Monte Carlo: view from the top
Drawing insights from David Cash, president and CEO of Endurance Specialty Holdings, Kean Driscoll, CEO of Validus Re, Charles Dupplin, CEO of Hiscox, Bermuda, James Few, president of Aspen Re and Torsten Jeworrek, CEO of reinsurance at Munich Re, we addressed three key questions facing re/insurers attending this year’s Rendez-vous.
Which conversations do you expect will be the most difﬁcult and most pressing in Monte Carlo?
Cash: I expect the conversation at Monte Carlo this year will focus on a combination of underlying rates and the need to improve the margins on reinsurance treaties. Over the last ﬁve years, we have seen a steady erosion in the proﬁtability of the core property and casualty treaties either as a result of underlying rates not keeping up with loss trends or due to an increasing awareness of the potential for catastrophe losses.
Certainly it is clear to me that reinsurers are comfortably solvent and, by that standard, rate increases may not be as critical as they have been in past years. That being said, the issue of low margins in the treaty marketplace is one that has caught the attention of reinsurers both in Europe and overseas and it is my expectation that we will see a steady push to correct this over the next few renewal cycles.
Driscoll: I think the most pressing conversations will be around supply:demand dynamics in the marketplace. Balance sheets have strengthened—not only in the reinsurance market and in comparison to 12 months ago, but also in the global insurance market—so the question will be how much demand there will be relative to capacity. Monte Carlo is the ﬁrst opportunity for people to get a feel for the supply:demand dynamic and how that will inﬂuence rates. People will be trying to calibrate where their marketplace will be.
Also, given that Monte Carlo is focused on European and other non-US business, some of the difﬁculties around sovereign debt will undoubtedly be discussed. It remains to be seen whether the situation will translate into opportunities for the reinsurance market. Reinsurance is a fantastic product for providing capital protection and relief if companies have issues elsewhere on their balance sheets, and it will be interesting to see whether asset markdowns translate into companies exploring more reinsurance solutions to protect the balance sheet from catastrophe and similar losses.
Dupplin: I think solvency and regulatory changes around the world are really big issues—there have been no great catastrophes thus far so they’re the issues that could alter the landscape of the industry. We’re in a fascinating phase, and Bermuda is doing very well and will ﬁnish putting its regime in place on time and in a very impressive way, but the story is different in Europe where there is going to be signiﬁcant uncertainty and Bermuda will have to react to that uncertainty.
I’m going to be particularly interested to hear insights on the issue from those based in continental European because there seems to be a rumbling of revolt over Solvency II and it will be interesting to see what they say about it during Monte Carlo.
Few: A long period of soft underwriting conditions combined with historically low investment returns are two reasons why underwriters are justiﬁed in asking for increased rate. Unfortunately, the poor economic environment is depressing demand and returns for all, making paying for those rate increases all the more difﬁcult.
Also the potential collapse of the euro is no longer highly unlikely. Are we ready for the implications on our businesses should such a scenario occur? What will be the ﬁnancial implications? How will policies denominated in euros respond? These are some of the difﬁcult questions we as an industry need to ask.
Jeworrek: The crisis in the eurozone represents the biggest challenge for global economic development and the capital markets at present. Political developments will have a great inﬂuence upon this, but are difﬁcult to predict. As a consequence, the reinsurance industry is exposed to the risk of potential further upheavals in the ﬁnancial markets, particularly relating to investment. Some lines of reinsurance could also be affected by a further deterioration in economic development, particularly in the peripheral states of the eurozone.
One consequence of the current sovereign debt crisis, not only in Europe but also in the US, is continuing low interest-rates for highlyrated government bonds. This creates challenges for the pricing of long-term reinsurance contracts. In addition, a rise in inﬂation could lead to claims inﬂation and thus to higher claims payments in future. The convergence of these two factors has resulted in negative real interest rates, posing a particular challenge for the property-casualty business of both insurers and reinsurers.
What do you expect the industry to agree upon this year?
