Traditional insurance and reinsurance players continue to benefit from the lower-cost of reinsurance capital and capacity, assisted by the growing pool of low-cost capital market and alternative capital. RLI Corp. is the latest example to emerge.
RLI Corporation, a traditional specialty insurance and reinsurance company, noted last year that “property premiums continue to be under pressure due to the high levels of competition and capital, both traditional and alternative.”
The firm’s expectation was that “more price pressure” was ahead, particularly on catastrophe lines of business in both primary property and reinsurance lines, with the worst declines to be seen in wind and earthquake exposed lines of business.
During the firm’s fourth-quarter and full-year 2014 earnings call yesterday, executives commented on the positive aspects of an abundance of reinsurance capital and the savings and improvements it has helped RLI to make to its own reinsurance protection.
RLI Corp. placed 60% of its reinsurance coverage at January 1st, across five treaties covering its casualty, property and multi-line businesses.
Craig Kliethermes, RLI’s Executive Vice President of Operations, explained the benefits that the abundance of cheaper reinsurance capital provided at the renewal; “We’re very pleased with the outcomes. We achieved risk-adjusted rate reductions ranging between 8% and 12%, with savings of ceded premium of approximately $6m.”
RLI has benefited from the higher level of competition in the reinsurance market in order to better diversify its sources of risk capital and expand the coverage they offered.
“We expanded and better diversified our panel of reinsurers, continuing to partner with very high quality names. We’ve broadened our terror coverage and also received a few other miscellaneous improvements in terms,” Kliethermes explained.
Additionally, RLI took advantage of the soft catastrophe reinsurance market to reduce its co-participation on some of the lower layers of its catastrophe reinsurance treaty by as much as 5% to 10%.
The end result is a cheaper, broader coverage, with expanded terms and from a more diverse panel of reinsurance capital providers.
Ultimately, Kliethermes explained that this allows RLI to hold onto more of its net premiums. He said that this reinsurance renewal “should increase our net premium retention approximately 2 points, which should allow us to continue our trend of better net premium growth relative to gross.”
That’s an important point. Even in this challenging market where percentage points are knocked off the underwriting side of the business due to softening and lower prices intelligent companies can use these trends to claw points back.
By taking advantage of the softer reinsurance market, the (super)abundance of reinsurance capital and likely also lower-cost alternative capital, RLI can lower its combined ratio a little with the increased premium retention.
Effectively, RLI is participating less, so retaining less of its reinsurance program, benefiting from expanded terms and conditions, while still enjoying lower pricing.
Kliethermes said; “We still receive premium and rate reductions overall for our Cat treaty, even after retaining less in those layers.”
This balancing act, of disciplined underwriting on the front side of the re/insurance business, with intelligent use of capital and reinsurance on the back side, can help companies to navigate this challenging re/insurance market environment more effectively.
Some of the reinsurance capital used by RLI may well have been that considered alternative capital, or from collateralized or ILS managers, however this is not clear. It’s certain that the insurer has sought out cheaper reinsurance capital though, in order to improve its financial outlook for 2015 and to save its own capital for other purposes.
“Fundamentally it was a question of using this cheaper capital that was coming in the market, making itself available, or using our own capital, and I believe we made the right decision,” Kliethermes said.
Where RLI is most affected by softening rates itself is in the wind (or hurricane) and earthquake insurance and reinsurance markets. Here RLI provides personal and commercial property covers, as well as some property facultative reinsurance covers. The rates in these markets are among some of the most affected and have caused RLI to give up some margin to compete on price.
Kliethermes explained; “In the wind and earthquake business we are having to give back sometimes double-digit decreases to remain competitive.”
However RLI relies on quality underwriting to differentiate itself, Kliethermes said, continuing; “It is a very competitive market and this is where underwriters can differentiate us. Knowing their niches, knowing the accounts where they can afford to give decreases and knowing when to walk away. We are fortunate to be in an oasis for rational underwriters, that have and will continue to make a difference.”
Michael Stone, President and COO, explained where the competition is coming from; “There is competition from all sources in this business. Certainly the alternatives are finding their way in. They’re partnering up with MGAs and other companies that are using that capital.”
This reflects the strategies being seen where large ILS managers are working with MGA’s to bring their capacity to the commercial and primary property insurance markets. By providing risk capital through MGA arrangements an ILS manager can help the MGA grow its share of the business, while bringing back returns for its investors.
RLI is clearly feeling the effects of this new capital entering these markets. Over time it is likely that the influence of ILS capital here will result in greater softening of these lines, perhaps pressuring some incumbents out of the most affected markets.
Stone was quick to suggest that it is not just alternative capital that is affecting these markets though, other traditional players also see opportunities to capitalise on these peak peril zone rates.
“But, you know, there is not a dearth of competition without the alternatives. So there is, the standard lines companies are moving in, plenty of specialists, including us in that space,” he said.
Memories may be too short, Stone suggested, as there hasn’t been a meaningful loss event in wind and earthquake markets for some time. However RLI still feels comfortable in these markets and continues to manage its exposures and tolerances, something that cheaper reinsurance capital assists with.
At some point the pricing may get too cheap, Stone continued, but this is where the reinsurance comes into play as its price declines as well, allowing RLI to continue working in these markets, which Stone said ultimately benefits the consumers.
Despite all this additional capital, both traditional and alternative, that is targeting the wind and quake markets, there has been no noticeable increase in demand, Kliethermes explained.
“I think our take-up rate is still about the same as what it’s been in commercial. I think it’s short of 10% of people buy earthquake coverage and I think it’s even less than that on the residential side,” he commented.
Then Kliethermes raised one issue that needs addressing, the fact that banks offer mortgage loans to homeowners without requiring them to take out earthquake coverage, “Unless the banker requires it, it doesn’t become a coverage that people think about.”
This is a huge issue in the U.S. insurance and mortgage market. A major earthquake in California would result in a huge burden on the government and taxes, as there is just not sufficient earthquake coverage in-force. Despite all the good work of insurers like the California Earthquake Authority, RLI and others, the premiums on earthquake property cover remain low, at 10% penetration or less.
In an ideal world mortgage lenders would mandate that those borrowing from them insure their homes for full-replacement in the event of a major quake, in the most earthquake prone regions. At the same time the lending banks should also protect their own balance-sheets, with covers such as parametric triggers a viable way to cover the banks from the most peak of events.
But that’s a topic for another day.
RLI Corp. shows that savvy use of lower-cost reinsurance capital, alongside disciplined underwriting, can provide a strategy to navigate the challenging market. This seems to be working for RLI so far, the question will be how it would perform when catastrophe losses bounce back to more average levels, or if price declines across many of its lines continue to soften.