As you’d expect, large U.S. primary insurers are monitoring emerging trends in the reinsurance marketplace, particularly the growth of alternative capital and ILS, the emergence of new reinsurance structures and the reduction in reinsurance pricing.
Two in particular are worth watching as they have both been sponsors of catastrophe bonds in the past, have large reinsurance programs and could come back to the insurance-linked securities (ILS) market in a big way if they choose to take advantage of the current pricing conditions, more flexible structures and appetite from investors for more risk.
Both Travelers and Chubb senior executives have discussed this in their latest earnings call in recent days, both saying that the companies are constantly watching these trends unfold to see whether the opportunities presented by ILS and alternative capital are increasing for them.
There has been a recent trend for large primary insurers to retain more risk, particularly the retention of more profitable business underwritten, as well as a trend towards multi-year, large, consolidated reinsurance treaties with reinsurance buying decisions moving to senior levels and bundled covers replacing multiple contracts.
These efforts have moved a lot of reinsurance buying into the realms of capital management and revenue smoothing, which has concerned some in the reinsurance market who have seen less premiums coming their way, while others have expressed concerns about large, bundled and consolidated treaties masking the underlying risks assumed.
However the consolidated buying approach to reinsurance has been a trend while the market was on the way down, in terms of price, and expanding with respect to terms and conditions. Now that the market is as keenly priced as it has been of late, with not much more room left for significant price falls, and terms have been stretched to a point where reinsurers are pushing back, it seems the focus for large primary insurers may now move back to how best to leverage the attractive reinsurance market conditions.
With the softening of reinsurance prices and the availability of alternative and also traditional capital now pressing on the primary market lines of business, which could see large primary insurers profits squeezed too, it seems an opportune time to take a long hard look at the coverage options and pricing available. That could bring ILS and alternative reinsurance capital even more into focus as risk transfer options for large primary insurers.
Both Travelers and Chubb are cat bond sponsors, Travelers most recently with Long Point Re III Ltd. (Series 2013-1) in May 2013 which was its fourth cat bond issuance, and Chubb’s last visit to the cat bond market was in March 2014 with East Lane Re VI Ltd. (Series 2014-1) which was the insurers sixth cat bond we have listed in our Deal Directory.
Having used the catastrophe bond market regularly as a source of collateralized reinsurance protection for a number of years we’d expect both of these insurers to continue to do so. However with market conditions as conducive as ever and alternative capital more easily accessible than ever before, there is now a chance for them to increase their use of ILS and the capital markets should they so wish by launching new structures or ceding additional risk through ILS vehicles.
Travelers CEO Jay Fishman discussed the way his firm views emerging reinsurance market capital trends and the current pricing environment during the recent earnings call, explaining that Travelers is looking at all the options available to it, including setting up its own internal alternative capital structures.
“We are certainly looking at everything,” Fishman explained.
Referring to the use of alternative capital and internal structures, such as captive or internal reinsurers similar to the rumoured plans that ACE Group has, he said it would need to be clearly beneficial to Travelers; “There’s obviously a lot of activity in that space. We’re not a big utiliser of reinsurance broadly speaking. So, when you look at the amount of ceded premium that we put out into the marketplace it really isn’t enough to jump through a lot of hoops and incur a lot of cost to create something that looks snappy but doesn’t really accomplish much financially.”
Fishman suggested that this is an ongoing process at Travelers, where it assesses the latest structures and initiatives in the market, a process that he at the CEO level is also engaged in.
“That doesn’t mean we are giving up. I am mindful of the fact that it is getting a tremendous amount of attention so I have actually been spending some of my own time making sure I can actually understand it and make sense of it. So far, without a lot of effect, to be completely blunt with you but we will obviously keep looking,” Fishman said.
This should be seen as encouraging by ILS investors and managers, as clearly the sector and its growing range of structures and vehicles that welcome third-party capital are getting increasing attention. Of course, in the current market environment it’s not surprising that CEO’s are engaged in understanding the growing variety of alternative market options available to them.
Price is not the key driver though, in Travelers case, as Fishman explained; “I don’t anticipate that the change in reinsurance pricing, in any broad measure, will have a meaningful impact on us. Again not because, for example, our property cat treaty wasn’t less expensive, it was. But it is just not enough on a premium base of our size to make a substantial difference.”
