greg Wojciechowski, president & CEO, Bermuda Stock Exchange

14) Moderator: Wyn Jenkins, managing editor, Bermuda:Re+ILS

To start with the big talking point: is this truly a hard market?

Christian Dunleavy: Our sense is that rates are pretty much inadequate in most places and increases are needed on both the casualty and the property side, and certainly on property cat. Based on what we can see, the headlines around rate increases have not portrayed the true story, which is that the increases have only kept pace with loss cost inflation.

There is no real additional margin, which is what the industry needs. The focus needs to be on fundamental price adequacy and there is still a long way to go in a lot of lines. But we think that will be a more organic process over a period of time.

Adam Szakmary: We agree. The shape of the cycle has changed. Typically, in the past you would have seen a more spiked post-event increase in rates, significant enough to keep rates higher for several years. We are not seeing that same bump, so getting more sustainable rates is our goal. The cycle will be a bit smoother as opposed to spiky but on current pricing levels that is assuming losses are within expectations.

Because of the flexibility of capital now and how easily it can enter the industry, there needs to be more of a fair trade than it has been. We do see some upward momentum after two or possibly three years of losses. There is a lot of noise in the market about losses being outside expectations, which should help even out of the cycle.

Dan Malloy: We have been participating in the property cat market this year for the first time in a few years and the headline numbers for rate increases seem to be holding up.

Outside the property cat area, the question is whether the recovery has legs. There have been big losses in many other lines as well on top of the challenging investment environment, so there is ongoing pressure on rates.

My sense on a lot of lines is that people are paying more but they are still paying less than they were two or three years ago. Given the kind of losses we have seen coming through the market on many lines, you are going to see people paying more year on year, especially as they realise they cannot rely on property cat profits to subsidise liability losses.

John Huff: We are not hearing people use the phrase hardening, rather, they are calling it a “firming” of the market. Certainly, we are hearing that loss portfolios were hit by hurricanes Harvey and Maria in 2017 and Michael and wildfires in 2018. In parts of the south east of the US, there are portfolios that have been significantly impacted by losses and you are seeing some firming there.

We are also seeing more discretion being applied based on how cedants are handling these losses; reinsurers are favouring cedants with the ability to handle claims and manage some of the so-called social inflation and the Assignment of Benefits crisis in Florida.

I would just say that reinsurers are squeezed to a certain extent. The market is not hardening to the extent that perhaps it ought to be to match the growing risk yet there is also some contraction in the retro market. Reinsurers are squeezed but there does need to be some upward movement.

Peter Gadeke: Capital to me is the key; that drives the market capacity and if you have enough capital that’s going to influence what the pricing is. If we go back to June 1, the pricing did go up for the cat renewals. That was more a recalibration, a risk reassessment; people’s view was that the risk increased so they wanted more money for that risk.

I don’t see that happening at January 1 necessarily. Cedants outside Florida will be saying: ‘I’ve not experienced a loss, why would I pay more?’. The larger cedants will look at that risk recalibration and view it as very specific to Florida—not necessarily something that will affect their portfolio as a global or national account writer in the US. I don’t think that bump we had in June 1 will be replicated.

The amount of capital in the market dictates it. The retro market is definitely on the move; it has lost $4 to $5 billion of capacity potentially so that will drive the way people look at the retro purchases. Equally, on the primary side the market is moving upwards particularly in property insurance. But reinsurers are sandwiched in the middle.

Robert DeRose: We applaud the positive market momentum that is occurring—it is certainly needed. If you look at the return matrix, rates have deteriorated for the past five years. We are at the point where it is not sustainable any longer. There will be a difference in the expectations of traditional and non-traditional capital but there has to be some improvement in the return matrix.

The only way to do that in the low interest rate environment is through underwriting discipline and a firming in pricing terms and conditions.

That is happening. I would not call it a hard market, but it is certainly a firm market and that has to be sustainable. If rates revert to where they were, I don’t see how that is a winning proposition. We are a little optimistic. The fundamentals are what they are and dictate that there needs to be improvement.

