Munich Re execs caution on casualty sidecar commutation challenge, risky asset strategies

In Monte Carlo today at the Rendez-vous event, senior executives of global reinsurance firm Munich Re explained that they see the trend for some longer-tailed casualty focused sidecars to offer high returns from the asset side as “not a good idea” while the potential for commutation discussions to prove a challenge at the end of a sidecar term was also discussed.

Munich Re hosted a media briefing in Monte Carlo and Thomas Blunck and Stefan Golling, both members of the board of management, seem equally against sidecars that have a significant focus on generating returns from the investment side, as well as on those targeting U.S casualty or liability risks.

Blunck, who has oversight of Munich Re’s reinsurance division at the board level, commented first, “Another element that I’d like to pinpoint is some of the solutions, for example sidecars that we’re seeing in the alternative space, are taking obviously more asset risk. Not all of them.

“Some are promising, for example, 8% return on investment, and for us, that’s not a good idea because you are taking a bold risk on both sides of the balance sheet in those cases.

“The reliability to pay claims, we believe, hinges also on a low-risk asset side. Asset underperformance can happen, and you are exposing with those solutions to the systemic risk of the capital market. So, for us, it’s not our appetite to participate in that space.”

Stefan Golling, who has responsibility for global clients, North America and Capital Partners at Munich Re’s board level, pointed to a chart showing U.S. liability loss ratios and said that market segment is expected to see further deterioration in performance terms.

With that in mind he highlighted that some of the longer-tailed casualty sidecars feature this type of US liability business.

“So the sidecars focusing on U.S. liability business. There’s reports around that those structures also have automatic commutations after five or seven years,” Golling said.

Referring back to the chart showing developments in the US liability market, he added, “I wonder how the commutation negotiations will look like between the sponsors and the investors, and whether there will be easy, agreeable answers found. Or whether there is substantial uncertainty coming back to either side.”

Later during the briefing Golling discussed alternative capital and insurance-linked securities investors, which while constituents Munich Re engages less with in terms of ceding risk to them these days, having shuttered its own sidecars, he still sees as an important market component.

“I seriously see the additional interest in the market as a positive for the market. I mean, no one would come and bring the capital to the market if you were all kind of running unprofitable businesses and so on. So generally, that’s a positive thing.

“When you think about the impact of the rate cycle, I mean, already last year, I think it was my message that I do not think that the alternative capital is influencing at the end the rate cycle so much. They have an impact as well as everybody has, but it’s most likely much more the behaviour, the underwriting discipline of the traditional players or of the combined market simply together.” Golling said.

Before adding that, “So I don’t see that they are, especially the cat bond market who is playing in a very specific segment, peak perils only, usually only in excess of a certain attachment point, that they are the reason why suddenly the prices for low-layer business in non-peak exposure zones should change.

“So therefore, I still welcome every new form of capital that shows interest. When you think about the trends that we have discussed, the volatility in the market, or the loss trends, I’m pretty sure one day this additional capital will be needed.”

The discussion shifted back to casualty and longer-tailed sidecars, the ones that have a heavy emphasis on generating more of their returns from the investment side while the underwriting is at or near break-even, which is of course reminiscent of what we used to see with the hedge fund reinsurers.

“Sidecars come in different constructions and structures, and I was pinpointing the ones that are taking quite a high asset risk at the same time, and only those,” Blunck said.

“And why? Because if you take this as our philosophy at Munich Re, if you take a bold risk on both sides of the balance sheet, of course you have much more exposure, and any asset underperformance or any systemic capital market event can deteriorate your portfolio such that you cannot pay the claims. That’s very simple, but it’s only those that promise 8% or 10% of return on investment.”

Golling went into more detail and also explained Munich Re’s own view, that it feels no need to cede risk away and now prefers to retain as much as it can.

“It’s not about whether we like sidecars or not. I think what I tried to point out is if we have sidecar structures and the potentially different ones as well, who have an automatic commutation after five or seven years, and we cover a class of business where we see that maybe sometimes the tail uncertainty maybe takes 15 years, 20 years, then I’m not so sure how the first commutation situation will look like,” Golling said.

Adding, “I think sponsors and investors need to simply be aware of that and have that in mind. And there, everybody has to make its own kind of decision.”

In conclusion he stated, “For us, it’s not so much a question of whether we like it or not. For us, it’s more a question whether we need it, because we see ourselves as a gross risk underwriter. The business that we write, we want to retain, and that’s the reason why we don’t necessarily entertain sidecars ourselves, because we have not the need, with a solvency ratio of 300% and an informed risk appetite, to cede business away.”