Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Even in a buyers market, reinsurance buying strategies diverge


It’s interesting to note that even in the currently low-priced, buyers reinsurance market and with ever greater quantities of alternative and ILS capital ready to take on risk, attitudes to reinsurance and retrocession buying can differ wildly.

Currently there is a gulf between two distinct camps of reinsurance buyers, those who are retaining more risk, as they feel it benefits their bottom-line to do so, and those who are buying more reinsurance or retro, as they feel market conditions are about as conducive as they are ever likely to be. This has been well documented in recent months as the industry press increasingly refers to large re/insurers ceding less risk to the reinsurance market.

A number of insurers and reinsurers continue to insist that holding more risk on their books allows them to realise more of the premium benefits of the business underwritten. This camp is typically very well-capitalised (perhaps over-capitalised) and do not feel they need the support of additional reinsurance capacity.

The other camp feel that taking advantage of market conditions to boost their reinsurance and retrocession programs, adding additional layers of coverage, lowering retentions and issuing catastrophe bonds for the first time, is a better strategy. Some of these are newer companies, but there are also long-standing and very well-capitalised re/insurance players in this camp too making distinguishing between the two groups a little tricky.

One difference we have noted is that one camp thinks of reinsurance and retrocession as another form of capital lever for their business, while the other does not always think of it in the same way, treating it as more of an expenditure on the other side of the balance-sheet but with certain benefits.

This is perhaps a philosophical difference that leads to some companies trying to extract as much value out of the business they write, at this time when they are highly-capitalised anyway and it feels safer to do so, while the others leverage reinsurance as a capital tool, to use as they would debt or any other source of additional financing.

Good examples recently have been Bermuda-based reinsurance firm Everest Re, a large established global player, well-capitalised and currently utilising reinsurance capital as well as ILS capital to help it optimise its business for growth. Everest Re is buying increasing coverage from catastrophe bonds and utilising third-party capital to help it grow as well with its Mt. Logan Re sidecar, all in an effort to make itself more competitive in terms of cost-of-capital through optimisation of its portfolio and capital.

Another recent example is the California Earthquake Authority, which has a different model as an earthquake insurer for Californian homeowners and so being well protected matters. The CEA has more reinsurance protection than ever before, thanks to traditional and alternative cover through its catastrophe bonds. Taking advantage of market conditions to better protect its customers has resulted in an ability to pass on savings to them as well. The CEA is also back in the catastrophe bond market right now looking for more cover through Ursa Re Ltd.

U.S. primary insurance giant Allstate is another who has taken advantage of market conditions and pricing to grow its coverage and now feels it has the best reinsurance protection it has ever had. Allstate has more coverage at both top and bottom ends of its program, thanks to a combination of cat bonds and traditional reinsurance.

Heritage Insurance, the Florida Citizens takeout insurer, is yet another that has benefited from market pricing and easier access to ILS and catastrophe bond capacity as a way to reduce its cost-of-capital. The insurer said recently that it enjoyed lower cost reinsurance thanks to the cat bond market. Florida Citizens itself would of course be another great example of a re/insurer making a saving in the low-priced reinsurance and ILS market.

Other companies though are not making use of the cheaper traditional reinsurance coverage available or taking advantage of the appetite of ILS investors, which has made capital market solutions such as catastrophe bonds and collateralized reinsurance cheaper as well.

Some large insurers and reinsurers have been actively retaining more risk, consolidating the reinsurance purchases they do make, buying multi-year covers and merging treaties, in an effort to extract every bit of extra value from the business they have underwritten. In some cases this means they are not as well protected as in previous years, but with excess capital on their books it currently doesn’t worry them.

An example is Argo Group, the Bermuda-headquartered international insurer and reinsurer, which has been making less use of reinsurance capacity in the last couple of years, as it seeks to retain more of the risk on its books.

CEO of Argo Mark Watson discussed this recently, saying; “Right now and for the last eighteen months we’ve been buying less reinsurance and by keeping more risk that’s actually helped our financial results. If you look at our loss ratios, on a gross basis versus net, you can pick almost any time period and gross outperforms net, which is why we’ve been keeping more risk.”

This strategy works for Argo in the current environment as it is so well-capitalised. Watson explained; “We have plenty of capital to support the risk on our balance sheet so it doesn’t make sense for us to buy more reinsurance as a substitute for capital.”

Argo will only look to grow its reinsurance purchase is it will be immediately beneficial to the bottom-line, not as a form of capital relief, Watson continued.

“If reinsurance pricing does move to a point where it makes financial sense for us to buy more reinsurance and I’ll define financial sense as it goes straight to the bottom line directly, or I should say immediately, as compared to capital relief, then I think we’ll definitely look at buying more reinsurance but that’s the only reason that we would,” he said.

Part of this trend is due to the way the reinsurance cycle has reacted to the low catastrophe losses of recent years and the high levels of capital in the sector, both traditional and alternative. While capitalisation levels remain high this gulf between strategies for buying reinsurance may continue.

However, as soon as losses begin to rise we could see some firms making sudden attempts to lock-in reinsurance capacity at the best rates they can. The fear that prices may rise at the same time as they suffer more losses, from business retained on their books, may create a sense of urgency among some firms looking to secure protection.

There is also a chance that we could see a sudden surge in reinsurance and retrocession buying at the upcoming January reinsurance renewals. Most are aware that pricing is almost as low as it can go and there is evidence that the bottom of the cycle is nearing. That could stimulate reinsurance and retrocession buying among some companies, who could see this coming renewal season as too good an opportunity to miss.

It’s a difficult choice for leaders of insurance and reinsurance businesses, deciding whether to retain more risk which could result in a major catastrophe hitting and with less protection a bigger hit to your balance-sheet and shareholder capital, or to buy more reinsurance and risk their loss experience remaining benign in which case the additional spend may look rash.

There is, without a doubt, an element of risk to both strategies. Under difficult circumstances both could backfire. However it is surely easier and preferable to explain to your shareholders that you were better protected than unprotected if the worst happened.

For us, this is another sign of the evolving reinsurance market and the evolving strategies emerging within it. Some companies could become much more focused on a buy-and-hold approach to underwriting, while others may become much more focused on using reinsurance as a lever to allow for growth.

The way re/insurers use and buy reinsurance and retro is changing, at the same time as the market is evolving with capital and new business models. It’s a topic that deserves more attention and one we’ll try to return to occasionally, as examples emerge.

Also read:

Big primary insurers track reinsurance trends, ILS & alternative capital.

ACE seeks leadership role in evolving reinsurance market: Greenberg.

Property & casualty to have lower level of cyclicality: Travelers CEO Fishman.

Evolving market, changing dynamics may end the traditional cycle: Willis.

Capacity drives the reinsurance cycle, least conservative sets the price.

How to respond to ‘biblical flood’ of reinsurance capital: Andrew Kendrick, ACE.

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