Monte Carlo: leading insight
Monte Carlo talking points
Each year at Monte Carlo, the re/insurance industry gets together and thrashes out those topics troubling, exciting and occupying the sector, with 2011 set to be no different. Commenting on those issues that will be addressed this September, Jamie Veghte, chief executive of XL Group’s reinsurance operations said that “market conditions, anticipated trading conditions at year end, and mergers and acquisitions” would undoubtedly be topping the agenda. Others likewise agreed, with Tatsuhiko Hoshina, chief executive officer of Tokio Millennium Re, indicating that the direction “rates are heading for January 1” and M&A activity—“a topic we address every year”—will be the topic of much of the conversation during the Rendez-vous. Hoshina added that “there are a few players that are always the topic of M&A talk” at the event, with the industry’s “tendency towards ‘bigger is beautiful’” meaning that such deals are regularly a topic of debate.
Tom Hulst, chief executive officer at Ariel Re, added that “international cat losses, the development of those losses, and their implications for results, capital and 2012 pricing will clearly be a topic of interest” at Monte Carlo this year, with the after effects of first quarter losses evidently still being reflected upon by the industry. Barbara Merry, chief executive at Hardy Underwriting, likewise indicated that absent a major cat event or significant M&A, topics for discussion at Monte Carlo would be “cat exposure and losses, the availability of reinsurance, sidecars, people movement and likely fullyear results—in other words, the usual”.
William Jewett, president of Endurance Specialty Holdings, said that “interest in how long the soft market will be sustained” will likely be the leading issue discussed at the event, adding that the impact of RMS model changes will be another—“admittedly secondary”—discussion point. Hulst agreed, saying that he expected that the RMS model change—“in particular the MTR-Regionalization changes and Storm Surge model”—would be discussed at Monte Carlo. Jewett added that “in many prior years, the primary topics of discussion have emerged around the time of the conference”, citing the tragic events September 11, the SCOR-Converium transaction, the Aon/Benfield merger and 2004/2005 US hurricane activity as defining issues that have topped the agenda at Monte Carlo. In terms of additional topics likely to be discussed, it would seem that much will hinge on events in those weeks immediately preceding the event.
An unlikely turn
Prospects for a turn in the market—be it on property cat lines or a wider hardening—will undoubtedly be a topic of discussion in Monaco, with the general consensus being that rates have firmed up somewhat, but unless there is a major event between now and January 1, prospects for a turn seem slight. Jewett said that the industry was “exhibiting signs that indicated that a market correction could emerge, and that a more rational view of capital and return among many insurers and reinsurerswas becoming increasingly apparent”, but added that he did not anticipate a significant turn at January 1. Hoshina said that “compared with last year”, rates are “stable or a bit harder on the property cat side”, indicating that at the June and July renewals, there were “some increases in rates in the US—much of this on the back of ‘Hurricane RMS’ generated increases” —but added that unless a major event intervenes, he does not foresee “a wider turn”. Veghte likewise said that at the “June 1 and July 1 renewals, we got very nice risk-adjusted increases on our North American cat portfolio, but it sadly hasn’t impacted the long-tail markets”. Merry said that Hardy’s “experience suggests that cat-exposed property lines of business—both US and international—are improving”, but added that whilst there were localised hard markets internationally, she did not “foresee a [wider] hard market”.
Hulst concurred, stating that “barring a major catastrophe”, there was unlikely to be a broad turn in the market, with any “material change in pricing confined to those lines of business that have produced underwriting loss on an incurred basis”. As he made clear, capital levels “remain sufficient”—even after first quarter losses—suggesting that conditions for a turn are yet to coalesce. Much will hinge upon the hurricane season this year, which will be at around its mid-point during the Rendez-vous, although the dislocation between pricing on cat business and other lines suggests that should a major cat event materialise, it is unlikely to become a lever to a wider turn. Touching upon other lines, Hoshina said that there wasn’t much movement on the casualty book or on the risk side, and predicted such lines would “likely remain stable for 2012”.
Sidecars—back in vogue
Sidecars have found themselves back in vogue this year after something of a hiatus, with Alterra, Lancashire and Validus all forming alternative vehicles in the face of significant industry losses caused by a succession of cat events in 2010 and 2011. Addressing such vehicles, Merry said that sidecars “have proved their worth...as an overspill for capital-hungry lines of business”, with such vehicles likely to be more prevalent as markets seek to “de-risk on cat exposures and demand from investors for uncorrelated risk increases”. Jewett agreed that sidecars “can be a highly efficient way to bring additional capacity to the marketplace—optimistically or otherwise”, with sidecars being able to “leverage existing management teams and capabilities”. Veghte concurred, adding that such vehicles are an “efficient way for investors to enter and participate in the reinsurance market with clear exit strategies and liquidity”. He predicted that such vehicles would form a “very significant part of capital-raising” going forward, although he said that their present deployment fell well short of that seen post- KRW, stating that “their current success is not clear yet”.
"Sidecars have proved their worth... as an overspill for capital-hungry lines of business, with such vehicles likely to be more prevalent as markets seek to de-risk on cat exposures and demand from investors for uncorrelated risk increases."
