The reinsurance industry needs a reset and is on an inevitable road to somewhere different, as relentless supply of capital means reinsurers need to adopt a lower cost-of-capital business model, executives from broker Guy Carpenter said this morning.
The influence of capital in all its forms, traditional and alternative, is creating change in the reinsurance market and reinsurers are currently bearing the brunt of this through the effects of lower pricing, higher competition, at the same time as ceding insurers become more savvy and prudent protection buyers.
“The business generally will need a reset. It needs to work to a lower cost-of-capital model, which will lead see a period of increased creativity around the use of additional and alternative capital instruments, as well as enhanced return vehicles,” Nick Frankland, CEO of EMEA Operations at Guy Carpenter told an audience of journalists and media in London this morning.
“So it’s interesting times and I really do feel we’re at the point, we’re poised on the brink of a really fundamental change in this industry and I think the next twelve months are likely to confirm that”, Frankland continued.
On this “inevitable road to somewhere different,” as Frankland termed the future that the reinsurance industry is heading for, themes of consolidation, scale, diversification and tiering are going to drive reinsurers strategies.
Frankland said he expects to see “significant consolidation” including among large reinsurance companies as they seek economies of scale, to position themselves at the forefront of cedents buying consideration and to consolidate their position as relationship players.
In terms of capital in the reinsurance sector, there has been a “relentless increase of supply from increasingly diverse sources,” according to Chris Klein, Head of Strategy Management for the UK and EMEA regions at Guy Carpenter commented. Guy Carpenter now estimates alternative capital as providing as much as 18% of global property catastrophe limit, a number the broker expects will continue to grow at a similar rate to that seen in recent years.
Frankland commented on the need for new business models and how reinsurers will have an abundance of choice in the directions they choose; “There’s a lot of choice out there for clients and lots of choice actually for reinsurers in how they construct themselves going forward, with the advice they need and the direction they need to take and newer capital.”
“So I think there’s significant variety and differing choice available. I think the innovation required to support that and these changes going on the underlying infrastructure of the market will certainly secure the future of broking firms. But clients are undoubtedly going to need more help navigating their way through this, it is going to be a very complex market and a difficult one,” Frankland continued.
So clearly Guy Carpenter expects a thorough reshaping of the reinsurance market over the coming years, with a continuation of the trends that have become so prevalent over the last two. While this may not be the news that reinsurers want to hear, the change will bring with it opportunity and it is up to reinsurers to grasp that.
There remains “significant margin” in the reinsurance business though, said Frankland, despite continued downward pressure on rates at the recent renewals. The Guy Carpenter Global Reinsurance Rate-on-Line (ROL) Index, a broad measure of pricing adequacy across catastrophe risks, was down by 11% at the renewals this year following at 11% decline the year before.
Despite this the business continues to be attractive due to the availability of margin, which is still enabling reinsurers to turn out profitable quarters while their loss ratios remain light. Once that changes things might become very different though and this is why new business models, the embrace of alternative capital, efficiency and expense management are coming to the fore.
Capital continues to be interested in reinsurance due to the margin but, for reinsurers that chase a higher return on equity, competing with a lower-cost, more efficient ILS management business model leveraging capital with lower return requirements is going to be increasingly challenging.
Historically, capital came into the reinsurance business to satisfy the potential demand that was expected to arise after major catastrophe or man-made loss events. It wasn’t always required though, Frankland explained, in many cases when capital flooded in the market was sufficiently capitalised anyway.
That trend no longer seems to be true. Reinsurance is now so attractive in its own right that capital interest in the sector continues unabated without any major loss events occurring. New forms of capital can enter and exit the reinsurance market rapidly and that combined with the attraction to a relatively uncorrelated investment opportunity is ramping up the interest in reinsurance and particularly catastrophe risks.
Frankland continued; “Reinsurance now appears to be a firmly established, profitable and diversifying instrument that is not dependent on biblical scale disasters to attract interest. It’s got interest of its own, without loss activity.”
Klein commented; “Nobody can predict what’s going to happen in five years time. We don’t think there’s going to be any significant change to the attraction of this industry for new capital.”
Efficiency does need to be addressed though. “We’re still quite a high cost industry, insurance and reinsurance when you look at the composition of the combined ratio and think about the cost of administering our business. That’s still relatively high and is something that this industry needs to address,” Klein explained.
Efforts need to be taken to put the additional supply of capital to work and those opportunities do exist, such as in narrowing the gap between economic and insured catastrophe losses, Klein said.
Frankland said that he expects all the patterns are set to continue and that the amount of alternative capital in reinsurance is likely to grow at a similar rate over the next few years, which suggests that in five years it could be as much as 30%+ of the property catastrophe markets.
Alternative capital will also find ways to expand its remit, Frankland said, with some classes of insurance and some casualty risks likely to be explored next. The end result will be a more spread capital base in the reinsurance market, with different tools helping capital to more quickly to enter and exit the market. Instruments such as sidecars are set to increase in use as well.
Frankland concluded by saying that he expects the industry to remain over-capitalised for quite some time to come.
“We are in a different place. How you use capital, how you deploy it, how you make money at slightly lower margins than before, all become key issues to address,” Frankland finished.
The commentary from Guy Carpenter is absolutely aligned with recent trends and Artemis’ thinking on the state and trajectory of the reinsurance market. As it heads down its “inevitable road to somewhere different” the reinsurance market has opportunities to become more efficient than ever before, which could ultimately lead to some business model outperforming others.
For reinsurers it’s vital to ensure they are actually on this road and not standing on the sidelines watching inevitability pass them by.