At XL size matters in reinsurance, but so does selecting the right capital

XL Group, the recently re-domiciled to Bermuda insurance and reinsurance group, believes firmly that size matters as a provider of reinsurance capacity, but also that when selecting how to manage risks choosing the right capital source is key.

Speaking during the companies second-quarter earnings call yesterday, CEO of XL Group Mike McGavick explained; “Our view was that becoming a leader in the reinsurance marketplace, particularly in the catastrophe marketplace where we had a very long track record of extraordinary results, was the way that we could continue to participate effectively in that marketplace given the structural changes that are going on.”

Of course XL Group and Catlin Group merged in 2015, which helped to bring together two experienced teams of reinsurance underwriters and the pairs balance-sheets. By coming together the resulting XL Catlin also benefited from a greater scale in third-party and ILS capital vehicle operations, with the New Ocean Capital ILS operations and special purpose syndicate at Lloyd’s of London among the ventures where investors can share in the re/insurers fortunes.

McGavick went on to explain how the combining of XL and Catlin helped it attain even greater relevance in the reinsurance market.

“Size is really mattering now in reinsurance and we believe that pushing this expertise into greater concentration would give us an opportunity to ride through those structural changes,” he commented.

“The guys that are getting hurt by all the alternative capital coming in are largely the smaller players,” McGavick continued. “So we think we’ve been well-positioned. We think that also is going to give us the opportunity over time, and we’ve already seen some of this particularly in terms of terms and conditions, to lead the market where it needs to go and not just follow it.”

Being able to position yourself as leading market in reinsurance is likely key for the traditional players, as is being large enough to attract significant amounts of alternative capital as well and for this to be seen as a complementary source of capacity by your clients.

At XL Group and XL Catlin, how the portfolio is managed, in terms of the balance-sheet or capital used to underwrite or cede the risks to, is a matter of some focus and the company is developing its approach.

Paul Brand, CUO of Insurance at XL Catlin and Chair of the Insurance Leadership Team, explained; “There’s an interplay between how much volatility we want to take on our own balance sheet versus how much that we want to have on reinsurers, or other types of third-party capital.”

And this is all part of an ongoing objective of centralising and reorganising its reinsurance buying, taking into consideration the larger and expanded platform with the addition of Catlin.

Being at or near the bottom of the market has its benefits here, Brand explained; “It’s quite a good time to be thinking about ways we can enhance and improve our reinsurance buying.

“We go through quite an exhaustive set of discussions around what the optimal points for some of these things are, and that depends upon our view of risk, our view of prices and the availability of different reinsurance products. But it’s easier to make improvements at the moment than as other times.”

By optimising the reinsurance underwriting, in terms of which balance-sheet or vehicle to funnel risk to, and effectively using third-party capital alongside it to cede risk to, or share risk with, XL hopes to be able to reduce its cessions across the combined XL Catlin entity, while actually becoming better covered.

McGavick explained; “When it relates to how we consider our reinsurance programs, that reinsurance program is now put together for the whole firm, and we are able as Paul noted to cede less, with what we think is actually better protection of our peak exposures and better protection to the overall loss experience.”

And McGavick said that the second-quarter has already seen the results of these efforts coming through in the results, as the catastrophe losses XL Catlin suffered were not considered outsized.

“We already are seeing the benefits to those lower cessions of profits and, we think, equal to or better protections for the firm. How individual cats play out is a whole different story, you never know what zone you’re going to get hit in, or how that fits with the whole story. But this quarter, we would tell you this came out as expected. It came out relative to our market share, or better, across the various events,” McGavick continued.

Brand further explained that XL aims to maximise its retention around the business and accounts that it likes the best, trusting long-term relationships to provide the quality of risks that it likes to keep on its own balance-sheet.

But at the same time XL has been exiting certain areas of the market and certain accounts, where it does not feel the reinsurance business fits with its own capital or that of its third-party investors or partners. Where this is the case, XL feels that new business originated is more than replacing any lost revenue.

Greg Hendrick, EVP and CEO of Reinsurance Operations, explained; “From a reinsurance perspective, on an expected basis, we believe the new business will outperform the business that we’ve exited and should improve.”

It’s interesting that XL Group sees this point in the reinsurance market cycle as an opportune one to optimise its use of reinsurance and the capital platforms the group has at its disposal. There is growing evidence that re/insurers may begin to take advantage of the very soft pricing available, particularly as many believe the bottom of the pricing cycle may be upon us.

Hendrick said that the company sees pricing in some lines as “very much reaching the bottom” and he added that it could well stay there for some time.

“I don’t see anything at the moment that would indicate a rush of capital coming into the business that would change that dynamic, of a lowering or diminishing of the rate of decrease, and kind of a flattening coming in,” Hendrick explained.

For large, diversified insurance and reinsurance groups like XL that have multiple balance-sheet vehicles, active third-party capital management and a trusted panel of reinsurers at their disposal, even if pricing does bump along the bottom for some time, Hendrick said it is possible to succeed and he sees XL Group doing very well in that situation.