When you consider reserves, the industry is being weaned off reserve releases and there may actually be pockets of unfavourable reserve development out there. That should drive further underwriting discipline.

Insurance-linked securities (ILS) investors also have learned some lessons. After a long benign period of cat activity, they now realise losses are possible and can be big. That is dictating some pricing improvement particularly in the retro area, and that is going to flow down into reinsurance. At primary level there is certainly a firming going on so, yes, the reinsurers are in the middle. Those forces will ultimately drive better momentum in the reinsurance arena.

How have ILS investors reacted to recent losses?

Kathleen Faries: We feel that inflows of capital are a bit flat; there is still a lot of trapped collateral out there and investors are pausing and looking at what is going to happen with pricing—especially investors that maybe have not entered the market yet. Investors already in the market are likely to stay. But inflows are flat.

No-one has yet mentioned expenses and costs. One of the other ways we can try to be sustainable is to continue to talk about the way we transact business. In Bermuda, I am the chair of RICAP Bermuda (RIsk meets CAPital), a digital decentralised re/insurance platform that uses distributed ledger technology to support many of the transactional functions of re/insurers.

The RICAP initiative in Bermuda is designed to get us to think about and talk about becoming a digital marketplace. I firmly believe that private, permissioned, blockchain—distributed ledger technology—could give us that digital highway that the market needs.

Global data standards built in collaboration with the brokers would be interesting and helpful. If we can come up with a way to move towards standardisation of data, with us all moving risk the same way, we could start to see real innovation around how we do business. There are also significant cost savings if we were willing to move in this direction together.

That is something we must talk about because our returns are not sustainable. We have to talk about how we transact business. I am not talking about trading platforms, we are talking about how we move risk, all the duplication of effort, and how we move data.

Brad Adderley: From our perspective, more capital is coming in. We are going to see new funds, new platforms being created. I hope the rates are firming—the truth is that it is not as simple as asking whether rates are hardening.

Andre Perez: It is not a simple dynamic but we see a significant inflow of capital. The majority of our clients made significant amounts of money last year and money is still coming in.

Szakmary: But is there a flight to traditional capital?

Perez: On the one hand you have investors’ expectations around how the market adjusts after a big loss; on the other hand, you have the fact their return expectation is much lower than your traditional reinsurer’s return expectation. Yes, they expect rates to move but their expectations are definitely lower. I do not think we are going to see the full-scale increases, even if we get a massive loss, because of this.

Huff: The old thinking was that ILS or alternative capital was a threat; the new thinking is that it is a tool. People are now using the term partner capital instead of convergence capital.

We are seeing more comfort from regulators with the use of that. Companies are using the discipline of traditional reinsurers for compliance and modelling, but having the benefit of alternative capital as well.

DeRose: There is a flight to traditional reinsurers, we have certainly seen it. We are seeing the primary placement being made with traditional paper fronting the deal but there may well be alternative capital behind it.

There is an integration going on and that is allowing for better pricing across the board because you are able to match the risk with the capital at appropriate attachment points. With that traditional front the cedant is confident he is going to get paid and that there are not going to be any collateral issues or disputes. They see a sophisticated partner. A lot of small cedants like traditional paper between them and alternative capital.

But it is more integrated. Markel acquiring Nephila was one important example of alignment. Equally, most of the bigger reinsurers are utilising alternative capital as a part of their own capital structure which brings their capital costs down and allows them to be more competitive in pricing. It is a true integration.

Greg Wojciechowski: The Bermuda Stock Exchange (BSX) tracks broadly what happens in the market. I don’t see any surprises. What I will say is that Bermuda is so perfectly positioned because, as at this roundtable, you have folks from one side of the industry talking to people from the other. That is a real testament to the centre of excellence that Bermuda is now—it is the Silicon Valley effect.

The BSX hosts some 380 securities with a market of capital value of about $35 billion. We think this is a very exciting asset class from the capital markets’ perspective. We have about 85 percent of the global ILS listed in Bermuda and some deals that were structured under new regulations in London or Singapore selected to be listed on the BSX.

