Profitable growth won’t be any easier for re/insurers to achieve in 2017

There is an expectation that achieving profitable growth in insurance and reinsurance in 2017 is not going to be any easy, as ideas that pricing is near to the bottom of the cycle are unlikely to translate into better profits or more growth opportunities without an innovative approach.

It’s clear that profitability has declined in the insurance and reinsurance market and the higher catastrophe losses witnessed in 2016 have helped to erode a little of the comfort buffer that some companies had been operating with.

However reinsurance companies are in the main looking more sustainable, in the current soft priced environment, than some of their traditional and specialty insurance counterparts, with the Lloyd’s market one area where pressure is perhaps being felt more, possibly due to the often higher cost of doing business there.

The fact that the large reinsurers profits look relatively sustainable even if the soft market is prolonged, as many believe it will be, suggests that there is margin left in the business for them, which of course suggests there is even more margin available to a more efficient business model, that utilises lower-cost capital.

While margin remains and reinsurance continues to be profitable for traditional market players, it will be deemed highly attractive still for alternative business models backed by the capital markets, and for hedge fund players or total return strategies that can leverage asset management to enhance (or replace) underwriting profits.

That all suggests the pressure won’t let up for now at least, amplifying the need for traditional insurers or reinsurers (as we’ve said many times before) to find their place in the value chain, identify what precisely their value proposition is, and identify how to extract a profitable revenue stream through it.

The expectation from many, as detailed here by Artemis and here by our sister site ReinsuranceNe.ws, is that pricing pressure will persist throughout 2017, even if prices only decline slightly, and that this pressure could well still be evident in 2018 at renewals as well, slowly eroding a little bit more margin from the business.

Gradual margin erosion will increase the pressure to gain efficiency, through reducing expenses, perhaps reducing manpower, leveraging more efficient capital, looking to the total return reinsurance model, embracing technology and insurtech, while always seeking to get capital ever closer to the source of the risk.

That suggests ongoing pressure on the traditional business model, as alternatives (capital, strategies, operational models) increasingly become the norm across the insurance and reinsurance marketplace.

One reason the large reinsurers continue to post good results is that they have been early adopters of the “getting capital closer to the risk” mantra, with global players using capacity at all tiers of the market, as primary insurers, reinsurers and retrocessionaires, providing choice and an ability to be more selective.

Company results display a clear trend towards margin protection and the best way to do this right now is by adapting to this “new normal” where “fast capital” is finding a more direct route to attach itself to risk, in order to extract a relatively uncorrelated return.

The expectation from players at Lloyd’s and in London is that pressure will continue through 2017 and beyond, reflecting a clear need for more than just modernisation, as that market has been striving for as long as the internet has been a thing.

It’s possible that reinsurers are adapting fastest right now, as evidenced by the adoption of insurance-linked securities (ILS) structures, third-party capital, technology and the shift into primary lines of business.

Primary companies have not had the luxury of being that one step removed from the risk, that has enabled reinsurers to have a clearer view of market trends and an opportunity to embrace the disruption as it targeted the industry.

Hence reinsurers, particularly the big global players, are increasingly competing with primaries, offering risk transfer across the balance-sheet and working at every point along the value chain.

That’s one approach, to try to extract value at every possible touch point. Another approach is to be extremely good at delivering value at one point in the chain, while extracting value from it in sufficient volume to power profitable growth. The specialists are making strides here, as are those seeking to become fee earners for third-party capital.

The other way to view this is to identify what piece of the traditional re/insurance model offers the most value to the evolved market landscape. Is it a balance-sheet? Origination expertise and contacts? An ability to analyse risks? Pricing power? Scale and reach? Distribution?

Then, by combining what you do best with the most efficient providers of the other touch points, you can attempt to leverage niche expertise in order to extract fees and profit that supports a different kind of business model.

The near-term looks set to see challenges continue. As a result a gradual move to new business models is possible among some of the smaller, more specialist players in the traditional market, as they learn ways to augment income through service provision and renting their skills to others.

If you’re not the cheapest capital in the re/insurance market, due to lack of scale, funding, or other factors, but you are the best underwriter/analyst/pricer of a certain class of risk, perhaps you too should be considering ways to offer your skills to providers of lower-cost capital, through partnerships or other arrangements?

There is no sign that conditions are going to get any easier in re/insurance, which suggests that these trends are all set to continue and some clearly will accelerate, such as the distribution changes coming thanks to technology. Under these circumstances, it will be important that re/insurer boards are open to change.

As profitable growth becomes increasingly difficult, particularly for smaller reinsurers, those with niches and market-leading expertise may find the shift to a business model where they offer services to others with capital an attractive proposition.