Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Cyclical downturn in ILS capital would benefit us: Swiss Re CEO


A cyclical downturn in the amount of alternative capacity deployed into reinsurance markets through insurance-linked securities (ILS) would benefit traditional reinsurers like Swiss Re, the Chief Executive Officer of the firm has explained in the press.

Christian Mumenthaler, Swiss Re CEOFor Swiss Re CEO Christian Mumenthaler, his interview in the Financial Times that was published this morning contains the Christmas and New Year wish that CEO’s of all major reinsurance firms have at this time of year.

That the ILS market will shrink and provide them with an opportunity to build greater dominance in global reinsurance once again.

Following the major losses of 2017 and 2018, which as we explained recently amounted to roughly $200 billion across a period of just 18 months, the ILS market has experienced a kind of resetting of investor expectations and a shake of sorts out is underway, as some investors have redeemed from funds, while others are cycling out to find other ways to move back in and access the sector’s insurance-linked returns.

Along with the capacity crunch in global retrocession markets, this resetting of ILS investor expectations and ambitions has not gone unnoticed by traditional reinsurers, of course, providing another opportunity to explain the benefits of their traditional business models.

Speaking with the FT, Mumenthaler explained that a “cyclical downturn” in ILS capacity would be a benefit to Swiss Re, reflecting the fact that his firm would be only too pleased to step back into areas of the market where it has found it harder to compete with underwriters that have a lower cost-of-capital.

He explained his thinking that the traditional, rated approach to reinsurance has benefits saying, “There was this huge enthusiasm for alternative capacity. When you have losses, I think some clients come to realise it’s actually also quite good to have somebody with a very strong balance sheet.”

But Mumenthaler went further, reiterating something he has said previously, that he feels in some areas of the ILS market the investor’s interests are not as strongly aligned as they should be.

Mumenthaler said earlier this year that he believes pricing has fallen to levels where, “There is a little aspect of what we saw in the financial crisis. A decoupling of people who understand the risk and people who take the risk.”

But in this FT interview, Mumenthaler has gone so far as to liken ILS to sub-prime mortgages, something the ILS market, its practitioners and investors would strongly refute and have refuted previously, as we explained here.

Mumenthaler said he still sees this separation between those who understand risk and those who take it, adding, “Some of the aspects of this alternative capacity market reminds me [of] some of the patterns you could see in the mortgage business before the crisis.”

We’ve discussed this before, explaining that this is precisely the position the equity investors who back Mumenthaler’s own reinsurer find themselves in, removed from the day-to-day underwriting decisions.

For it is Swiss Re’s own shareholders who are exposed to financial impacts, should the company face major losses, and they are without a doubt decoupled from the people who understand the risk.

Given the amount of retail investor money backing major reinsurers’ shares, versus the largely institutional nature of ILS investment, it is likely that there is a far greater understanding of the risk being taken among sophisticated ILS investors than there is among reinsurers’ shareholders, we would suggest.

Mumenthaler also implied that capital is sometimes being deployed with little thought for the investor’s ability to make returns on their allocations to reinsurance as well.

We cannot comment on all ILS investment managers’ capital deployment decisions, but we are certain that those we know well are constantly and acutely aware of their fiduciary duty to their investor base and deployment decisions are not taken lightly.

Mumenthaler highlighted the slicing and dicing of risk in ILS structures as being a feature akin to the mortgage market.

But reinsurance towers are also sliced and diced in this way. With some markets acting as lead underwriters and others the followers, who often deploy their capital based on another’s risk appetite and pricing in many cases.

The Lloyd’s market is a prime example of this, where a lead underwriter may be from a large equity backed re/insurer and makes decisions that are far removed from his ultimate providers of capital, the shareholders.

A following market at Lloyd’s may choose to sign on a slip based on the lead underwriters’ view of the risk, a decision which for them too is removed from their capital providers in most cases, although perhaps these followers are more closely aligned with their capital providers than a major reinsurance firm is with its shareholders?

So we feel it’s wrong to suggest that re/insurers underwriting decisions are more aligned with their shareholders than the ILS market’s capital deployment decisions are with their investors. If you want to talk remoteness from the capital deployment decisions, then a major reinsurers capital providers are much further removed than a pension fund which backs a specialist ILS investment manager.

What matters is being able to demonstrate a fiduciary duty to your capital providers and always operating with their best interests at heart, even though sometimes this can still lead to losses when an aggregation of major disasters strikes, as we’ve seen across the last two years.

A senior executive mentioning the sub-prime mortgage crisis in relation to ILS is an almost annual occurrence though and has been since the ILS market began.

Clearly major reinsurers see a significant opportunity for themselves at this time should the ILS market face difficulties or shrink and intend to do what they can to perpetuate any myths that would help this cause.

But, given the activity in the marketplace we expect a shake-out won’t last all that long, especially given the number of new initiatives and start-ups planning to come to market, with many backed by third-party institutional investors.

As we explained yesterday, there is a good chance that reinsurance and retrocession market capacity continues to grow as we move further beyond these renewals and into 2019, with ILS initiatives set to bring more and new capital to market.

Reinsurers aren’t set to have everything their own way as we move through 2019. In fact the challenges faced may increase again, once the current shake-out of some areas of ILS is over.

There will be no let up in the need for major reinsurers to demonstrate greater capital efficiency, lower expense ratios, the resulting higher margins and a growing ownership of their risk origination. While at the same time they will also increasingly need to behave like technology companies wielding capital in the most efficient manner, rather than financial companies wielding technology.

Any downturn in ILS capital would certainly be a benefit to Swiss Re.

But, in reality the firm is likely to make greater leaps forward by focusing on continued disintermediation of the re/insurance market value-chain, taking increasing ownership of risk origination and by ensuring that smaller markets cannot compete on its terms, so a continuation of the strategy seen across recent years anyway.

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