Reinsurers as gatekeepers of risk, agnostic providers of capital: A.M. Best

As the convergence of global reinsurance and capital markets continues apace, some traditional reinsurers are adapting to become the “gatekeepers of insurance risk,” according to A.M. Best, making being agnostic to form of underwriting capital used key.

As the gatekeepers of insurance risk, rating agency A.M. Best says that it expects some traditional reinsurance firms will become increasingly adept at managing the risk share and their alignment with alternative forms of capacity and the insurance-linked securities (ILS) market.

This has been developing for some years, but at the end of 2015 the importance of an efficient source of underwriting capital, that can augment and lower the cost of your own capacity, is clearly becoming an essential element of a traditional reinsurance strategy.

Those reinsurers who do not tap into alternative capital and ILS, either for their own retrocession, through risk-sharing vehicles like sidecars, by fronting or transforming risks for capital markets investors, or by moving into full management of third-party investors money through SPI’s or funds, may find their capital efficiency lagging behind those who do embrace the trend.

This shift towards reinsurers as gatekeepers of risk and managing the alignment of capital sources is expected to be seen across “property and non-property classes of business,” A.M. Best says, adding that this trend “is expected to continue.”

“Reinsurance companies understand the need to form larger, global, well-diversified operations with broad underwriting capabilities to assess risk and to serve as transformers of risk to the capital markets,” the rating agency explains in a recent report.

A.M. Best also says that; “Reinsurance companies will make the argument that they can best serve insurance companies in terms of matching risk with the most appropriate form of capital.”

This is a natural position for both insurance and reinsurance companies to take. However, there is a risk that if they do not embrace the capital markets rapidly enough the established and larger ILS fund managers will equally be able to position themselves as able to access and act as conduits to risk.

The larger ILS fund managers are becoming a staple feature of so many reinsurance renewal programs now, and well-known as efficient capacity options for brokers, that they have access to a significant and growing slice of the market. That share is expected to grow and coupled with the capital markets expertise and investment structures already in place, positions these ILS players to continue to disrupt the traditional companies that lag behind in embracing change.

So the hunt for efficiency and to reduce the cost-of-capital continues apace and looks set to continue as the capital markets take a growing share of available insurance and reinsurance risk.

By leveraging alternative capital across the balance-sheet, traditional re/insurers can focus on putting their own shareholder equity to work in underwriting the most profitable opportunities, or innovating in new lines of business.

However, A.M. Best warns that it won’t be easy for everyone, saying; “As all market players look to become more efficient, be it through disintermediation or going directly to sources of risk, this tug of war will result in fewer hands in the pot – ultimately making it better for the purchaser of protection but likely at the expense of some franchises that exist today.”

And that’s important. The ultimate effect of the convergence trend will result in benefits for protection buyers, firstly buyers of reinsurance and retrocession but the efficiency will trickle through to primary players, helping insurance buyers to benefit too.

But efficiency in the market will result in further consolidation, some players finding it impossible to adjust and as A.M. Best says above, the death of some likely very well-known re/insurance franchises that exist today.

“Reinsurers understand that the ability to move in and out of certain classes of business swiftly through market cycles will lead to a strong advantage over the competition,” A.M. Best continues.

Leveraging lower-cost capital from third-party investors can help reinsurers to achieve this goal, putting in place alternative capital vehicles that can be set up quickly to augment capacity could be one way of gaining this competitive advantage.

With scale, reach, competitiveness, efficiency and diversification all set to be key for reinsurers, positioning themselves as gatekeepers of risk and agnostic providers of underwriting capital could be the best strategy to take them forward.

There is sure to be a painful adjustment for some to undergo, as they try to move in this direction, either partially or wholly. It won’t work for all companies, culture will have a bearing on how well the shift to efficient providers of risk capital can be executed and some will even fail.

A.M. Best discusses a “new reality for the reinsurance market” where returns are lower and underwriting needs to become a larger contributor to profits and returns.

This could result in reinsurers adopting strategies of “more cautious risk selection, more diversification of product offerings, a wider geographic reach, and conservative loss picks.”

That, alongside a willingness and ability to take advantage of alternative capital from third-party capital market investors; “Could actually lead to significant success for some, although not everyone will win in the end,” the rating agency suggests.

So managing third-party capital, or providing it with ways to access and share in the risks underwritten, are key traits for reinsurance firms going forwards. Just how large a share of global insurance risk they can become gatekeepers for remains to be seen.