Bermuda remains at the centre of innovation for this sector and ILS is here to stay. We are continuing to help drive the discussions around ILS as an asset class with its centre of gravity right here in Bermuda.

From a purely capital market perspective, the original genesis of the ILS sector had two drivers: the fact that the risk was uncorrelated from other capital market instruments, and the fact that interest rates were so low.

Both those factors remain true today and this remains a very exciting time for the space—it is increasingly seen as partner capital as opposed to alternative capital. The first time we came out to Monaco years ago nobody wanted to talk about ILS; now everybody wants to talk about it.

ILS is increasingly being seen as environmental, social and governance (ESG)-compliant, which could also help drive growth. We think it is a great global story for Bermuda, for a new asset class environment.

Arthur Wightman: I’d like to revisit part of the earlier conversation where it was implied that investors were learning lessons from the impacts of recent events on their capital. Many of these investors are long-term investors in the sector who made their allocations after prolonged and expert periods of due diligence.

Two things are being called into question by these investors. First, on certain recent events the industry has evidenced significant loss creep, for example with Typhoon Jebi. This is something that may not have been as evident to investors for some time, especially given much greater losses. That leads a question more around the models that are being used, and the confidence being represented in initial and even subsequent loss estimates as well as certain structural reporting issues, than it necessarily does in relation to the sophistication of an investor.

Second, the level of transparency in the insurance-linked sector regarding trapping of capital varies considerably and in many cases is somewhat opaque.

These are issues that investors should have expectations around and those expectations are not being met as well as they should.

These are the likely reasons for the retardation of the speed of flows into the sector compared with those we have seen in the past. For this to work sustainably, trust needs to exist that the system in place will work as all stakeholders expect it to. For the two reasons noted, there is some ground to cover.

Neville Ching: We are now talking about cat risk being a much longer-tail class than we realised in some instances; people have learned a lot. But there is still more to learn and we should never believe we are in control. There is a lot of expectation around making returns and planning for the future but there is this big unknown in climate change. That is the big issue that will come in to play at some point.

Gadeke: As we head into the renewals, some funds have had a really tough time with their investors. Some have had impaired capital that is trapped, others have lost it completely. And now we are seeing more losses on top.

I am hearing people say there are fresh inflows but to me there is limited fresh flow of capital. There are people reacting to what they had, and reloading to the amount they have trapped, but brand new money is very tough to come by.

My impression is that fund managers and investors are taking stock and looking at things such as rate increases and the risk calibration of the models in Florida.

Peter Dunlop: The unexpected effect of losses from secondary events, like storm surge or convective events, is also significant. Similarly, in 2018 the California wildfires surprised the market, which had not priced adequately for that hazard. Investors are seeing heavy losses from what are secondary events and now realising that every storm has its own unique characteristics. It does not follow that the heaviest storm causes the biggest loss.

Add to that the human aggravating factors of fraudulent claims and the Assignment of Benefits crisis in Florida and investors are left with losses they could not have foreseen. It’s created a confidence problem. I feel sorry for cat modellers who are being blamed, because some of these factors are completely unpredictable.

Plus, let’s not forget that the brokers still hold a lot of influence over pricing, which is some way away from the pricing that underwriters’ models suggest.

Gadeke: That is what underwriters do—price business without relying only on models. But I agree that investor confidence is waning. Investors are asking a lot more questions about the risks.

Szakmary: It is an education process. Some investors were not sophisticated until now and they are looking for partners and for ways to diversify out of cat.

Dunlop: Even so, are you charging what your models are telling you? I doubt you are. That is part of the problem.

Can clients with a better loss experience expect a better deal?

Gadeke: You have to be selective. If a client has performed well and demonstrated they gave a very good handle on losses, they will get better treatment. If they say they do not want to pay any more then the reinsurer will probably be quite sensible with that client. With someone else who got all their numbers wrong and losses exceeded what they thought, that is a very different conversation.

Dunleavy: I have sat with a number of clients who have said how much more original rate they are getting—yet they don’t want to pay more for reinsurance. It is a very complicated picture. I agree that it is client by client, but the conversation needs to be about what you are being paid to assume the risk from their balance sheet.