Cash: I think there will be unanimity that pricing needs to increase in the US, in particular in product classes that are heavily reinsured— complex casualty classes of business and businesses involving high severity risks—each of which have gone through multiple years of rate reductions. Our industry is at the point where companies’ historically positive loss reserve emergence is starting to wane which together with chronically low interest rates is a recipe for meaningfully lower proﬁtability.
When you put the pieces together, I am expecting to see reinsurers seeking improved underlying rates and reinsurance terms in the US over the next few years.
Driscoll: I think there was a general recognition last year that in some emerging markets there had been insufﬁcient resources committed to understanding the potential for meaningful economic and insurance risk. Rate increases that have since come through in loss -affected territories have been pretty reasonable and have largely reﬂected those risks. This year I think that there will be general consensus that the cat market is generally well priced, but not excessively so.
Beyond that, I think there is general agreement that the casualty market is probably generally deﬁcient and without the availability of compelling investment income, there needs to be a continued focus on underwriting proﬁts in order to meet our cost of capital.
Dupplin: Generally, you never get anything everyone agrees on at the Rendez-vous. It’s an interesting stop-gap in the business planning phase and people leave Monte Carlo with impressions of where directionally rates are likely to head.
This time I suppose everyone would agree that investment returns are poor and they’re likely to remain that way for a long time. Shareholders look for a certain level of return from their share capital, with the return on capital a combination of underwriting proﬁt and investment returns. If one side of the book goes down drastically, you’ll have to seek to address the balance and offer a reasonable return for your shareholders by altering the other. Whether that will actually happen in a dynamic market remains to be seen, but it will provide some stiffening to rate sag.
Few: Improving data quality is essential for more accurate pricing, accumulation control and modelling. This is particularly the case for commercial risks involving complex supply chains.
Growth in emerging markets presents exciting opportunities for the insurance and reinsurance markets. As an industry, we should attempt to meet growing demand without compromising the need for a fair return on capital.
Finally, overreliance on model outcomes should be avoided. The industry needs improved research and development to help understanding of risk such as natural catastrophe exposures, supply chain risk and credit risk.
Jeworrek: I think that all market participants agree that we need more transparency, especially in respect of complex risks. In recent years, we have seen rapid growth in the interconnectedness and complexity of the economic, social and technological environment. This presents a range of challenges for the management of accumulated risks. Local events can increasingly lead to high losses as a result of both their domino effect and resulting loss cascades. The boundary for insurable events is inevitably determined by the identiﬁcation, understanding and assessment of such risks. Thisis where reinsurers, risk-modelling ﬁrms and brokers can offer a lot of support for their clients. Knowledge networks can make an important contribution in this context. Mutual cooperation will further improve risk management on both sides of the re/insurance industry’s balance sheet.
What strategies do you expect reinsurers to employ in 2012–2014 to maximise their relative position and returns?
Cash: I am mostly observing two trends—geographic expansion and increased focus on specialty lines of business. Younger, smaller reinsurers with presences in Bermuda and London, will increasingly be looking to build out teams in the European, Asian and perhaps Latin American markets. In effect these companies are saying ‘there are many client companies that are big enough to be relevant to us, but small enough that they don’t want to have to travel to London or Bermuda’ and the way they do business with these clients is to have a physical presence in or close to these markets. This trend helped to spur the build out of the industry in Zurich and may do the same for other locales in the future.
The other trend is that there is an increasing demand for capacity lines of reinsurance where specialty underwriting skills are required. This is particularly true in emerging markets such as Latin America. It is also true of the specialty lines of business such as trade credit and surety, engineering and agricultural reinsurance. In each case, clients need both capacity and at times advice and support in covering new or more complex risks.
