S&P conference looks at global reinsurance market

Reinsurers have looked for strategic growth through new products and coverage, as well as possible mergers and acquisitions (M&A), according to panellists at the annual 2018 S&P Global Ratings Bermuda Reinsurance Conference, which took place at The Hamilton Princess Hotel on Nov. 6 and 7.

With the sector beset with secular changes and elevated competitive pressures, panel discussions at the conference centred around reinsurance pricing trends, the sustained influx and influence of alternative capital, M&A, and opportunities for growth.

On the bright side, the US economy continues to chug along in what S&P Global Ratings chief US economist Beth Ann Bovino described, in her keynote address, as a Goldilocks period. Still, she warned, there are bears lurking in the economic woods. The global economic upturn has likely peaked, she said, and the strong dollar is hurting emerging markets while interest rates and oil prices are rising.

As it stands, S&P Global Ratings forecasts US GDP growth of 2.9 percent this year and 2.3 percent in 2019. Beyond that, we expect the world's biggest economy to expand just 1.7 percent in 2020--a tad below the estimated long-term growth potential.

Respondents to a poll at the conference pointed to macro trends as only a moderate short-term risk to the reinsurance sector, with nearly half (46 percent) saying pricing adequacy was the biggest threat.

In the aftermath of last year's record catastrophe losses, the rebound in reinsurance pricing that many expected has been relatively muted, which will weigh on reinsurers' underwriting results. This year's catastrophe losses may cause some reflection within the sector, and could perhaps provide some support to current pricing levels, but the underlying prognosis for relatively stagnant pricing trends looks unlikely to shift significantly in 2019. S&P Global Ratings has pointed to profitability falling below the cost of capital on a sustained basis as a potential trigger for revising its outlook on the sector to negative.

“We have to start managing our business assuming current conditions persist,” said Mario Bonaccorso, executive vice president and CFO at PartnerRe He added that in an environment of rising interest rates, he's optimistic on the casualty line of business, but that it won't all accrue to reinsurers' bottom lines because pricing “has to catch up with some inflation of cat losses.”

Still, reports of the death of the pricing cycle have been greatly exaggerated, David Flandro, global head of Analytics at JLT Reinsurance Brokers, told conference attendees.

“What we're really bad at in this sector sometimes is we take the last three or five years and extrapolate into the future forever,” Flandro said, adding that he believes the sector reinvents itself every decade or so. “We're at the beginning of another cycle that's not disinflationary.”

Last year, the reinsurance sector generated returns on capital of only 1.2 percent, or 6.3 percentage points below its cost of capital--the worst level in more than 13 years. Despite modest reinsurance price rises following the 2017 catastrophes, the return on capital in 2018 may not materially exceed reinsurers' cost of capital, given the year-to-date catastrophe losses.

Looking further ahead, poll respondents said alternative capital would have the biggest effect on the sector in the next decade. And as a source of capacity, alternative capital has consistently expanded, reaching almost 20 percent of global capacity in the third quarter of this year. Moreover, the question around whether alternative capital would bolt after losses materialised seems to have been answered, with these new entrants having met the stresses of 2017's natural-catastrophe losses and the market reloading without any major issues.

“Like any market, results vary. Generally speaking, investors understood they were taking catastrophe risk, and it was a busy year,” said Frank Majors, co-founder of Nephila Capital. “If our investors are signing up for catastrophe risk and they're thinking hurricanes, we need to educate them about the other risks."

Cory Anger, global head of insurance-linked securities (ILS) Origination and Structuring at GC Securities, agreed. “One of the pitfall that existing investors need to be mindful of is that we were in such a benign environment from a loss perspective for so long that we need to remember there is volatility in this sector,” she said. “I don't think the fact that we've had more sizable losses is changing the appetite.”

Meanwhile, US mortgage reinsurance has been one of the few lines of business that has performed well in recent years. Joseph Monaghan, executive managing director at Aon Benfield, estimates that there are about 40 distinct balance sheets in the space. “There are opportunities to add to that. We've seen new participants come in this year, and we'll see new participants come in next year,” he said, adding that total risk in force is approaching $20 billion. “I think you could double that, certainly.”

On another front, reinsurers are facing a number of challenges regarding regulation, which clearly creates costs that eat into providers' bottom lines. This is exacerbated, panelists said, by different levels of regulation in different markets.

“The biggest challenge from regulation is trying to get a very level playing field across all markets,” Jay Bullock, EVP and CFO of Argo Group International Holdings, told conference attendees. “It feels like we spend an awful lot of time trying to answer the same or similar questions in multiple jurisdictions. There's just not a consistency, and that makes it very difficult to plan your business.”

Greg Richardson, chief risk and strategy officer at Transatlantic Holdings, suggested that regulation can actually add to reinsurers' risk, rather than lessen it. “We're putting some of our best brains in serving the regulatory customers instead of our real customers,” he said. “It's a managerial distraction. I think it actually creates risk and doesn't mitigate risk.”

Michael McGuire, CFO at Sompo International, went further, saying “the level of oversight we have to have to meet regulatory requirements in each district has gotten to the level of, I'd say, insanity.”

One way reinsurers are evolving is in the embrace of technology. Turab Hussain, chief risk and actuarial officer at PartnerRe, said that technology is “changing where the risks sit.” “As reinsurers we're all looking for more data and how we can use technology to better inform our thought processes,” he said.

Still, technology isn't a cure-all, panelists said.

“Does anyone in this room think that technology isn't going to change the insurance industry in our lifetimes? Of course it will,” Andrew Newman, chief executive officer (CEO) at Willis Re Alternative Strategies, told conference attendees. "Is it going to be the disruptive force that was predicted? We're a long way away from that.”

Transatlantic's Richardson said that the industry has always been in predictive analytics, so new technologies “pale in comparison to the invention of the PC or Excel” as truly transformational. On the topic of blockchain, he said it “has an appeal, but I think the economics are questionable.”

“The amount of intellectual capital and investment--for what are highly specific functions--the transaction volumes and the amount of costs you could conceivably take out just aren't enough,” he said.

Looking for other ways to evolve, some reinsurers have turned to M&A--expanding their scale, divesting nonperforming businesses, and/or diversifying into less-commoditised lines of business. There have been a few deals affecting Bermudian reinsurers this year, the latest being RenRe's acquisition of Tokio Marine's reinsurance business, Tokio Millenium Re.

“I think the trend of consolidation is going to continue,” said Sompo's McGuire. “There are still a number of companies that are smaller--some have created a nice niche and can continue as smaller companies. But there could be pressure points. The margin of error or margin of safety becomes less and less.”

There are other ways, too, to grow and achieve cost-effectiveness, said Michael Sapnar, president and CEO of Transatlantic Holdings. “You can drive costs out of the business through partnerships rather than acquisitions,” he said. “I don't think you'll necessarily see M&A for cost savings, but there are other reasons for acquisitions.” Either way, global reinsurers have ample opportunities to expand. “There are a lot of areas to grow, especially in shrinking the protection gap,” Sapnar said. “I'm kind of interested in why people still aren't buying.”

Bryon Ehrhart, global head of strategic growth and development at Aon, agreed. “The great news is, risk continues to grow throughout all industries,” he said. “And that represents an opportunity.”