In reinsurance “if you’re not relevant, you’re gone” – James Slaughter

With ongoing market pressures continuing to reshape the need for global reinsurance industry firms to remain relevant is key, with those who fail to do so at risk of disappearing from the reinsurance landscape, according to Liberty Mutual’s James Slaughter.

For reinsurance participants in the North American region it’s certainly still a buyers market, as benign losses, ample capacity from traditional and alternative sources, and low investment returns persist, enabling cedents to experience favourable conditions as prices have continued to decline.

While the glut of excess capital in the reinsurance sector, exacerbated by the benign loss environment and also the supply demand imbalance in the space, provides some buffer to reinsurers in the event of a significant loss, it’s also driving down prices and pushing companies to increasingly search for relevance and yield, sometimes outside of their more typical, traditional business lines.

Relevance means reinsurers being capable of adding value to their clients and this desire to achieve it is resulting in heightened centralisation of reinsurance purchasing, consolidation and the improved utilisation of alternative capital.

A result of the current environment, notes ratings agency Standard & Poor’s (S&P) in a recently published report following a panel discussion at the 2015 Bermuda Reinsurance Conference, sponsored by S&P and PwC Bermuda, is the growing trend among the larger insurers to centralise their reinsurance purchasing.

S&P explains; “Where once, distinct business units would buy reinsurance on their own to help smooth their earnings, the purchase of this protection has steadily moved to a centralised function at the holding company level, making for cost savings, portfolio optimisation, improved views of risk capital, and capital allocations.”

Another reason for a shift towards a centralised reinsurance model, explains James Slaughter, panelist and Senior Vice President of Global Reinsurance Strategy at Liberty Mutual Holding, is that cedents have become better at analytics and have become as smart, or even smarter in some cases, than the reinsurers themselves.

As larger cedents continue to centralise their reinsurance buying it adds further pressure on reinsurance entities, brokers and reinsurers included, to search for ways to add value to the client and remain relevant to the industry, which has driven consolidation across the entire insurance and reinsurance landscape.

“If you’re not relevant, you’re gone,” said Slaughter, emphasising that he, as do the other panelists, expect further merger and acquisition (M&A) activity in the coming months, as market challenges persist.

It’s expected that consolidation will likely involve the smaller reinsurers being swallowed up or merging to create a larger, global player, and those with larger balance sheets, claims-paying records and strong relationships will be favourable to cedents as they increasingly look to minimise costs and better manage their exposures.

Panelists expressed differing views on the future role of smaller reinsurers, highlighting that their role will become increasingly less significant if all they are doing is providing commodity capital, but that those which can carve out a niche will bring value to the market.

This brings to mind the greater utilisation of alternative reinsurance capital in the space, which provides and opportunity for insurers and reinsurers, small and large, to smooth their earnings and minimise their exposure peaks and troughs, via innovative, diversified structures in a cost-efficient manner.

S&P draws on the presence of third-party capital and how investors have looked to its largely uncorrelated returns and diversification benefits at times of historically low interest rates.

“Meanwhile, as historically low interest rates have forced investors to look for returns outside traditional fixed-income assets, this alternative capital has been flowing in from catastrophe bond issuances and collateralized reinsurance vehicles that have increased the supply of capital allocated to catastrophe risk.

“In addition, the line between the reinsurance and insurance-linked securities markets has become blurred.”

Slaughter explained that this current environment is a benefit to his firm, highlighting that it signals an opportunity for the reinsurance sector to distribute risk in a lower-cost manner, enabling new risks and new markets to be explored.

The centralisation of reinsurance buying is likely to continue so long as returns in competitive business lines remain low and so to will the consolidation trend with companies looking to remain relevant and attempt to fight off the competition.

But by utilising the wealth of ILS structures, via the establishment of collateralised vehicles, sidecars, catastrophe bonds, hybrid investment models and so on, re/insurers can supplement their traditional coverage or capacity with diversified capital in diverse markets and risks, ensuring they add the most value to their clients and shareholders for the lowest cost in the current tough operating landscape.