Soft market, third-party capital top reinsurance survey concerns: Xuber

by Artemis on May 7, 2015

A new survey of global reinsurance professionals has found that the top concerns and challenges that the industry faces are the ongoing soft market conditions as well as the threat posed by third-party reinsurance and ILS capital.

Respondents to the survey, undertaken by Xuber the insurance software arm of Xchanging, listed their top concerns for the rest of this year as the soft market, third-party capital, mergers and acquisitions, maintaining underwriting discipline and regulation.

81% of the reinsurance market participants polled cited the soft market as one of their top five concerns, while 66% cited the competition presented by third-party sources of reinsurance capacity and insurance-linked securities (ILS) investors.

Clearly these two are intertwined and any concern about softening has to consider the competitiveness of lower-cost forms of reinsurance underwriting capital, such as ILS sourced from investors such as pension funds, sovereign wealth funds and family offices.

“The erosion of traditional reinsurers’ market share due to abundant supply from third party capital and falling prices in the soft market have combined to make some carriers vulnerable, which has sparked a wave of mergers and acquisitions (M&A) activity,” Xuber explained the link between the three most cited concerns.

“The soft market is the issue underlying the different challenges reinsurers will continue to face,” commented one survey respondent. “It can lead to a lack of broker and underwriting discipline which may translate into disputes.”

“No-one knows what’s going to arrest the general slide in pricing across the broad spectrum of business classes,” another respondent said.

The industry faces a prolonged soft market, exacerbated by rising capacity from both traditional and third-party or ILS sources, as well as a loss environment that remains well below averages. The lack of losses is not draining capital from the sector as would more typically be expected. Add on the growing pool of ILS and alternative capital from investors and asset managers and it’s easy to see why participants list these concerns.

Interestingly, Xuber’s survey pulled out insights into concerns which have been overlooked, although well documented here at Artemis.

As one respondent said; “The real threat is publicly-listed insurers and reinsurers who have to maintain scale to appease their shareholders. Ergo, they’re writing everything. What happens to all those classes of business that (for years) have been propped up by property catastrophe? If the margin in cat continues to be eroded how can businesses afford to maintain these marginal lines?”

This is a valid concern. Somebody continues to underwrite the lowest priced business, or accounts where terms and conditions have been broadly expanded. This suggests that some underwriters in the market will be leaving themselves exposed to outsize losses, should the worst happen.

Even the lowest-cost forms of capital, or the most diversified global reinsurers, need to be careful to avoid pricing below technical levels or accumulating outsized exposures due to expansion of terms and conditions.

A London-based respondent commented; “Slack underwriting discipline in a soft market is the most serious avoidable issue for any reinsurer and the one most likely to imperil the company.”

M&A was cited by 66% of respondents, placing it level with third-party capital as a business challenge that reinsurance executives expect to face throughout 2015.

Xuber notes that while M&A is listed as a challenge that reinsurance businesses will face it is also seen as an opportunity, particularly for smaller companies which may need to acquire scale.

A respondent explained that the “wave of consolidations” seen across the industry is another symptom of the soft market as reinsurers battling falling margins seek to form larger businesses that have the scale to see out the challenging market conditions.

Another said that M&A may present opportunities to boutique underwriters with a niche value proposition for clients; “The effect of mergers and acquisitions has the great potential of creating niche players in the field – those who are too small to compete with the big players but who bring unique expertise and talent to the table.”

Terms and conditions, expense ratios, the need to diversify the portfolio of business, technology, legacy systems and competition from new markets were all cited as additional challenges that reinsurance faces.

While the threats seem many and mostly related to trends which erode reinsurer margins and profitability, and could do so for a protracted length of time, the respondents also see opportunities in the current market environment.

The biggest opportunity cited is to make better use of risk analytics and modelling, through greater investment in technologies that can help underwriters to be better informed, make improved risk selections and ultimately to seek to enhance margins.

The second biggest opportunity cited by respondents is to partner with third-party capital and ILS investors. It’s interesting that this continues to be seen as both threat and opportunity so many years after this trend began.

Reinsurers have had every opportunity to partner with large investors, specialist ILS investment managers or to launch their own units to manage capital for third-party investors. These opportunities remain, there are a significant number of large investors who would readily partner with companies that can source quality risks and that are willing to establish semi-permanent structures to allow investors to share in their underwriting and growth.

Xuber says; “Although third party capital was listed as one of the key challenges, reinsurers understand that new investors entering the market do not possess the unique expertise to expertly manage risk. Consequently reinsurers have a distinct opportunity and advantage over alternative capital.”

This opportunity and advantage is only relevant if reinsurers are forward-thinking enough to devise structures that allow investors to share in their risk premiums, while also growing their books. The requirements that investors are placing on these partnerships are becoming more complex all the time.

The report continues; “Faced with this pressure, reinsurers can choose to ignore it, see it as a challenge, or decide to partner with the third party capital to seek new business opportunities. A number of reinsurers have realised that while the alternative capital is keen to enter the market, these newer investors do not necessarily have the depth of understanding of risk to invest most effectively. This creates opportunities for reinsurers to utilise their market knowledge, understanding of risk and modelling expertise to help third party providers to invest in the reinsurance risk space.”

Other opportunities cited by respondents were M&A, where scale is required, creating niche market expertise and making effective use of data.

Xuber sums the findings up well, saying; “The multitude of challenges facing the reinsurance industry in 2015 will also create new opportunities for the smartest businesses – and technology will be the key weapon companies use to exploit these emerging possibilities.

“Surviving and prospering in the soft market will require companies to operate at optimal efficiency, and better use of automation and technology will be an invaluable aid to achieving these goals.”

Leveraging advances in technology, risk analytics, modelling and making better use of data, alongside capital that is more efficient, lower-cost and more mobile than ever before, is perhaps the key opportunity for the reinsurance market over the next decade.

It’s an opportunity that might change the reinsurance landscape more over the coming ten years than has been seen over the last fifty.

“With market conditions so tough, technology may be the difference between success and failure which means that now, more than ever, reinsurers will need world class data to drive their businesses,” Xuber said.

We would add that data alone may not be enough to help you if your cost of underwriting capital prices you out of the market.

But of course better use of technology can actually be a factor in increasing efficiency and reducing cost-of-capital.

Chris Baker, Executive Director at Xuber, explained; “With margins tight and prices falling, reinsurers are under great pressure to ensure their processes are as efficient as possible. Surviving and prospering in the soft market will require companies to operate at optimal efficiency, and their IT systems will be central to this. Only the savviest of reinsurers who recognise that technology can be the catalyst for change will emerge unscathed.”

Again, we’d add that the savviest of reinsurers also need to be thinking about capital as a catalyst for change, alongside technology, as we move through the next few years.

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