If you are talking about mostly cat that is one thing, but when you get to non-cat there is way too little margin with not a lot of investment coming through. There has to be something moving. People have mentioned reinsurance sitting in the middle: retro costs are going up, ILS investors are expecting a higher return, original rates are going up yet reinsurers are expected still to offer a discount.

It is just not sustainable over the long term. I am also seeing reinsurers do two-year deals on things like wildfire risk backed by ILS capacity for one year only. So what if that ILS capital pulls out after a year? It is case by case, but the general trend has to be up for rates.

Dunlop: What about the protection gap—is this where the real growth opportunity is for the industry? The industry needs to grow and needs to reach those that do not buy, or cannot afford, insurance. I agree with Greg that the insurance industry needs to look towards what good it can do in society.

Dunleavy: My view on the protection gap is that there is also a pricing gap. We cannot just be saying we will take on that risk out of good will, we have to take it on at a risk-adjustment rate. On things like flood and wildfire there is quite a gap.

In some of the regions hit by Hurricane Dorian there has been a terrible human toll as well as property toll, but it is a very difficult conversation around the protection gap.

Perez: When ILS started its main regions were Florida wind and California quake. Reinsurance is so fundamental to the Florida insurers, and a lot of them have such a light infrastructure, that reinsurance is not going anywhere. It is a very different situation when you talk about national programmes or things that are outside Florida.

At some point you have to have this capacity being treated as special. We need more rate, yet I can assure you we are seeing capital come in.

Szakmary: The retro market will push the rate bar up. We will see a difference in the way carriers that have performed in line with expectations versus outside of expectations are treated, but the momentum we have seen at the mid-year will continue. There is a move to rated capacity and that is going to push the rate up.

Gadeke: The product in the retro market may also change. Will they offer aggregate capacity? Because the payback ratios are just not there right now. The investors have had a real education in underwriting. They are realising that for their 8 percent return or whatever it is, there is some real risk in that return.

Wojciechowski: Now they know it is a challenge to the overall market it is getting its act together in terms of trapped capital. Maybe its investors are understanding what their potential ultimate yield is going to be—maybe it is not 6 percent, maybe it is going to be 3 percent.

I do not think that is going to be a deterrent because those investors with risk appetites are still going to look at the space. They will just price it in.

Ching: Then it comes back full circle to the performance of the model. I do think we are entering a new phase where the funds are more thoughtful about the return matrix and what their budgets are going to be for the future.

Dunlop: Investors have a better choice now. One benefit of the double-dip loss years is investors can now compare and benchmark ILS funds and say with the benefit of loss data that ‘these guys did better than these guys, so I am going with them’—there is most certainly a flight to quality going on.

Adderley: I hope that is the case as opposed to using fund managers because they charge a lower fee. Do you think the market is looking for an access point or a partnership? Is it just about the fee, or how are you sharing your view on risk? Do you view this capital as a partnership?

Szakmary: We certainly see ILS as a partnership because our investors see Hiscox as being in this space for the long term. People have come to Hiscox—because of the brand, because of the history, and because of the reputation. We talk about ILS as partner capital.

DeRose: I agree in terms of numbers, but if you look at the amount of capital much is linked in some way to traditional reinsurers.

Perez: I do not think we can lump all the ILS funds all into the same bag because some of them have completely different strategies. In the case of Hiscox, it is very much banking on its reputation and track record. But then you have ACE basically accessing third party capital for the retro placement. So it is different strategies: some are partners and some see it as competition.

Could we see some ILS funds look to set up rated reinsurers?

Szakmary: The most efficient way to bring products to your investors and your clients is effectively what you try and sell for. If you can have permanent capital where you are changing fees longer term that is good for ILS managers.

If you want a rated balance sheet, which is a promise to pay, standalone managers will need a strong risk management framework to create a rated insurance company.

Huff: Does that mean it will be a good rated insurance company? What made Bermuda is well-run, rated companies. If they can harness more capital, more efficiently, that is great as long as it can be managed and does not in any way tarnish their reputation.

