London needs ILS innovation, as reinsurance market challenged: LMG

by Artemis on May 10, 2017

The London market is increasingly challenged and under pressure, according to a new report from the London Market Group (LMG) and Boston Consulting, with reinsurance a particular area of concern and the higher cost-of-capital of London re/insurers proving detrimental to their success.

The latest London Matters report from the LMG points to “significant challenges”, with reinsurance as well as London players’ ability to tap into emerging market business both key concerns as premiums underwritten in London from these areas of the marketplace are shrinking.

Carriers with the lowest cost-of-capital are faring much better in the competitive re/insurance market environment, the report finds and London is not well set up to compete for certain types of business, such as large, structured reinsurance risks.

Additionally, while global reinsurance firms look to emerging markets to identify and underwrite new risk pools, the London market’s traditional players are often not of large enough scale to compete in this area and likely do not have the diversification to enable them to discount their underwriting capacity as much as a global player can.

As a result of this and other factors, London’s share of global reinsurance business is shrinking, the report warns, which in a highly competitive market where the efficiency of underwriting capital is increasingly key perhaps does not bode well for the London market’s future in certain risks and regions.

London’s re/insurance market can be an expensive one to do business in, despite the clear benefits of access to specialty risks, participation in the Lloyd’s underwriting market and proximity to counterparties and key players or partners.

It seems that this is no longer enough in reinsurance though and with alternative reinsurance capital increasingly influential, while the major global reinsurers and markets like Bermuda or Zurich becoming more competitive, it’s a difficult time for some London players and for London’s position in some areas of the global risk market.

As ever, insurance-linked securities (ILS) and alternative reinsurance capital are cited as an opportunity that could help London at this time.

Of course London has been trying to complete its ILS regulations, but the finished version was unfortunately held up from publication due to the announcement of an impending UK general election.

The report states that; “London has proven to be adaptable and has embraced the full range of alternative capital flowing in to the global insurance sector.”

This is indeed true and evidenced by a number of ways ILS funds are working within London and Lloyd’s, but it could be easier and made more efficient.

For every ILS player or investor successfully operating in Lloyd’s and within the main London market hub, there are numerous who don’t as it’s either deemed too costly, or too onerous to gain the necessary approvals and set up a business structure to work there.

“London Market insurers are increasingly creating partnerships with specialist investment firms. One particular route is the Lloyd’s Special Purpose Arrangement (SPA) Syndicates operating under this structure have grown from providing a quota share of 0.7% of the Lloyd’s market in 2010 to a quota share of 3.0% in 2015,” the report continues.

This is entirely true and there have been good progress made here, but again access to these structures and a sidecar type approach to Lloyd’s, could be much more simple and efficient.

The report also says; “We believe demand for alternative structures is likely to increase To establish a leading position the London Market needs to continue to find innovations that best match capital with risk.”

Innovation is a key word, as any ILS structures need to offer something new to the market, rather than just being a competitive alternative for what is working very well elsewhere, and of course London will continue to struggle to compete on speed to market (due to its regulatory environment) and likely the cost of operations for some time.

Nicolas Aubert, Chairman of the LMG, commented on the report’s release saying that many challenged remain; “This latest intelligence confirms that things are not improving and we cannot afford to be complacent.

“Now is the time to maintain our focus and, indeed review and revisit our plans, so that we can build momentum in our work to protect and enhance the pre-eminence of the London Market in an increasingly global and competitive market.”

Paul Clark, Partner at Boston Consulting Group, added; “BCG’s analysis re-affirms London’s traditional areas of strength and unique position in the global insurance market. Yet London’s long-term competitiveness is under threat. To respond, the Market will need to redefine its relationships with emerging markets and work with regulators to support market needs. The upcoming Brexit process could provide an opportunity to deliver on both.”

While ILS and alternative capital is seen as a key component of enhancing London’s competitiveness in insurance and reinsurance markets, it will take much more than the regulations to realise that ambition.

London needs to embrace alternative capital more wholeheartedly, including welcoming it into Lloyd’s in a manner that reduces friction, expense and can compete with the other ways that capital market investors now access reinsurance risks around the world.

London has a lot of catching up to do in this regard, but if efforts could be taken to open up London’s underwriting markets to ILS funds and institutional investors more fully, some progress in lowering the market’s cost-of-capital and becoming more competitive on certain risks could be made.

London can catch up, but it will take radical steps and perhaps a radical rethink about what it means to have a re/insurance market and how that market construct works. Liquidity, transparency, ease of access, low barriers, innovation, efficiency, all need to be right at the top of the agenda for London as it looks to navigate the challenges it faces today.

Of course, what radical change would mean for London’s traditional players remains to be seen and at some stage in the future stark choices will need to be made, we believe, over traditional structures, market access methods and company lines, versus more efficient, liquid and capital market backed re/insurance risk transfer.

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