Efficiency, flexibility and effectiveness to drive reinsurance buying

by Artemis on November 26, 2014

If there were three key features of reinsurance or retrocessional protection which have come to the fore in 2014 they would have to be capital efficiency, the overall flexibility of coverage being offered and the effectiveness of reinsurance coverage to meet a buyers needs.

As we’ve moved through 2014 the rhetoric from insurers, reinsurers, brokers and insurance-linked securities or alternative capital providers has changed, moving from a focus on the growing competition, to a discussion of underwriting standards, to now become more focused on the efficiencies available and how new sources of capital can actually help the insurance and reinsurance sector to grow.

This is pleasing to note, as the discussions earlier this year looked set to pitch traditional reinsurance firms and ILS specialists up against each other in a battle of underwriting prowess. Now the traditional market has become increasingly aware that the vast majority of ILS managers and specialist alternative capital providers utilise significant underwriting diligence in their capital deployment decisions, which has helped the conversation to move on.

Similarly, the discussion is beginning to move beyond purely focusing on the threat that ILS and third-party capital poses to traditional reinsurance business, becoming more of a discussion on how the traditional and non-traditional can work together and how multiple types of capital can come together within reinsurance programmes.

Moving the discussion forwards, encouraging education and understanding and becoming more open to new ideas, solutions and business models will help the re/insurance industry to find the best way to leverage different types of capital. It will also help the ILS and alternative reinsurance capital market to expand, help traditional reinsurers to work in tandem with new sources of capital for the benefit of reinsurance buyers and help insurers to grow thanks to the security of readily available reinsurance and risk transfer capacity.

We should note that sadly this conversation has not moved on in all circles, particularly some publications that continue to hark back to headlines from the late 1990’s around ‘betting on disaster’, or to focus on ideas around ‘yield hungry investors’.

In our opinion these views are now becoming a little old-fashioned and are rarely backed up with any substantial evidence or even opinion. As re/insurance market participants increasingly learn to appreciate the positive benefits that new and more efficient sources of capital bring to reinsurance and catastrophe risk financing, the industry can in time hope to educate others in the positive role it plays in the transfer of risk.

Evidence that the conversation has moved forwards, become more constructive and that the focus on reinsurance protection efficiencies are increasingly front-of-mind were seen at the key reinsurance meetings of Monte Carlo and Baden-Baden this year.

While discussions were clearly focused on the pricing and rates of reinsurance protections secured in the run up to January, there has also been much more focus on the efficiency of different capital sources and how best to deploy them, the effectiveness of different structures, capital and risk transfer tools as well as the ultimate effectiveness of the protection.

At the same time there has been discussion of how the re/insurance industry can grow its footprint, increasing the amount of capacity required from it, to accommodate alternative and third-party capital and to create new opportunities for traditional players as well.

These are constructive discussions which show that the initial, perhaps knee-jerk, reaction to declining U.S. property catastrophe rates stimulated by the influx of new capital, has given way to something more thoughtful and perhaps useful to the industry as a whole.

One of the key messages from both brokers and reinsurers alike is the need to find ways to apply third-party reinsurance capital and ILS capacity to new lines of business. There are two strands to this discussion, new opportunities in established lines of reinsurance business and new opportunities in new lines or regions of the world.

It isn’t always the case that brokers and reinsurers see eye to eye, but in this case the need to find more ways to deploy ILS and alternative capital will benefit both parties. For brokers clearly there is additional fee income available from finding new ways to leverage ILS capital, while for reinsurers the expansion of the remit of ILS capital may bring new opportunity to them, as well as reduce the competitive threat in capital saturated lines like property catastrophe.

Finding the right place in the reinsurance tower for different types of reinsurance capital is another ongoing topic of discussion. With ILS, catastrophe bonds, collateralized covers, sidecars, industry-loss warranties (ILW’s), aggregates, multi-years, quota-shares and more on offer, it’s important that capital is deployed as efficiently as possible and into the areas of the reinsurance tower where it can be most efficient and the risk meets investors, or reinsurers, appetites.

