The development of the insurance-linked securities (ILS) market has helped to enlarge global reinsurance capacity, according to SCOR one of the world’s largest traditional reinsurers, and the firm says alternative capital is a complement to reinsurance, not a substitute for it.
SCOR, one of the world’s largest reinsurance companies, released its new three-year strategic plan, called “Vision in Action”, covering the period mid-2016 to mid-2019 this morning. Having delivered on its previous plan “Optimal Dynamics” SCOR is setting itself goals and a strategy to succeed through some of the most challenging reinsurance market conditions seen.
As you’d expect, the insurance-linked securities (ILS) market and alternative reinsurance capital feature in the presentation of the strategy and SCOR, perhaps unsurprisingly, seeks to position ILS and the interest of the capital markets in reinsurance as a complement to its own business rather than a threat.
SCOR itself utilises alternative capital and ILS structures such as the catastrophe bond, mortality bond, collateralised reinsurance sidecar and also operates ILS investment funds as part of its Global Investments offering. The reinsurer has benefitted from the development of the ILS market, as it has utilised it both for retrocession and also to earn management fees.
SCOR makes it very clear just how important it feels the ILS market is, however, and as you’d expect, SCOR’s messaging makes it clear that it believes ILS is no replacement for the reinsurance company.
The firm says that “Development of Insurance-Linked Securities has enlarged the overall reinsurance capacity,” but adds that the complementary nature of ILS and reinsurance has outweighed it becoming a substitute for it.
Indeed, SCOR believes that ILS and the alternative capital wave has had less impact on it than on other reinsurance firms, as its SCOR Global P&C division is underweight in some of the key areas that ILS has focused to-date, such as in Florida where SCOR claims to only be number 27 in the market.
SCOR also notes that it has a “minimal appetite for writing inward retrocession” another area of reinsurance that the ILS market has taken significant market-share.
SCOR sees ILS as a tool to help it protect shareholders equity and better manage its own capital, utilising it for its own retrocession, as well as earning fees via its ILS fund investment managed through its SCOR Investment Partners brand.
Currently SCOR says it has $685.5m of outstanding retrocessional reinsurance protection from a mix of catastrophe bonds, mortality bonds covering largely pandemic exposures and its reinsurance sidecar, which is a significant sum. SCOR has been in the catastrophe bond market since at least 2000, when Artemis recorded the first transaction involving the reinsurer, Atlas Reinsurance plc.
SCOR’s says that “The cat bond phenomenon is largely fuelled by reinsurance companies and enlarges the overall market capacity.”
In fact this has been the case, but in recent years sponsors of catastrophe bonds have been rather more on the primary side and in many cases reinsurer involvement has been as a conduit for risk, in other words to earn fees or maintain additional stake in a program.
The development of collateralised reinsurance and the growth of the ILS fund manager has also seen ILS evolve beyond a market “fuelled by reinsurance companies”, we would suggest. With ILS fund managers in direct competition with companies like SCOR and other major reinsurers providing fronting and transformation services to the ILS investors in order to extract more fee income, perhaps from business that is moving away from them.
In fact, SCOR believes that the reinsurance industry is “less exposed to technological “contestability” than other industries.”
While it is without doubt that the reinsurance business model and its position in the global financial market is key to economic stability, there are many elements to the model and the day-to-day business that SCOR and its competitors undertake that is contestable and will face direct competition.
SCOR places the development of efficient financial markets, such as the development of alternative capital, ILS and catastrophe bonds, in this bracket where it says its business is less contestable by new developments and innovation.
It’s a very bold statement, particularly as the Insurtech trend is in its infancy, the ILS market continues to eat into reinsurer market share and new business models are emerging which are forcing responses and innovation from large reinsurers exactly like SCOR.
Insurtech has a chance to eat significantly into some of the bread and butter business of the reinsurers. The ILS market is already doing that and will continue to do so, while also becoming more specialised and eroding margins in some of the more customised areas of reinsurance as well.
Of course insurance-linked securities (ILS) are in direct competition with SCOR, suggesting contestability, in many areas of the global market and its coverage is expanding.
Additionally new business models are bringing risk capital closer to the source of the risk, shortening the value-chain and blurring the lines between insurer, reinsurer and other capital providers.
All of this suggests clear contestability for areas of the reinsurance business model, ultimately resulting in a shrinking of opportunity and a need for reinsurers like SCOR to embrace these trends and to innovate in order to be increasingly specialised and also to ensure that its balance-sheet capital is put to work effectively.
While reinsurance is unlikely to be fully contested, some areas are far too specialist, niche, long-tail and customised, requiring the strength and stability of a balance-sheet such as SCOR’s, much of the rest of it can and will be contested by efficient capital, technology and innovative new business models.
SCOR is realistic though and agrees that these trends will also be to its own benefit, saying; “The reinsurance industry will benefit from the current technological and financial revolution, which includes alternative capital, connected objects, big data and automation.”
But that will require the company to embrace these trends and be fully open to the fact that it may have to relinquish certain parts of its business to new capital, technology and market entrants, with its best chance at having any control over this being to get involved in these trends meaningfully as they develop.
SCOR does recognise the need for innovation, saying; “The potential for innovation in the reinsurance industry remains strong and will be enhanced by new needs from insurers, changing regulation, better understanding of risk correlation, and better understanding by insurers of their own portfolios, etc.”
However, even a reinsurers own efforts in innovation will spur competition, new entrants and copycat attempts. It’s common in industry for periods of rapid innovation to stimulate greater competition, as they promote transparency, generate new business models and connect the dots between competing elements.
Again, we’d say that makes reinsurance contestable, as pretty much every sector in industry worldwide is proving to be as progress and innovation accelerate. It may not all be contestable, but the pieces of a reinsurer left behind after the contest is over may look very different to the pieces of the reinsurance business model we see today.
Reinsurance is contestable by ILS, insurtech and new business models, as well as the disruption of the risk to capital value-chain. But we see this as an evolutionary step-change in the insurance and reinsurance business model which is going to happen, rather than a forcing of competition on incumbents.
Of course reinsurance and its business model is not going to disappear, in fact we may just see the lines blurring even further, but disruptive change has happened is continuing to and could well accelerate in years to come. All of which means positioning yourself as an innovator ready to embrace and leverage new trends and change is vital for reinsurers right now.
Finally, SCOR’s new plan has lowered its return on equity (RoE) targets to 8% plus (compared to the 10% plus it earned through its Optimal Dynamics plan), unsurprisingly given the state of the reinsurance market and the competitive pressures it does face.
That suggests efficiency is going to be key for reinsurance companies such as SCOR over the coming three years, as an 8% RoE is not the level of return this industry has been more typically used to.
Adapting to that new lower return world will need innovation, change and a willingness to be flexible and to embrace new technology, capital and business models. This is not a time to stand still in reinsurance and admitting where your competition is coming from is an important step forwards, we would venture.
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