IAG looks to expand quota share coverage, aggregate erosion continues

Australian general insurance firm Insurance Australia Group (IAG) is to continue making greater use of reinsurance capital, with the company exploring new quota share arrangements with its counterparties even as its aggregate layer of protection continues to be eroded.

Reporting its results today IAG revealed that the strategy of increasing its reliance on reinsurance capital is set to continue into what is its new financial year, first-half 2018 for the insurer.

Increasing use of reinsurance capital has been seen across the Australian and New Zealand insurers in recent years, as they have dealt with an increasing claims burden due to severe weather, flooding, cyclone and earthquake events in the region.

IAG has made capital optimisation one of its core strategic goals, with greater use of reinsurance capital seen as a way to increase the diversification of its capital sources and to reduce the reliance on its own equity capital.

In a world where reinsurance pricing is soft and reinsurance capital abundant, this strategy is a healthy way to grow an underwriting business on the back of third-party sources capital, while taking the volatility away from your shareholders.

IAG has already topped up its catastrophe reinsurance tower this year, adding a $1 billion layer in June that sits on top of its main catastrophe coverage.

But having blown through its full-year catastrophe allowance in its 2017 financial year, just ended at 30th June, the insurer is looking to take further volatility out of its results for the future by exploring the potential for adding more quota share coverage.

As a result, IAG is looking for quota share partners that can help to strengthen its regulatory capital position even further.

IAG already has the much-discussed 20% quota share with Warren Buffett’s Berkshire Hathaway, which gives it access to a significant source of reinsurance capital across its whole account.

The insurer also has other quota shares in place, including line specific quota share reinsurance for cyber risk, crop, financial lines and third-party liability exposures.

At this stage it’s not clear whether any new quota share arrangements would be whole-account, perhaps an expansion of the insurers existing arrangement with Warren Buffett and Berkshire Hathaway, or more line of business specific in areas where IAG feels it needs the reinsurance capital support.

Of course the insurance-linked securities (ILS) fund market could provide IAG with a way to reduce its exposure to specific peak perils and peril regions, with ILS fund managers au fait with the quota share arrangement that sometimes underpins their collateralized reinsurance contracts.

Meanwhile, IAG continues to eat into its reinsurance arrangements for the new financial year, having gone over its catastrophe budget in the last.

In the full-year 2017 to 30th June, IAG went $142 million over its catastrophe reinsurance budget allowance, resulting in the insurer exhausting its $96 million of specific catastrophe coverage and eroding at least $140 million of its aggregate program as well.

Reinsurers have continued to support IAG, with increasingly favourable pricing and terms at its most recent renewals, despite a higher attritional loss rate due to events in the region.

IAG has continued to utilise its reinsurance support and given the erosion seen on its sideways or aggregate coverage with around $50 million claimed, the insurer has around $340 million of reinsurance left to call on in the next financial year, after the 20% quota share.

So with reduced aggregate protection available through its first-half 2018, IAG is perhaps looking to other solutions to help it to secure reinsurance capital to better manage its volatility and reduce the potential impact to its equity holders.

Additional quota share protection, either through an expansion of its arrangements already in place or the addition of new quota share partners, would provide some additional certainty for the insurer as it looks to manage the volatility in its results.