Customised or tailored reinsurance arrangements, alternative risk transfer (ART) solutions and insurance-linked securities (ILS), alongside insurance technology developments (insurtech) are all seen as key to help mutual insurance firms grow their businesses and compete.
As insurance businesses seek to grow, expand their capital and capacity base, access new regions or customers, risk capital in its many forms is becoming a tool that can allow these growth ambitions to be pursued flexibly.
In a new sigma report, global reinsurance firm Swiss Re discusses the resurgence of the mutual insurance firm, noting that there has been increasing activity in the mutual insurance sector, with a rising share of global re/insurance premiums underwritten.
While there are some challenges ahead for mutuals, which are noted in the report, Swiss Re highlights reinsurance, alternative risk transfer and insurance-linked securities as tools that will all provide mutual insurers with an opportunity to acquire increased financial flexibility, which could help them to navigate a more regulated environment with tighter capital requirements.
Also of note is the fact that Swiss Re believes that insurance technology (insurtech) will help mutual insurers with opportunity and that the sector must upgrade its underwriting and distribution techniques to survive in a digital age.
The mutual business model is well suited to digitalisation and insurtech is expected to create opportunities for mutual business models to be developed which seek to shorten the risk to capital value-chain, just like the ILS and capital markets have been doing to-date.
In fact, mutualisation of risk through the use of advanced technology, insurtech, algorithms, machine learning etc., to enable advanced risk pooling techniques and perhaps even true peering of risks among members, could result in a mutual insurer model that directly accesses the capital markets for its reinsurance and risk capital requirements, thus raising the efficiency of the business model dramatically.
Risk-based capital requirements can be a particular problem for the mutual insurance business model, making smaller mutuals or those with a narrow focus less competitive. Access to capital is therefore important and within this risk capital, such as reinsurance or from the capital markets is key to help mutuals increase their flexibility when meeting capital requirements.
Capital solutions are key, along side risk transfer, Swiss Re explains; “Together with customised reinsurance solutions and alternative risk transfer mechanisms such as insurance-linked securities, this will give mutuals increased financial flexibility to grow their business and compete with other types of insurers.”
Combining technology with capital markets or ART solutions could make mutual insurers significantly more viable, particularly when considering the peer-2-peer insurtech startups and how some of those would like to access efficient capital sources, instead of having cumbersome balance-sheets.
The mutual insurer business model also answers some very important questions right now, particularly with respect to risk commensurate pricing.
In the future, as insurance moves towards technology led pricing Swiss Re notes that some customers could be priced out of conventional insurers, as the risk indicates pricing that is unaffordable. Mutualisation, where the risk is pooled among members, could help to make coverage more affordable, by diversifying it within the mutual pool.
Technology algorithms could help to make this process even more refined, by truly peering risks off one another in order to make coverage more affordable across the group. P2P insurtech startups today are largely just mutual pools, not really peering risks against each other in the true sense of the word but as the technology advances this technique could be a significant contributor towards making coverage more affordable in peak disaster zones, or in emerging markets, so helping to also narrow the insurance protection gap.
“Without the distraction of providing returns to external shareholders, mutuals could play a crucial role in keeping insurance premiums affordable and certain risks insurable,” Swiss Re explains.
And risk capital will play a growing role in making insurance through mutuals more efficient and ultimately cheaper for their customer base.
Swiss Re explains; “Reinsurance and alternative risk transfer mechanisms such as insurance-linked securities can also provide mutuals with increased financial flexibility to cope with unexpected losses, grow their business and compete with other types of insurers.
“Customised solutions, including innovations to allow collective access to reinsurance or other forms of risk-absorbing capital, are developing. This will widen access to risk transfer solutions for mutuals, which hitherto may have been deterred by cost or limited market interest in small-value transactions.”
This concept of enabling collective access to reinsurance, or other forms of capital such as ILS and ART solutions, could be another efficiency driven by technological development, insurtech startups which are not constrained by legacy views of the risk to capital value-chain, alongside structures and capacity from the capital markets.
Mutual insurers are already utilising the capital markets, with around 20% of non-life catastrophe bond issuance already linked to this segment of ceding companies, according to Swiss Re.
The reinsurer explains; “Insurance-linked securities are another external solution that can strengthen a mutual’s capital position. Collectively, mutual insurers account for around 20% of annual issuance of non-life cat bonds.
“But in general, interest in securitisation deals among mutual insurers has been limited. Sponsors have tended to be concentrated among a few large mutuals, especially Japanese co-operatives and some of the large US mutual insurers.”
But complexity and the required minimum deal-sizes can be an issue for mutual insurers accessing the capital markets through ILS, Swiss Re’s sigma report explains.
“The complexity of the transactions, the typical minimum deal size to make the issuance cost-effective, and worries about disputes with counterparties could be factors that hold many mutuals back from participating in the ILS market,” the report states.
Swiss Re also highlights that; “Many of the catastrophe bonds are parametric or index-based, and mutuals could be put off by having to manage the resulting basis risk.”
But the reinsurer also notes that “product innovation is helping to widen the range of potential market participants,” and “market innovations (eg, to lines of business included in the portfolio, loss triggers and collateralisation) continue to bridge the gap between investor appetite and those seeking risk transfer solutions, potentially encouraging more mutual insurer involvement.”
On coverage type it’s important to point out that in 2016 this is no longer a significant issue. The catastrophe bond market is largely indemnity based with 64% of the risk capital currently outstanding tied to an indemnity trigger and also 64% of the current year issuance using an indemnity structure, as Artemis’ data shows.
Additionally, the broker and facilitator owned cat bond lite or private cat bond platforms are making accessing the capital markets through a securitisation more feasible in smaller deal-sizes. The proliferation of smaller catastrophe bonds in the last few years demonstrates that the capital markets are no longer out of reach.
Of course the rise of collateralised reinsurance coverage, provided by the ILS fund managers and other capital markets backed reinsurance players, now ensures that capital market coverage in ILS form is available to all and mutuals would be advised to explore the ILS sector and build relationships with ILS fund managers now, with a view to bringing some of this capacity into their reinsurance arrangements.
Finally, Swiss Re notes that technology and digitalisation will likely give rise to mutualisation 2.0, as mutual insurance groups leverage P2P type business models as seen in the insurtech space to reduce underwriting and distribution costs.
The same insurtech space can also provide mutuals with ideas for reducing their risk capital costs and lowering intermediation, while also building closer relationships with their customer base. Efficient capacity, ILS and securitisation could all play key roles in the emergence of a next generation mutual insurance model.
Swiss Re’s sigma highlights the use of blockchain and smart contracts as one next generational step, and this could certainly accelerate efforts to reduce the chain of intermediation between the clients risks and the capital backing the mutual risk pools.
However agnosticism is key and blockchain is not the right solution for everything. Just the same as for a mutual insurer selecting risk capital, being agnostic as to form and provider is key, most important is identifying the efficient sources, structures and technology that will better enable the transition to next-generation business models.
You can find a copy of Swiss Re’s latest sigma report on mutual insurers here.