John Charman, the sometimes outspoken, often insightful CEO of Bermudian insurance and reinsurance firm Endurance Specialty Holdings, said that he believes that we will see an increasing convergence between the traditional and alternative sides of the market.
In an interview with the Royal Gazette (here) Charman explains that he expects traditional reinsurer business models will converge with third-party or alternative reinsurance capital players, as both sides come to terms with a market transformation driven by the “most brutal competitive trading conditions” he has witnessed in his 44 year reinsurance career.
Charman also told the Gazette that he remains in the market for an acquisition, if the right deal that added strategic and tactical value could be found. Charman believes that bigger is better, with reinsurers wielding $5 billion to $10 billion of capital most likely to succeed.
That’s bigger than Endurance right now, which suggests that the reinsurer will continue its search for acquisitions until it finds something with the right fit.
On the currently challenging market environment, Charman said; “The global reinsurance markets are experiencing the most brutal competitive trading conditions that I have experienced in my 44 years in the industry.”
Interestingly, Charman said that he feels that the challenging reinsurance market environment is negatively impacting alternative capital vehicles and insurance-linked securities (ILS) players.
“It is my view that market conditions have caught up with many of the third-party capital vehicles that have been established since 2005. As a result they are finding it increasingly difficult to fill the buckets they are paid to fill,” Charman told the Royal Gazette.
This is perhaps true of some smaller ILS players, who may struggle more to be signed onto large reinsurance programmes. However for the larger ILS players the anecdotal evidence points to the opposite, as they find themselves increasingly in demand as capacity providers, with smaller traditional reinsurance players often the ones losing out and being dropped off the slip.
Market dynamics are certainly affecting ILS players, in the same way as they affect every reinsurer, however the difficulty in filling risk buckets is just as prevalent on the traditional side of the market right now, it would seem.
Charman notes that as catastrophe reinsurance business supply is finite, ILS and alternative capital players are increasingly being tempted to move outside of peak nat cat risks. This is certainly true for some managers, however the largest ILS managers are mostly focused on catastrophe or weather risks and this focus continues today at a time when traditional players are increasingly seeking diversification.
Charman raised a concern about depth of underwriting strength in ILS and alternative capital, saying; “The big concern that I have always had about these types of businesses is the lack of underwriting bench strength within their companies. Historically, the differentiating factor between underwriting businesses is the ability of their underwriters to select the right risks thereby presenting a greater opportunity for them to be more profitable.”
He went on to say that ILS players use a model driven approach to underwriting, something that is actually not true for the majority of players. He said that in his experience this has always been a bad approach to underwriting.
ILS players would likely agree wholeheartedly with Charman on this point. The underwriting expertise at many ILS managers is actually very high and with more and more deals being done on an indemnity basis the expertise levels are increasing all the time.
This issue of underwriting ability and discipline really needs to be parked until the market sees more losses, at which time we will be able to say whether ILS managers have relied on models too much, or conversely whether traditional players have given away too much on terms and conditions. There’s currently little evidence either way, aside from people’s anecdotal experience and prejudice against one business model or the other.
Charman went further to say that over the coming years he expects to see ILS or alternative capital businesses having to either “start acquiring real diversified insurance or reinsurance companies or return their funds to their investors.”
“In essence, in the future they are going to look and operate much more like the traditional market vehicles,” he continued.
Another interesting point. We’ve discussed the deepening of the convergence between capital markets and reinsurance before, as well as how the distinction between ILS and reinsurance will keep blurring and alternative capital could become indistinguishable from traditional reinsurance.
Charman seems to feel that this is where the market is going, saying that traditional players cannot expect the status quo to remain as it is today. “They need to evolve quickly into entities that possess the characteristics of both traditional and third-party vehicle businesses. The future for us will be very different from the past.”
From his comments it would seem that Charman feels that traditional reinsurance players like Endurance may have the upper hand over ILS as the two sides of the market continue to converge. However, who will be able to dictate terms if the two sides consolidated remains to be seen.
It seems likely that efficiency and cost-of-capital will dictate some of this, at the point that alternative and traditional become more similar, with traditional players bearing the brunt of price declines and rising ratios, it’s by no means certain how their businesses will look in a few years time (if market conditions continue).
Perhaps the most interesting point of the interview to note, is that if Charman is right about traditional reinsurers needing to evolve to have “characteristics of both traditional and third-party vehicle businesses” then his firm Endurance will itself need to start managing, or using, third-party capital.
That’s something it hasn’t done in any meaningful way to date, so perhaps should be watched out for as these trends play out.