XL’s McGavick likes the look of a capital agnostic reinsurance future

by Artemis on October 29, 2014

Michael McGavick, CEO of insurance and reinsurance firm XL Group, is looking forward to a reinsurance marketplace of the future, reshaped by new and alternative capital, resulting in a more agnostic approach to matching risk and capital for XL’s clients.

McGavick typically has an insightful and useful view on the market and is unafraid to share a considerable amount of his thinking on alternative reinsurance capital, insurance-linked securities (ILS) and the structural change that the reinsurance market is undergoing. In the re/insurers third-quarter earnings call, McGavick discussed some more of his thoughts on where the market will end up in years to come.

McGavick is clearly not afraid of the threat that the capital markets could erode his business or margins significantly, instead feeling that the fact that institutional investors are so interested in the insurance and reinsurance space as an asset class is a positive.

“I always want to be in a space that is more attractive to capital than less and  seeing these new forms of capital coming into our sector, while we have short-term difficulties in the long run, this is good news and this provides us more capital to solve more of the world’s problems and that’s our job.”

While a positive for the re/insurance sector, what is important is finding out how best to use alternative reinsurance capital and to leverage ILS and alternative capital structures to achieve better protection and to support business growth as well.

McGavick continued;

“So, I really like it. Exactly how to apply it is the great question. It comes in a number of ways. One, as you notice, we are ceding more than we were in the past. We are doing it not only because of what’s going on in the reinsurance marketplace and because of what alternative capital is already doing in that market, but also because we have re-thought how to create greater stability in terms of our earnings all the time.”

“So we have been doing, I think, a better job and a more strategic job of buying reinsurance. That’s partly influenced by what’s going on in the pricing environment, partly influenced by what’s going on in the search for capital. So that is one place where we are conscious.”

On the subject of putting alternative and ILS capital to work alongside, or instead of, XL’s balance sheet capital, McGavick said that the firm has not done too much in that area to date

“The second thing that we consider all the time is whether or not, in every case, it has to be XL’s capital that goes to the client’s solution.”

“We haven’t done anything dramatic in this space, but we spend a lot of time thinking about it, because in the end if our underwriting can determine a solution for a client that is made better by using capital other than our own, we should do it.”

This capital agnosticism and willingness to use investors capital instead of shareholders is an important step for insurers and reinsurers to come to terms with. Moving further in this direction has difficult to address issues attached to it, around cost-of-capital, conflicts of interest (or which risks go where), operational costs and as this strategy is increasingly embraced may require a wholesale restructuring of the traditional business model.

McGavick acknowledged that XL has taken a first step down this road with New Ocean Capital Management, its ILS investment manager unit that it established along with private equity investment firm Stone Point Capital. However there is likely more to come in this area from XL, just the exact strategic direction is yet to be decided.

“We have to be open to that because ultimately, if you are solving the clients’ problem that’s why we are in business and that’s where we are well paid for our activities. So we are looking at a variety of models for how to achieve that.”

“One we’ve already shown the market through New Ocean, but I can assure you there has been a wide range of people coming by with ideas. We have had a few that originated here as well and as things evolve, of course, we will announce them.”

McGavick provides an interesting bit of insight into how potential institutional investor partners approach XL and what strategies they are interested in. This tallies with the experience of other investment managers we speak to, who find investors increasingly coming to the market with ideas driven by their experience of investing in capital markets.

“I do want to note though there has been one change in how that market is behaving that I think is very important.”

“I think this speaks to the importance and centrality of underwriting in what will come. When this started out, this was all about those who gather assets and they were calling all the shots. They were designing basically fit for purpose things for themselves and not really for solving clients problems so much. My view is different.”

“As we’ve seen conversations evolve, especially the last six months or so, the people coming to us are no longer saying, ‘Hey we’ve got a big bunch of assets and we are good at this, you just go off and don’t lose too much money on that underwriting stuff and we’ll make a bunch of money,’ which was kind of how the first conversations went.”

“Now we are realising we have to be able to gather together pools of risk in an effective way and then match that to a solid asset gathering strategy. That’s a more balanced partnership, a more reasonable and sustainable way to solve clients problems. And we happen to be pretty good around here at creating profitable portfolios of the kinds of risks with characteristics that match well to the goals and characteristics of some of these asset managers.”

This is an exciting development, as it allows insurers and reinsurers to focus on what they do best, while the investment focused managers of institutional money can provide input to structures and strategies, depending on the ambitions of investors and their risk appetites.

This is one of the potential future business models for insurers and reinsurers, as the risk conduits to investment houses, originating, sourcing and structuring solutions which match investors appetites and needs. Whether this is where XL wants to be is doubtful, at the moment the majority of insurers and reinsurers would rather see themselves as partners with capital, rather than service providers to it.

McGavick is optimistic, which leads us to believe he sees strong possibilities for XL to increasingly partner with new sources of capital (alternative or note) in the future. The reinsurance market that emerges on the other side of this period of structural change is one that McGavick looks forwards to and sees opportunity in.

“So I am very optimistic that by being thoughtful about how to go forward and being the kind of underwriter we are, that the world that’s coming is one that plays right into the hands of a global carrier with a complex risk profile and the selfless attitude about how to solve client problems and not just how to throw their own balance sheet around. So I like the world that’s coming and I think we are poised for it.”

The key is being open to the changes that insurance and reinsurance companies are experiencing and finding ways to adapt your business model in order to make the most of the opportunities that all of this interested capital presents. XL Group, like other large re/insurance companies such as ACE Limited, is positioning itself to be ready to benefit, lead the trend and prosper from the changing reinsurance market dynamic.

“That’s kind of how I see that all playing out. It’s going to show up in lots of ways across the entire place and every one of us has to be open to and thoughtful about how we can be creative and enable that capital to come in and solve client problems.”

McGavick’s comments suggest that XL may be quite a long way down the road with thoughts on where its strategy may be headed and even with discussions and the building of relationships with some of the sources of institutional capital that are showing interest in the space.

Earlier today we reported that XL’s ILS asset management unit New Ocean Capital Management has recently signed a distribution agreement with a global financial institution, which demonstrates the firms desire to be at the forefront of this trend towards an agnostic approach to capital and capacity sources. It’s going to be an interesting few years as the trend plays out.

Comments like this from senior re/insurance industry executives should also be seen as positive by ILS investors and the institutions that would like to partner with their books of risk. As we increasingly see large insurers and reinsurers discussions on how to leverage alternative capital becoming more advanced, when they had been declining in favour of detrimental comments on the quality or permanence of capital, it bodes well for investors gaining increasing access to the returns of reinsurance risk in the future.

Read some of our previous articles mentioning XL Group:

New Ocean ups income to XL, hires COO, signs distribution agreement.

XL CEO says new capacity likely to come from alternative capital arrangements.

Also read some other recent articles on reinsurance capital trends:

Big primary insurers track reinsurance trends, ILS & alternative capital.

ACE seeks leadership role in evolving reinsurance market: Greenberg.

Property & casualty to have lower level of cyclicality: Travelers CEO Fishman.

Evolving market, changing dynamics may end the traditional cycle: Willis.

Capacity drives the reinsurance cycle, least conservative sets the price.

How to respond to ‘biblical flood’ of reinsurance capital: Andrew Kendrick, ACE.

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