Hoshina and Hulst were less convinced about the deployment of sidecars, with Hulst saying “I don’t believe the current market opportunity is such where we could say sidecars have broadly ‘proved their worth’ in terms of value creation on a risk-adjusted basis for investors or sponsors”, although he agreed that such vehicles are a clear “alternative to raise short-term capital”. Hoshina added that “the current level of pricing really doesn’t justify sidecar formations all that much”. He said that he didn’t think that “investors regard sidecars as an opportunity at present—or a high return one”; rather the present formations were in preparation for the “next big event”. In the event of a Katrina-type event, Hoshina predicted the formation of new sidecars rather than another class of players as “with firms trading below book and investors not able to pull away, it seems unlikely they will want to create new insurance establishments as they did in the past”. He added that the “sidecar alternative would be a great way to invest and raise capital”, predicting that such vehicles will be the obvious outcome of the next major event. Jewett however said that it wasn’t an “either/or” situation—sidecars could likely “dampen the number” of new entrants in the event of a market dislocation, but they still would not preclude the creation of new companies.
Much has been made of the new RMS version 11, which has had a not insignificant impact on cat pricing in the US, with a hardening of affected lines already evident at the US’s June and July renewals. There is an expectation that the full ramifications of the new models will not play out until January 1, but what does seem clear is that the industry would like to ‘iron out’ the sudden changes in cat exposures these model changes usher in. Addressing whether dramatic changes such as RMS 11 were encouraging firms to establish their own proprietary models, Hoshina said that such things “are easier said than done”. Rather than a departure from using third-party modelling firms, he suggested that a “blended approach” will be the way forward, “drawing upon input from all three modelling firms”.
Hulst and Jewett pointed to the emphasis placed upon the models by the ratings agencies, regulators and other constituents, saying that companies couldn’t simply develop their own models because they did not agree with current results. Veghte added that reinsurers have always sought to not rely on a single model “for either pricing or risk management”, with changes in the structures of a single commercial modeller unlikely to “prompt a change in behaviour”. He said that the full implications of the new model change on “pricing and risk management is not yet clear”, indicating that it would take “at least a year” before its full impact on “pricing and capacity demand” is clear.
Hoshina said he suspected that “following ‘Hurricane RMS’, the industry will also review how it applies models to assess its risks”, with firms needing to spend more time drilling down into their models to examine whether the output is correct, “rather than simply applying each interpretation of risk without question”. Jewett described this as a “healthy development” for the industry that would “encourage firms to take a harder look at the models”. He noted that manycompanies, including Endurance, have historically augmented the commercial analytics with their own proprietary models. However, Merry suggested that there might nevertheless be a temptation among reinsurers to “use whichever model helps them to say ‘yes’ to writing a risk”, with such a dynamic likely to place “competitive pressure on the third-party models”. Touching upon whether re/insurers are becoming over-reliant on modelling firms, Hoshina said that the industry is increasingly turning to third-party research centres in order to examine natural perils, with such institutions acting as an extra pair of eyes that will “play an increasingly important consultative role going forward”.
The last few years have been difficult on the investment side of the business, with the financial crisis and its extended hangover meaning investment returns have remained decidedly sluggish. And challenges remain in what is “undoubtedly a difficult investment environment”, according to Hulst, who added that conditions have been more impactful for those firms with a “high-degree of investment leverage” given a focus on longer-tail lines. Meanwhile, recent ructions in Europe and the US have meant that the usual flight to quality hasn’t been quite as straightforward as it has been in the past. As Hoshina outlined, Tokio Millennium Re maintains a “very conservative” investment portfolio, with a heavy weighting to US governments and agencies with a weighted average credit rating of AAA for the entire portfolio, but said that given the uncertainty around the implicit guarantee of government-sponsored agencies and the negative state of the US government finances, the company has begun to diversify into more corporate bonds. In terms of duration,the company has stayed neutral to the strategic target as it does not see interest rates rising anytime soon. This strategy has helped to keep investment income consistent throughout this period, Hoshina said. Generally, the company remains very cautious, because in this very volatile environment, you don’t want to get hit by the repercussions of another financial crisis, he concluded. Merry concurred, describing investment returns as “pedestrian” unless reinsurers were willing to subject their portfolios to a “higher risk profile”. She added that “at times of intense underwriting risk, it is difficult to see how a ‘double or quits’ approach to investment risk makes sense”.
"In response to those financial troubles that have characterised the past few years, expectations have increasingly come into line with risk and return, with reinsurers and their stakeholders have increasingly come into line with risk and return, with reinsurers and their stakeholders simply having to manage their way through the troubled investment environment."
Veghte indicated that perhaps the “more interesting question around investment yields is how companies have handled it relative to their pricing models”. He said that XL Re—for its part—responds to investment yields on a regular basis, with returns being a factor in “why we have got fairly uncompetitive on long-tail lines”. He said that others were evidently taking a more long-term view on investment returns, with the competitive pricing environment evident in the casualty market a product of firms using “higher yields in their pricing assumptions than they are actually getting in their investment portfolio”. Until this changes, pricing is likely to remain more competitive than returns on investment would otherwise suggest. Nevertheless, Jewett said that in the current low interest rate environment “most companies and stakeholders have a fairly pragmatic view of return”. In response to those financial troubles that have characterised the past few years, “expectations have increasingly come into line with risk and return”, with reinsurers and their stakeholders simply having to manage their way through the troubled investment environment. And with the ongoing financial crisis looking likely to get worse, they may yet have to hold their breath that little while longer.