Szakmary: In terms of the protection gap, don’t forget cyber. Cyber is an area for which I do not think there is enough capital in the reinsurance industry right now to hold the risk.
Don’t get me wrong, cyber is tough stuff and we have spent a lot of money across the entire group, but it cannot just be a reinsurance solution.

There are so many more datasets now: cloud outreach data and breach data, there is electrical distribution. Suddenly you can analyse risk. You can quantify the cyber and transfer on to other markets that want alternative yield.

We only have so much capacity to put out there and we need to create specialties in cyber. Cyber is a pretty broad product but we are beginning to quantify it. The industry is trying to get its head around coverage but what people want is expense payment, quick payment reassurance which the reinsurance industry has not been able to do historically.

When you think about better ways to be relevant and solve the protection gap this can work. But you need a five-day payment based on a parametric trigger when it hits this index. It is also an area in which Bermuda can really start to take a lead.

Huff: I absolutely agree, I am very bullish on cyber because it plays to Bermuda’s strengths and being a very agile market, being very innovative, being entrepreneurs. The book has not been written on cyber, what the coverage and the value propositions are going to be. I think there will be some quick failures who will then go on to the next big idea.

We are shifting the product and the value proposition for the end customer, not to be indemnification but to be protection.

There is not just paying the claims—throwing money from the reinsurer to the insurer to the policyholder—it is guiding them along the way through the underwriting process of what they have to do first of all to even get cyber coverage. It is making sure they have an infrastructure in place that can respect cyber resilience.

Then it is making sure the goods and services are in place from the insurer to make those available when there is a cyber attack. What people are really buying is the professional services from their insurer to get them through a cyber attack, and make that a seamless process.

It is a great line of business for Bermuda because it will change and regulators will drive it now. Regulators are going to push the industry to standalone cyber, and they are going to clean up some of the ambiguity around silent cyber.

Szakmary: Deals are being done with cyber in ILS right now. It is part of diversification strategies as part of the ILS education process.

Investors are looking at the benefit of a rated balance sheet and the diversification profile better managing the peaks and the troughs. Cyber is part of our strategies—a diversified strategy that we have always known as a core part of the long-term capital sell. That is where investors are going.

Ching: In terms of cyber, there is more data piling into the industry. We executed the first cyber index-based trade a year ago. It is currently a standalone trade, but it was the first of its kind and more are in the pipeline. The access to information and data is such that more deals will be done, but we will need appetite from new investors as well as permanent capital to cover this risk.

Going back to the industry being more efficient, what is possible?

Faries: Everybody recognises the fact that we have to find a more efficient way to transact business. What we are trying to do is say ‘let’s once and for all get everybody around the table’.

The brokers are central. The placement is still initiated by a broker, so you have to have the brokers at the table if you are going to think about digitising a placement. That is what we are trying to do.

We would love for Bermuda to lead. This has to be a global initiative but what we are trying to do is encourage Bermuda to lead the discussion. First about what that world might look like, second to lead on testing whether we think that private, permissioned distributed ledger technology is the right technology to build that highway. We want to see this happen in Bermuda, kicking off a global transformation.

Gadeke: The brokers are saying ‘where do I fit in?’. That is a very key part. I had a deal last year where if I was totally in the market on a digital platform, it would not have been placed.

We have to get it over the line at some stage. I think brokers also need to come together.

Faries: That is going to be the big one—trying to get three or four brokers in the room to say ‘why don’t we sit down and do this together’. Everybody is going off and doing their own thing at the moment. That is going to be tough but not impossible.

Gadeke: I think it is coming, that is the aspiration.

DeRose: It makes perfect sense but my question is, with all these technology advances are commissions going to be reduced? Is the broker’s commission going to come down?
Faries: From my perspective we have to start somewhere. The market is going to evolve into a digital marketplace, but we are so far behind where the world is going. But it will happen.

We ultimately want to be transacting business at a lower cost, but the change is going to take time, and industry-wide collaboration.