More companies should adopt a hybrid reinsurance model: McConachie

Market conditions see reinsurance firms struggle to generate desirable returns on the underwriting side of their balance sheets, leading Neil McConachie of Fidelis to ask why they aren’t writing less business and instead shifting capital to try to make a return on the investment side.

“There’s always been two ways to earn money as an insurance company, on the underwriting, which everyone is aware of, but I think people forget that actually most of the profits generated in the industry over the last 25 years have been from the asset side,” said McConachie, Chief Financial Officer (CFO) of Fidelis Insurance Holdings.

In a challenging reinsurance market the sustainability of the traditional reinsurance business model has come under the spotlight, particularly at a time when hybrid models are becoming more common and showing signs of success, highlighted by the Warren Buffett Berkshire Hathaway approach, which recently reported profits from its investments at a time when underwriting returns declined significantly.

McConachie notes that both the traditional and alternative markets have excelled in optimising underwriting portfolios, adding that “Bermuda does it better than anywhere in the world,” as firms are “managing to squeeze more and more returns out of their underwriting portfolios for the same amount of risk.”

But instead of expanding and applying that same logic to the investment side of the balance sheet, the majority of the market is attempting to offset declining margins in underwriting by simply writing more business.

McConachie expands on this, highlighting that companies are just “writing more and more and more premium, and trying to keep the profits up.”

“It’s such a crazy idea to say you know what, let’s do something radical and actually write a little less premium and take some of that capital and move it over to the other side of the balance sheet and try and make a return here,” continued McConachie.

The hybrid, or hedge fund-backed reinsurance model, which aims to balance the underwriting and investment side of the business to generate a total return that outperforms the market, is becoming a more common structure and feature within the overall re/insurance market, with Fidelis being one of the most recently launched such ventures.

“There are very few pure reinsurers anymore,” says A.M. Best Vice President, Property Casualty Reinsurance, Robert DeRose, “most of them have primary insurance operations that are getting closer to the customer, they’re trying to find the risk, and most of them have capital market vehicles.”

“And on top of that, many of them have alternative asset strategies within their overall asset strategy,” continued DeRose, emphasising the rise of hybrid reinsurance structures in recent times, as firms look to become more efficient, through leveraging third-party capital, increasing their underwriting value and maximising investment returns.

DeRose also explained how from a ratings agency stand-point, the hedge fund reinsurer approach acts as a “balancing mechanism,” which “enables the insurer or reinsurer to navigate the cycle,” so long as management and underwriting are prudent of course.

Adding, however, that due to the inherent lack of knowledge A.M. Best has on the actual investors in these types of funds, does raise some concern over whether they truly understand their exposures, and how they will react post-event, the latter being a question the entire industry has been grappling with since the growth of ILS.

In response, McConachie highlighted the comfort and stability a rating from an entity like A.M. Best offers to investors, and said that “as the ILS space, the alternative space is starting to diversify away from property cat, it may be that an A.M. Best rating is going to be seen more often in these vehicles, because it does give you the ability to write a lot of stuff with lower rates on line.”

Being able to pullback on writing certain, competitive business lines, or even to cease writing business altogether at times of market turmoil is a sign of disciplined, prudent underwriting, but in order to keep shareholders and clients happy, profits need to continue to come in from somewhere.

And it’s this desire and need to generate returns that will drive the expected increase in established hybrid reinsurance business models. If everyone continues to write more and more business in competitive business lines where rates are increasingly pressured, it’s hard to see a turn in the market anytime soon, absent several large loss events, perhaps.

On Fidelis, and further arguing the case for the benefits of the hybrid, non-traditional reinsurance model, McConachie said; “What I like about our model is it kind of works in any market, we’re not chasing premium, if markets get better than we can allocate our risk to the other side of the balance sheet, if they stay as they are then we’ll keep it kind of balanced between the two sides.

“I hope other companies do it; it would be great to see some of this endless quest for growth to actually slow down a bit.”