Change is afoot in the global reinsurance market as reinsurers and service providers come to terms with the new paradigm of managing third-party capital for deployment within reinsurance underwriting business. The reinsurance market is changing and reinsurers are entering a period of transition from managing their own capital to managing ‘other people’s money’.
The use of third-party capital, largely sourced from institutional capital markets investors such as pension funds, hedge funds, endowments and specialist insurance-linked fund managers, has been a feature of the reinsurance market for more than a decade but has experienced a boost in the last two years.
Savvy reinsurers have been working out how best to leverage capital from third-parties, alongside their own shareholder capital, in their underwriting in order to earn management fee income for some time. These reinsurers were quick to the game and have already got established ILS or collateralized reinsurance vehicles in place to allow them to capitalise on the growing interest investors are showing in reinsurance business. For others, who weren’t so savvy, it’s a game of catch-up as they rapidly put in place frameworks to allow them to manage other people’s money.
Allan Waters, President & CEO of Sirius International Group, Ltd., the Bermuda based reinsurance arm of the White Mountains Insurance Group, Ltd., said recently at the White Mountains investor day that he believes ILS and third-party reinsurance capital has the potential to create a big change in the basis business model of certain lines of reinsurance business.
You may remember that Sirius has itself recently launched its own ILS specialist entity, Sirius Capital Markets which has offices in New York and Bermuda, to capitalise on the third-party reinsurance capital trend. It’s clear from the comments Waters made at the recent investor day that Sirius, and White Mountains, believe that the change the reinsurance market is facing could be significant.
Waters said that Sirius is facing a transition, from managing its owners capital for risk and profit to managing third-party money for risk and profit. Waters called third-party capital OPM, or ‘other people’s money’ a fitting acronym. Waters said that the whole industry is going to go through this transition, from managing its owners capital for underwriting and profit to managing ‘other people’s money’ for underwriting and profit.
Waters said that the business of managing ‘other people’s money’ can be good for reinsurers, as managing capital for a fee doesn’t require so much capital of your own, is not very risky and can generate a good return on capital for the manager. However he stressed that the reinsurance market is facing a big transition and that getting from where we are today to the new paradigm of third-party capital being leveraged throughout the reinsurance market is going to take time.
There will be both winners and losers in this transitional period for the reinsurance industry. Waters said that Sirius wants to participate in this new market paradigm, as does most of the rest of the reinsurance sector, including brokers and other peers of Sirius, who are all trying to jump in and not get left behind.
Waters said that everyone is trying to keep in the action as it happens and that he sees reinsurance as a very good business which is transitioning into perhaps a more efficient capital approach to running the business.
Waters explained that the Sirius Capital Markets team will have split responsibilities, operating almost as two companies. The New York office, run by Michael Halsband formerly of Deutsche Bank and Goldman Sachs, will be responsible for marketing and bring in assets under management. The Bermuda office, run by Deanne Nixon who’s been with Sirius for over ten years, will perform the risk selection and run the assets under management for a fee.
Sirius intends to use its track-record in reinsurance to attract capital, by effectively offering third-party investors a slice of the firms attractive profits it has been making when managing its own capital. So it sees third-party capital management perhaps as a little diluting of its existing business, but feels it is necessary to be involved.
However, even if the profit is slightly diluted, Waters said he expects it to complement its existing business model and to bring in new opportunities from brokers as a result of entering this new side of the reinsurance market. He expects it to add value over time, although stressed it won’t move the figures in the first few years. It needs to attract sufficient assets before it will begin to really contribute to the bottom line, he explained.
The worry for many reinsurers has to be whether they will dilute the profit they have already been making when underwriting with their own capital if they add into the mix third-party investors capital. The strategy has to be to acquire incremental business, so as not to dilute the premiums earned, and to become more capital-efficient in order to make managing ‘other people’s money’ a viable component of the reinsurance business.
Those who enter the ILS and third-party reinsurance capital management space without a well-thought out strategy will risk cannibalising their existing business, reducing their income and may find themselves struggling. Reinsurance firms who end up in this situation will likely become targets for acquisition or have to fall back on their existing business relationships but lose out on some of the more attractive business which will likely go to those with lower cost-of-capital.
Raymond Barrette, Chairman and CEO of White Mountains Group, mentioned that the capital currently coming into the reinsurance space from pension funds could be just a drop in the ocean as it’s such a small percentage of their assets right now. He said it has the potential to be a tsunami of capital through the property catastrophe reinsurance business, but he believes they are well placed to defend their position as Sirius has a diverse, global book of property CAT business.
David Foy, CFO at White Mountains, discussed whether the third-party capital would exit the market either after a major catastrophe loss event or if global interest rates picked up. He believes a large event may slow the growth of this capital in reinsurance, but then it will come back in. Higher interest rates again could slow it, but as investors get a taste for reinsurance and catastrophe risk as an asset class, understand it, study it and appreciate its return profile, he doesn’t see them going away.
Some useful insights from one of the reinsurance groups that is actively positioning itself to become a center of excellent in managing third-party capital in reinsurance alongside its own capital. The transition faced by reinsurers like Sirius is indeed huge and challenging. Just how big a transition this will be is not yet clear and will largely depend on just how much capital continues to flow into the space. It will be interesting to watch the Sirius’ progress as it transitions alongside the rest of the market.