Driscoll: I can only really talk to Validus’ strategy. Our number one priority is to focus on growth in book value. Diversiﬁcation is something that we strive for, but only in areas and products where we feel we can understand the risk and receive an appropriate margin for the business. We emerged from 2011 in pretty good stead, following what was a difﬁcult year, and despite more than $100 billion of global cat losses, we still produced an underwriting proﬁt. We were unrelenting in our focus on understanding risk, particularly in non-peak territories, and were careful about appropriately managing and pricing that risk. We were the only short-tail company in our peer group to have made money in 2011, while a lot of what others would consider diversiﬁed companies made a loss. Diversiﬁcation for its own sake has certainly lost a lot of ﬂavour.
That said, we have not changed our mentality on diversiﬁcation— we will maintain a focus on our current proﬁle. We believe that where we are currently positioned is the best-priced segment of the global market, but if other areas change and more margin comes into those territories or products, we will certainly look to broaden our product offering. But in the end it is all about growing book value. If there are sufﬁcient market opportunities we would always look to put our capital to work, but if there are not opportunities, then I think ourselves and the wider market will manage capital aggressively through whatever means necessary. Validus has a consistent track record of returning capital to shareholders in our seven years history, as has the wider market.
With respect to M&A, it is difﬁcult to say. We have done two deals in our history and they have been not only incredibly successful economically, but transformative for our company in terms of our business scale and proﬁle. That being said, these transactions can be difﬁcult to accomplish successfully and so I would hesitate to say that we will see a broad amount of M&A, but you never can tell what will happen.
Dupplin: The industry is in an interesting state, because in terms of the amount of business it’s seeing, the vast majority is Western European and North American—where there’s a culture of risk transfer—but there hasn’t been any real growth in these regions for some time. If you look at growth elsewhere, obviously the developing nations have a lot more potential risk to place, but there isn’t the risk transfer culture—a factory owner in China doesn’t as a matter of course insure every risk, whereas an owner in Germany does. It’s a cultural difference, but I think that culture is changing and you’ll see far greater risk transfer in emerging markets. I’m predicting a future that’s fairly static in the Western world, with decent growth in developing countries.
There’s also a lot of discussion regarding the changing capital structure of the reinsurance industry. There are precious few stock companies being born nowadays, while there are an awful lot of collateralised entities being established around the world. The perennial issue when one gets a wave of new insurers is that while there are some people who know what they’re doing, there are a fair few who are rather green. I dare say one or two of the green collateralised boys will slip up on banana skins along the way, but in general collateralised players appear to be here to stay, and the industry’s having a good long think about what the future shape of capital structure should be. One reason you don’t buy a new stock company today is because it’s like buying a motor car—you buy it for $1 billion, but when you put it on the stock exchange, it’s only worth $900 million. That’s not very enticing for the formation of new companies, whereas if you put £1 billion into a fund, then it’s worth $1 billion the next day. Admittedly you pay the fund people to run it, but it’s fundamentally doing the same thing and earning money from risk transfer. I feel that’s a very interesting debate for the industry. There’s no right or wrong approach, it’s whatever’s convenient for the world, and I think we’re looking at a period where elements of the capital structure are likely to change for the long term and that’s to be reﬂected upon, discussed and accepted.
Few: Diversiﬁcation remains a key strategy for many despite the international loss activity that characterised 2011. I expect that reinsurers will however focus on making sure that diversiﬁcation considerations do not detract from all products paying their own way and contributing to return on capital targets.
In addition, I expect that reinsurers will continue to be cautious in underwriting long-tailed lines until such time as the underwriting rate better reﬂects historically low investment returns and the possibility of signiﬁcant inﬂation in the future.
Jeworrek: There is no one-size-ﬁts-all strategy for reinsurers. It largely depends on the business model of each company. Diversiﬁcation, of course, is one of the most important assets of a global group such as Munich Re. Increasing premium volume can only be sustainable if premiums are adequate for the risks covered, and this applies all the more in the difﬁcult economic environment we face at the moment. The big question will be how quickly, and to what extent, reinsurers succeed in compensating for the reduced interest-rate level with price increases at the next renewals. Ultimately, our industry is faced with the challenge of achieving stable earnings and reducing its dependency on investments. This will only be possible with healthy returns from our core business.