Bermudian reinsurance firms are increasingly becoming insurance firms, as the significant shift in underwriting portfolios of major players based on the island continues. Alongside a shift to primary business the Bermudian re/insurers are also retaining less risk, as they make use of market conditions and alternative capital to better manage their exposures.
Part of the reason for the shift to primary insurance is cited as the increasing levels of competition Bermuda’s reinsurers face from the capital markets, with ILS and catastrophe bond investors making the once core peak catastrophe reinsurance zones their mainstay.
This has severely eroded the margin available to a traditional reinsurer, hence they are becoming more insurer than reinsurer, as their portfolios are now more heavily weighted to primary risks than reinsurance.
As you can see from the above, the Bermuda cohort of re/insurers rated by Fitch have moved from 53% reinsurance to just 44%, and 43% insurance to 51%, just in the space of the last ten years.
The decline in reinsurance underwriting has been most pronounced over the last four or five years, which is the period where the capital markets, through alternative capital vehicles, ILS and catastrophe bonds, have managed to increase their share of the reinsurance market considerably.
Fitch Ratings explained; “The recent segment shift to insurance reflects the more challenging market conditions in reinsurance, particularly property catastrophe business, where traditional companies have been losing business to the capital markets.
“As a result, Bermuda-based companies are looking more to insurance business for growth, both organically and through acquisitions.”
Fitch said that it expects that this shift away from reinsurance underwriting will continue, although not at the dramatic pace seen to-date as competition is expected to increasingly ramp up in the primary insurance space as well.
Herein lies a problem for reinsurers, who shift out of one segment because of competition potentially losing access to return to it as easily in future, only for the segment they shift into to become as competitive, as we’re seeing today in catastrophe exposed primary property insurance, certain commercial property lines and areas of specialty insurance such as marine and energy.
This raises questions about where else re/insurers can shift their focus, without adopting new business models to leverage technology and more efficient sources of capacity in order to raise their competitiveness and dramatically reduce their expense ratios.
On the other side, re/insurers in Bermuda have been retaining less of the risks they underwrite, making greater use of reinsurance and retrocession, or in sharing risks with third-party capital.
“The retention ratio declined by 2 points–3 points annually since 2013 to the mid-60% level for insurance, the mid- 80% level for reinsurance and the mid-70% level in total, down from consistent mid-70%, mid- 90% and mid-80% levels, respectively, as reinsurance and retrocession utilization increased with falling rates,” Fitch Ratings explained.
Unfortunately it’s not possible to understand how much of the increased cessions of risk out of Bermuda had been picked up by ILS and alternative capital, but it is safe to assume that a decent proportion will have ended up backed by the capital markets.
It’s also worth considering some re/insurers efforts to establish their own internal reinsurance vehicles, often backed by third-party capital and sometimes with a total-return strategy as well (ABR Re, Watford Re, Harrington Re, etc) and how these vehicles could also have contributed to their parents retaining less risk, but with the added benefit of the parent sponsor still being able to extract some additional margin out of that ceded business, through fee income and profit-sharing.
Increased cessions and lower retention rates could be a trend that will continue for some considerable time, until re/insurers work out how to extract the maximum margin from the business they underwrite without over-exposing themselves to the risks. Working out how best to achieve that is an ongoing process we see in the reinsurance market today.
Fitch Ratings continued; “This declining retention ratio trend may not stabilize in the near term as market indicators suggest that risk transfer pricing has still yet to reach a bottom.”
As these shifts in strategy continue the reinsurers will increasingly become insurers, despite the higher combined ratios that business typically brings with it.
Will those that have relinquished reinsurance business, particularly in key property catastrophe zones, ever be able to increase their shares in those markets again, now that ILS and the capital markets have made those peak-zone risks their home?
If the shift to higher combined ratio insurance continues, while the need to retain less also increases as the volatility has to be taken out of the portfolio, isn’t that going to exacerbate the re/insurers ability to make margin and meet their cost-of-capital over the longer-term?
The outlook just doesn’t get any easier and certainly calls for increasingly radical responses to the market environment.