Still plenty of runway

Some of the rationale underpinning the consolidation taking place in the market right now is born of desperation rather than sound logic and a desire to respond to the needs of customers, many of whom do not welcome some of the large deals taking place among reinsurers.

That is the view of Stephen Postlewhite, chief executive of Aspen Re, who argues that his company’s highly diversified business portfolio, combined with substantial investment in modelling and analytics over the years, has resulted in a much more balanced business and a greater ability to weather the soft market conditions.

“The reality is, in many cases companies have simply run out of strategic runway. They have been focused on too narrow a business model and in lines where there is now intense competition and very soft rates,” Postlewhite says.

“As such, they have also found themselves with too much capital compared with their more diversified competitors and they cannot compete. This is something we spotted years ago and why we have built a well-balanced, diversified reinsurance business. Some of these same companies have been phenomenally successful in the past and they have strong share prices still on the back of this. Some are now able to use that to plot a different strategic future.”

“It will be the companies with significant access to the right capital combined with the right approach to underwriting that will win through.”

He also stresses that although some of the deals may be successful, any large scale merger or acquisition comes with many inherent risks and some will not be successful. Despite some commentary to the contrary, in his experience many cedants are not supportive of the consolidation taking place.

“The message we are getting from brokers is that clients want variety and the ability to choose from a panel of strong reinsurers. This could pose something of a challenge to some of the reinsurers going through deals now,” he says.

“The fact is that this M&A activity will also lead to fallout on many levels. Some clients will be forced to change their panels because the exposure from combined firms is too great and we will also see significant people fall out. We are already starting to see both these things happen.”

Size isn’t everything

Postlewhite also believes some companies “mistake size for relevance” in this market and have taken the notion of a tired reinsurance market too literally. “They believe being twice as big will be a key differentiator. But if they are simply doing the same things as they are now, that will lead to the same outcome.

“Those people who interpret relevance as scale and nothing else are, I think, missing the point. Relevance is not about that. It can be helped by scale, to a certain extent. I believe that you demonstrate relevance to a client by taking the lead, taking a position with them. Rather than just trying to sell them a product, demonstrate to them that you understand their business and you can think around the way they should be structuring their reinsurance programme. If you can show them that thought leadership, they will see you as relevant,” he says.

Postlewhite adds that he doesn’t experience clients saying that they don’t want to work with Aspen Re because of its size.

“While there are times when cedants would like us to take on bigger lines, it is certainly not the case that they don’t want to work with us because of size. While I agree that very small players might find it difficult, size is not an issue at the level where we compete.”

Size is also sometimes cited as being helpful when dealing with increasingly onerous regulation—the high costs and deep expertise increasingly required to manage this regulatory burden might well be easier for larger corporates to bear.

But Postlewhite also turns this argument on its head. “First, I think much of it has to do with a relationship with regulators. If a company has invested in that, it pays dividends in the long term. Second, regulators tend to be more nervous of bigger companies than smaller ones—the level of regulatory oversight is also, to some extent, proportionate to a company’s size.”

He believes that Aspen Re sits largely apart from the main pressures forcing consolidation. He says that the company has always sought a diversified portfolio and a multi-line business model and, as such, is able to direct resources and capital to the parts of its business where rates are adequate and there is the potential for growth.

It is not size that cedants are seeking, he says, but breadth in terms of both products and geographical reach where you can be closer to the client.

“You don’t need GWP of $20 billion to have a good range of products,” he says. “There are very few places we do not operate in and very few products we do not underwrite. I think that we manage that business model and infrastructure very well.”

Postlewhite sets great store, especially in this market, by the company’s financial modelling capabilities which, he says, underpin everything. They have been at the heart of the company’s strategy since Aspen’s formation and it has invested in them continually over the years.

The quality of these is reflected by the “Very Strong” enterprise risk management rating given to Aspen by Standard & Poor’s—the highest possible.

