Risk selection and pricing to be key in reinsurance market transition

As the global reinsurance market transitions from one dominated by companies backed by equity shareholders to a new capital mix, with alternative capital sourced from third-parties a growing component of global reinsurance capacity, diligence in the selection of risks and pricing will be key.

As the influence of the capital markets increases in reinsurance and insurance circles. As risk and capital collide transforming catastrophe risk, and increasingly other lines of reinsurance business, into asset classes with broad appeal for institutional investors. The reinsurance market looks set to undergo, at the very least some major changes, at the most a structural transformation.

With forecasts predicting that as much as $100 billion of new alternative capital may enter the reinsurance market from institutional investors such as pension funds, deployed as insurance-linked securities, catastrophe bonds and collateralized reinsurance, the topic of how to react and adapt in order to remain competitive is becoming more widely discussed.

In an uncertain climate, such as the one the reinsurance market now finds itself in, there are really only a few ways reinsurers could react.

One option is to embrace the alternative capital and find ways to leverage it within underwriting, manage it within dedicated units for fees, or to benefit from broader and cheaper risk transfer by using it. However this option won’t keep you safe from the competitive effects of new capital, according to some.

Another way is to try to compete head on with it, something that is not recommended unless you have the scale and diverse book of business to allow you to compete, or to try to avoid its impact entirely by diversifying.

Scale up, build a larger business through mergers and acquisitions, buy or leverage specialists which can bring new lines of reinsurance business into your organisation and help you to find new profits. Of course this still leaves the other areas of the business at risk and as capital broadens its hunt for returns to new areas of the reinsurance market it may just be offsetting the competitive effects for a time.

The final option is to carry on regardless and focus on what you do best. Again perhaps not advisable as the change being stimulated by alternative capital has the potential to be far-reaching and it may be easy to get caught out if you’re not prepared.

Insurer American International Group (AIG) has some fantastic advice for any reinsurers, or indeed insurers, thinking of following any of these strategies as they seek to navigate the changes in the reinsurance marketplace.

When discussing increasing competition in the marketplace, which has been stopping AIG from increasing pricing, Chairman Steve Miller told Bloomberg, that with no pricing power left due to competition, the focus has to be on providing better service than the competition.

“The main thing that will distinguish us is that we select the right risks and price them right with our premiums. And if that means that we lose some business elsewhere so be it,” Bloomberg quotes Miller.

That’s a fantastic bit of advice and applies to insurers, reinsurers and also those working with alternative reinsurance capital. As the market becomes increasingly competitive, pricing suffers and the key differentiators become the levels of service offered, innovation within the organisation, returns offered to investors and the ability to select and price risks accurately.

That calls for greater underwriting diligence, a focus on a strategic business plan and a customer focus on everything that reinsurers do. Alongside innovation, customer focus and client centricity are going to be key features of successful reinsurers, insurers and ILS specialists in years to come. That customer centric approach will need to be applied to cedants, partners and investors alike to be successful.

Capital and investors are fickle and they will go where they see the greatest opportunities to profit. Right now, capital may have flooded into the property catastrophe reinsurance space in recent months and a considerable amount is also sitting on the sidelines waiting for new reinsurance-linked investment opportunities to emerge.

However, this initial interest will eventually be tempered, with capital and investors becoming more choosy about how and where they access reinsurance as an asset class as the options available to them grow. Here the ability to differentiate or distinguish oneself may become key.

It is the reinsurers, ILS investment funds and reinsurance asset managers that can prove real diligence in their underwriting, stable attractive return potential, as well as a real skill for selecting the right risks to deploy capital into, at the right price and at the right time (in the cycle and seasons), that will likely emerge the most successful.

AIG’s approach of focusing on the delivery of stable business at attractive rates, even at the expense of some other business opportunities which are perhaps not a core focus, is a good lesson that applies to all participants in the reinsurance and ILS space. When the market is full of competition, focusing on what you do best is perhaps the only strategy to follow.