What to do with all this ‘superabundant’ re/insurance capital?

by Artemis on January 8, 2015

If you listen to the market and the media (including Artemis) the insurance and reinsurance industry has a problem due to being awash with excess levels, some might say ‘superabundant’ amounts, of both traditional and alternative risk capital.

Traditional reinsurer capital levels have increased over recent years, largely due to a dearth of large catastrophe losses resulting in consecutive profitable years.

At the same time continued inflows of money from the capital markets and institutional investors such as pension funds have entered the sector, looking to benefit from the relatively non-correlated returns of catastrophe and reinsurance risk.

Now the industry finds itself awash with a superabundance of capital and the industry needs something to do with this capital, it needs to be put to work.

While it is not put to work, all this capital is doing is applying pressure on the market and pricing, as it ramps up competition between markets, both traditional and alternative, forces prices and rates downwards and ultimately can result in a slide in underwriting discipline as re/insurers and alternative capital or ILS markets need to deploy it.

Or it can be returned, to shareholders by traditional players or to institutional investors by the alternative markets and insurance-linked securities players. This is happening increasingly on both sides of the market, traditional and alternative, as excess capital gets returned rather than be put to work at rates which its managers feel are not sufficient.

Or a third use for excess capital might be to ramp up the mergers and acquisitions activity, financing consolidation in the market. M&A typically uses up some excess capital due to costs, so that at least should soak up some of this ‘superabundant’ capital, shouldn’t it?

So excess capital can create market pressure, softness and reduce discipline, be returned to those who ultimately took the risks, or finance consolidation and expansiveness. But given where the reinsurance market is in its development cycle, with all the innovation we’re seeing in both traditional and third-party capital structures, as well as technology and risk modelling, couldn’t there be a better use for it?

Steve Hearn, Deputy Chief Executive of insurance and reinsurance broker Willis Group and Chairman of the London Market Group, wrote an opinion piece for the City AM newspaper which was published this morning and highlights the excess capital issue, but also offers what is probably the best solution to it.

Hearn wrote:

“We would like to have a constructive dialogue on how the industry can take the burden away from the government in the right circumstances. We have access to superabundant capital, while the state has finite funds from taxpayers. We should be able to work with governments around the world to increase the amount of catastrophe losses that are pre-funded through insurance and not post-funded by the public finances. That is the socially valuable role the insurance industry should be playing, and we need to find the right way of fulfilling that role once again.”

Here is the solution to excess capital problems that the market faces. Expanding the remit and coverage provided by insurance, into emerging and developing markets to increase their insurance penetration and as a result ensure that more of the global catastrophic losses that impact society are funded in advance by insurance and reinsurance (or ILS) capital.

Just yesterday reinsurance firm Munich Re reported that of the $110 billion of economic losses from natural catastrophes that it recorded in 2014, just $31 billion were covered by insurance. That figure remains woefully low and it is the responsibility of an under pressure insurance and reinsurance sector to narrow that gap.

Of course this isn’t a simple task. It involves many factors, from greater education of what insurance is, the benefits of it and how it can best be used in emerging and developing economies of the world, to a new mindset among some incumbents so that they embrace technology, techniques like parametric or index triggers and sell their risk capital to the right people in the most suitable ways.

Product design, innovation, education, technology, diplomacy, providing insurance, reinsurance and risk capital at both the micro and the macro level. Capital agnosticism, structure agnosticism, trigger agnosticism, counterparty agnosticism. Providing the right and best solution for the use-case in hand and ensuring that it leverages all the latest techniques that have been learned, be they traditional or alternative risk transfer.

It actually might require changes at the leadership level, new blood is often required to lead companies into a new world. It may require efficiencies, resulting in some painful decisions. But it is vital that the re/insurance industry realises its issues are solvable and focuses in the right areas in order to begin that, potentially long and difficult, task.

Hearn is absolutely right that this is one of the biggest opportunities for the insurance and reinsurance (and ILS) industries. However the fact it needs saying also shows that the industry has perhaps been too narrow in its focus for too long and has got a little stuck in its ways.

‘Superabundant capital’ need not be a problem. In fact it’s probably the best opportunity that this industry has ever had.

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