“We have very robust and innovative financial modelling capabilities and they drive our ability to target the right mixture of risks across the portfolio,” he says. “Because we write both insurance and reinsurance and we also cover multiple geographies, this allows us to both leverage the capital we have in a very efficient way and blend the right mixture of risks.”

The company’s established presence in European markets and the US is increasingly complemented by a growing contribution to the business from less mature markets such as Latin America and Asia which contributed around 20 percent of Aspen Re’s total premiums in 2014.

He explains that Aspen’s approach has been patient and controlled in these markets. It has tended to move its best people, already imbued with the Aspen culture and commitment to its financial models, from other regions to establish a footprint in these markets rather than poach teams and hire executives who could be unknown qualities.

“That approach combined with investment has ensured we are now well positioned in some of these markets. We have been very tenacious in getting to know the brokers and clients in these regions very well and that is bearing fruit in terms of our access to risk. Even in a really tough market we get access to good business,” he says.

Discipline is important though. “We will always walk away where we don’t see value-add; we would have grown more in some regions if we had been willing to set aside our pricing and underwriting principles but that is not something we are prepared to compromise,” he says.

While he will not frame it in terms of having a ‘walk-away price’ he says the company is clear in its willingness to avoid doing opportunistic deals. “It is not just about each individual deal but about considering the full client relationship and establishing a very broad and deep understanding of our clients wherever we work.”

He says there are good clients and bad clients in this environment. “With clients who we have known well and stuck with for many years, we provide meaningful capacity across many lines of business. There is mutual trust and we see the relationship as a partnership.

“Then there are others who are simply looking to be opportunistic. There will likely be little longevity in what they are currently looking to do. We are less likely to support these clients and will be more price-sensitive in discussions with them.”

He stresses that the company’s diversification means that it has very sophisticated capital models. Its diversification can mean that its capital profile when underwriting catastrophe risk, for example, can be very different to that of a monoline cat player. This logic can be extended further when its diversification across insurance and reinsurance is considered.

“We have very robust and innovative financial modelling capabilities and they drive our ability to target the right mixture of risks across the portfolio.”

“It means we can be quite clever in the way we consider and structure a portfolio,” he says. “The insurance and reinsurance businesses complement each other. If we did not have insurance, we would have to allocate more capital against reinsurance risks, for example. That gives us a great strategic advantage over many of our competitors.”

Expanding markets

This process of diversification is also ongoing. He notes the company’s expansion into the credit surety market in recent years as well as its Aspen Capital Markets business and more recent move into accident and health business.

Postlewhite expects future growth to increasingly come from some of its hubs in developing countries. “I see very healthy prospects for growth in Latin America and Asia. They should continue to enjoy very good economic growth and increasing insurance penetration and it is really a question of a rising tide in those markets which we can benefit from.

“I think we can start to grow our share of the pie in some of these markets; we have some good franchises already and we continue to invest.”

One example of this ongoing investment came in Australia recently where Aspen hired Andrew Parker, who joined from Hannover Re, as head of its Australian branch in Sydney, and Paul Wedlock, who joined from Swiss Re Australia, as senior underwriter.

“We see strong opportunities for us there and there are several other examples of that sort of opportunity elsewhere around the globe,” Postlewhite says.

Going down, down, down

The biggest impediment to growth could be the ongoing soft market, with rates in many lines of business substantially below what they were a few years ago—and below what reinsurers would like them to be.

Postlewhite agrees that property-catastrophe rates have fallen steadily for the past 18 months as have many areas of casualty business. But he believes they are now reaching a plateau as an inherent underwriting discipline in the market starts to kick in.

“We are starting to see a natural floor being reached in some areas,” he says. “We are seeing declines starting to slow now as we get close to minimum pricing for the most efficient cost of capital. That said, in more specialist lines that are less commodity driven, it is less of a concern.”

While a floor on pricing may be close in cat business, he believes the large amount of capital in the market could start to also have a negative effect on some other, less commoditised areas, such as some more complex property lines and parts of speciality business.