So price alone does not particularly help Travelers, which is again encouraging to hear for ILS investors as it supports suggestions that downward pressure on pricing is stimulated by supply more than demand.
Fishman has also discussed the arbitrage opportunity, of using cheaper reinsurance to help you grow and underwrite more primary insurance risks, but he remains skeptical about that opportunity.
“I have also been asked whether we would be interested in building a book of business and in effect arbitraging it against the reinsurance opportunity. I am always mindful that when you take on risk on the right side of your balance sheet there is some permanence to it and the reinsurance profile on the left may or may not be permanent,” Fishman explained.
He continued; “You’ve got to be very cautious and careful about not finding yourself in an under-reinsured position or in a mis-match, which can happen and has happened.”
Despite all the research and investigation that Fishman and Travelers have undertaken they remain underwhelmed by some of these more complex opportunities. Fishman said; “There is a lot of moving parts here and we are sure looking at it pretty hard, but so far I would say nothing really excites me, at least a great deal.”
If the more complex structures, such as internal vehicles, do not excite Fishman perhaps the opportunity to issue much larger catastrophe bonds and to lock in protection for three years, or more, might. It will be interesting to see whether Travelers returns with another cat bond, under the Long Point brand or another, over the course of the next year as it will clearly have an opportunity to upsize its use of ILS cover.
Chubb has noticed the benefits of cheaper reinsurance pricing, its CFO Richard Spiro said during the insurers earnings call, despite the fact it is not a big buyer in relation to the size of its business.
Commenting on the benefits from cheaper reinsurance, Spiro said; “We’ve been able to enjoy lower reinsurance costs based on the renewal of our major cat treaties back in April, so that obviously will be helpful. So although we’re not a big buyer we do have some other reinsurance programs in place, so that’s (pricing) always helpful.”
Similarly to Travelers, the Chubb Group of Companies is keeping an eye on developments in the ILS and alternative reinsurance capital space to see what structures emerge that may be of use to the firm.
“We are obviously paying close attention to the developments in the marketplace, looking at all the different things that are going on and all the different structures and we have an open mind about it,” Spiro explained.
Spiro continued; “We’re monitoring whether some of these alternatives would help improve the overall performance of our portfolio either by promoting growth or by managing some of our volatility and we’ll continue to look at some of these.”
However, to date Chubb has not found anything it wants to embrace right now, apart from of course its regular issuance of catastrophe bonds. Again, similarly to Travelers nothing has yet stood out as a solution to this goal of growth or smoothing volatility.
“We haven’t found any of these big new structures that make sense for us at the time being. But we are looking at, our individual businesses are looking at, the lower reinsurance costs to see if there are ways that it can benefit the business,” Spiro said.
“We’re keeping an open mind and it’s kind of hard to pinpoint exactly how the lower reinsurance costs will impact us, but clearly, in the near term, we’re going to enjoy the benefit of lower costs,” he commented.
So both of these large U.S. primary insurers have had similar, perhaps informal, initiatives underway to assess the new opportunities that ILS and the growing alternative capital, alongside cheaper reinsurance, are offering to their businesses. So far the large and complex structures that others are said to be working on, sources suggest these efforts are much more broadly underway than at ACE alone, are not yet clearly attractive to them but the opportunity to acquire cheaper protection does seem to be.
If large players like Chubb and Travelers are looking at how best to capitalise on recent reinsurance, ILS and third-party capital trends, you can be sure that other primary insurers, from large to small, are also investigating their options.
These insurers could have a huge opportunity to upsize their use of catastrophe bonds, if they wanted to, in the coming months and as both have a history of cat bond sponsorship they are clearly worth keeping an eye on. For those insurers that have not yet sponsored a cat bond, market conditions could make this too good an opportunity to miss.
Regarding the other, larger more complex, alternative capital arrangements, there is perhaps an opportunity for innovative brokers and consultancies to find ways to make these structures work for large primary insurers like this, helping them to embrace alternative capital and alternative risk transfer and optimisation structures more fully within their business.