The reinsurance industry has to get used to the fact that we are now in a world where underwriting margins for property catastrophe business are lower and likely to stay that way, thanks to the influence of ILS and alternative sources of capital, according to Swiss Re CEO Christian Mumenthaler.
Speaking during the reinsurance giants full-year results media conference this morning, Mumenthaler recognised the growing influence of the capital markets and insurance-linked securities (ILS), which he believes has now permanently altered the reinsurance industry landscape.
He discussed the growth of the ILS market and so-called alternative capital, saying that of the spectrum of alternative capital mechanisms for bringing the capital markets into reinsurance, it is the collateralized reinsurance product that has the most growth.
But he called this “not that transparent” saying that it wasn’t really clear how much collateralized reinsurance had been impacted by the loss events of 2017, but adding that it was “mostly able to reload” anyway.
When asked about how the influence of the ILS market affects his business Swiss Re, as a globally diversified reinsurance player, Mumenthaler made it clear that the capital markets has had a lasting effect on the market.
“I think this is here to stay,” he explained, adding that alternative capital remains largely focused on the catastrophe exposed lines of business, “Because that’s where the biggest margins have come from.”
Of course, it’s not just the margins that attracted the capital markets into the property catastrophe reinsurance and retrocession arena.
In fact, the entry of the capital markets into reinsurance, through direct and securitised mechanisms such as the catastrophe bond, was designed by the likes of Swiss Re, as they recognised the industries inability to absorb the very large catastrophe losses on its own.
ILS and alternative capital was designed to take the peak catastrophe tail risk exposures away from the likes of Swiss Re and Mumenthaler highlighted that cat bonds are typically “higher up” as a result, while collateralized reinsurance plays much lower down in the reinsurance tower, including in the working layers of catastrophe risk.
While the likes of Swiss Re actually helped to design many of the first cat bond and ILS structures or instruments, the effect of alternative capital’s growth can now clearly be seen in the same companies results.
The lasting effect that ILS capital has had in reinsurance has now changed the landscape forever, something Swiss Re is only too cognisant of.
While alternative capital targeted property catastrophe, which happens to have been where some of the biggest margins in reinsurance were to be found, this negatively affected traditional reinsurers.
“That’s where the biggest profits have been for insurers and reinsurers,” Mumenthaler explained.
He added, “We need to get used to a world where margins are much lower there and we need to find ways to get margins from elsewhere.”
As a result of this fact, that no longer can reinsurance firms rely on the same high property catastrophe margins to support their businesses, many strategic directions are being taken by companies eager to replace this lost catastrophe underwriting income.
Mumenthaler’s comments make it clear that he does not feel the margin will ever come back again, in those peak property catastrophe zones where ILS and alternative capital continues to grow its share.
This is why so many reinsurers have been leveraging growing pools of third-party capital themselves, as a way to maintain a foothold and at least extract some fee income from business where once their margins were significant.
Swiss Re has not really taken this approach, as yet, preferring to leverage its global diversification, expertise and ability to underwrite extremely complex risks and programs, rather than working with investors to maintain its share of the lower-margin catastrophe risks.
The firm does have a history of sponsoring catastrophe bonds, although only $100 million remain outstanding, while its Sector Re sidecar has fluctuated in size but Sector Re has never grown to the size of its competitors vehicles.
On whether the influence of alterative capital and ILS will increase in reinsurance, Mumenthaler noted that it remains as much as 98% focused on catastrophe risks and said, “I think it will struggle to expand.”
But the fact remains, that ILS and alternative reinsurance capital has begun to dominate what was once the source of the business with the highest margin for reinsurers.
The lasting effect this capital and its structures will have on major reinsurers like Swiss Re, at a time when the industry is undergoing significant change, make it no surprise that firms are looking to potentially transformative partnerships (like SoftBank) at this time.
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