“This will often be from a pricing base that we consider pretty price adequate. Unless something significant happens that is the inevitable conclusion,” Postlewhite says.

But he believes any discussion about rates alone is inadequate when characterising what is really going on in the market at the moment. He believes the market is already seeing a more important and profound shift occur in the terms and conditions being offered on policies.

Important shift

“We are starting to see changes occur in terms and conditions, both for the original risk and for the reinsurance coverage,” he says. “That is potentially a more dangerous change. We are seeing clients ask for multi-year, aggregate deals, multi-class deals as well as more esoteric changes such as adding terror exposure, cyber exposure, business interruption, and contingent business interruption, and removing exclusions.

“But those terms and conditions are put there for a reason and to remove them can have drastic implications. This is where skill and expertise on the underwriting side really come into play and make a real difference.”

He says many of Aspen Re’s underwriters have previous soft market experience, which makes a big difference at a time such as this. He also stresses the importance of good financial models and internal capital models in this type of market as well as leadership with the backbone to say ‘no’ to deals.

“It is very important to understand the point at which prices are adequate and the point at which they are not,” he says. “It seems like an obvious statement but it is actually quite difficult to understand price relative to capital within a portfolio—but this is something Aspen spends a huge amount of time calculating and analysing.

“We look at it on a marginal basis: we ask what the next dollar of income means in terms of capital to support it and how we can make a profit from that. We always want to know the precise impact that will have on our ROE.”

In terms of growth, Postlewhite also stresses the importance of its growing role as a facilitator of alternative forms of capital. Aspen Capital Markets, now two years old and led by Brian Tobben, was formed to develop alternative reinsurance structures and leverage Aspen’s existing underwriting franchise.

“This is a growing franchise for us, mainly focused in the reinsurance cat risk space but it is also looking at products outside of that. One of the big unique selling points of what we offer is just how transparent we are in the way we deal with investors in this segment of the business.”

He believes this will become a differentiator in this market, especially in the aftermath of a big loss. There will be some investors who will feel they have been misguided by the funds or reinsurers they are working with and could become disillusioned as a result.

“Those that have always been open and transparent will do better following a loss than those that have not,” he says. “Some capital will disappear but the money that will stay will come from investors who have always understood the risks; these may even do more. Truly embracing this as a concept also means being there post-event.”

He also believes that capital will be sucked out of the market if interest rates rise, as they are forecast to do in the next 12 to 24 months. “This is bound to remove some capital,” he says. “It will take capital out of the market both directly (due to falling values of fixed income investments) and indirectly as better yields emerge in other asset classes.

“But if the deals you are doing are transparent and underpinned by good technical underwriting it is unlikely investors will be walking away.”

Ready for change

Either way, he is clear that the market is going through a radical and fundamental change. This will result in almost no commodity or monoline lines being left in the traditional reinsurance market and any risk that can be commoditised being increasingly absorbed by alternative risk transfer structures and capital.

“There will be winners and losers,” he says. “The companies that will remain will concentrate very heavily on non-commoditised, difficult to underwrite risk and develop much deeper and broader relationships with cedants. They will be doing larger and more complex deals with clients which generate significant value for both parties.

“Those that are able to embrace these concepts and add to the thinking in constructing them are likely to be winners in the longer term.”

He believes companies that establish the right relationships with third party capital providers will also gain in the long term, as long as such relationships are structured correctly and apply rigorous underwriting standards.

For commoditised business, the lowest common denominator in terms of cost of capital will win through, he believes.

“It will be the companies with significant access to the right capital combined with the right approach to underwriting that will win through.”

Combined with what he sees as inevitable casualties from the current round of consolidation, he believes the industry will look very different from now in five years’ time. “Some players will not succeed going down the M&A route. In addition, too many firms underestimate the importance of underwriting skill and will get badly stung by the soft market and dangerous terms and conditions.

“Those things will come home to roost. Losses will take their toll and while there will be fewer players, the industry will ultimately be stronger.”