Different investors, from pension funds, to hedge funds, to family offices, also have different risk and return requirements and there is work to do in the ILS and alternative capital space to work out how best to segregate capital to ensure it is being put to work where it can be most efficient and meet each investors goal.

The effectiveness of cover is also under discussion, with a key area of focus revolving around the need to find ways to provide reinstatements within ILS and alternative capital markets. This is an interesting discussion which actually offers traditional reinsurers a real opportunity to engage with alternative capital providers to team up on providing protection that both transfers risk and provides the security cedents want from features such as reinstatements. We’re beginning to see the partnerships between some traditional players and their third-party capital units looking to solve some of these issues by combining the balance-sheet with ILS capital.

Flexibility is also discussed, again in terms of how effectively protection meets cedents needs, and here the traditional reinsurance market has done stirling work to offer improved terms, multi-year covers, aggregate protections and other features that the ILS markets were pushing.

At this late stage in the year, with less than a month to go until much of the reinsurance sector break for Christmas, it is important to get down to business and forget about dolling out rhetoric laden press releases.

Traditional reinsurers need to accept that there are some areas of the risk curve where ILS may be preferable and more efficient, but equally there are areas of the risk curve where traditional reinsurer’s balance sheets are without doubt best suited still.

Finding the optimal mix of capital sources, coverage terms and conditions should be on everyone’s minds as the market looks to get its 2014 business sewn up and the January renewals signed. Of course that should not be at the expense of discipline, or see terms so stretched that the deal economics are eroded.

As the focus moves to efficient and effective reinsurance and risk transfer, with capital sources being mixed and new, or capital market structures being leveraged, it will be interesting to see whether the renewal cycle itself gets disrupted. We’ve already discussed at length the chance that the traditional reinsurance market cycle may never be the same again, but could we see the market find capital so abundant at all times of the year that the traditional January, June, July etc renewal periods become less important?

Some large reinsurance programmes have already moved away from the typical cycle of January or June/July renewal, with some choosing to renew before or after these busy periods so as to hit the market when it is less saturated with new deals.

With capital and capacity seemingly more mobile and more freely available throughout the year now, it seems likely that more cedents will choose to go this way, breaking from the norm and encouraging new capital into the market across the whole underwriting year.

The upshot is that there are significant changes afoot in reinsurance and purely providing capacity at the key market junctures from your own balance-sheet may not be a winning strategy going forwards. But focusing on how best to work with new sources of capital, alongside your own, to create innovative reinsurance solutions is a much more profitable use of time than constantly trying to battle against it. Equally ILS and alternative capital needs to continue to look to the traditional markets as partners alongside which it can expand the market by working together.

Reinsurance and risk transfer buyers are going to expect efficiency, effectiveness and flexibility from their purchases. It’s down to the combined reinsurance and ILS market to become more focused on innovation and product design in order to ensure that clients needs continue to be met with the best solutions possible.

At the end of the day, this is all about meeting client needs with the most efficient, flexible and effective re/insurance coverage possible, no matter where the capital comes from.

Some recommended reading on how the reinsurance & ILS market’s are evolving:

Weaker terms erode reinsurance economics, introduce unmodeled risk: RenRe CEO.

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

Innovate or perish. A message for insurers and reinsurers from Aon.

Brokers face disruption too in challenging reinsurance market: PwC.

A smarter, more client-responsive reinsurance market: Willis Re.

Differentiate or consolidation ahead for reinsurance industry: PwC.

Innovate & adapt to navigate a reconfigured reinsurance industry: S&P.

Structural change, lower margins, a deeper reinsurance convergence.

Citi Group highlights insurance securitization as a disruptive innovation.

Proactive innovation through ILS is driving change in reinsurance.

Insurance-linked securities market calling for innovators: PwC.

Innovative and client focused approach required to drive growth in ILS.

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