Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Survival – it’s all about the value you bring to the chain


At this time of year, as peak-conference season begins, the market tends to reflect on conditions and the drivers setting up dynamics for year-end and beyond.

Reinsurance market value chainIt’s not surprising that we look ahead to another January reinsurance renewal season that is certain to be intriguing and competitive, given where the market dynamic currently sits.

This year one factor has become increasingly clear.

It’s vital to be able to identify the value you bring to the risk-to-capital chain and to be able to monetise it effectively.

Five years of successive reinsurance price declines were followed by only a brief hiatus, after the 2017 catastrophes demonstrated that the losses, while large, would not resurrect the reinsurance market cycle of the past.

The explosion and continued growth of alternative capital and Insurance-linked securities (ILS), as well as the growing innovation and disruption presented by start-ups and InsurTech strategies, have ensured that conditions are now challenging for many re/insurance market participants.

There is constant discussion in the market on how best to find new underwriting opportunities, narrow protection gaps, put your money behind emerging risk pools, break into cyber risk and emerging business lines, leverage third-party capital, or transform and transition a legacy re/insurance model into a digital and technology led business fit for the future.

All of this is well and good, valuable initiatives and potentially helpful to traditional re/insurer longevity.

But what incumbents really need to do and fast, is identify the value they bring to the market chain of risk-to-capital.

At its essence, insurance and reinsurance is about risk transfer.

Shifting risks to those who can better afford to bear them, and as a result diversifying risks globally to add capital efficiency. This core service offering remains invaluable to society today.

But while the core tenet of insurance and reinsurance remains invaluable, that’s not to say it has to be delivered in the same way it was decades ago.

Neither does it mean that you can charge the same costs for it, when efficiencies are flooding into the business model and transferring or placing risks is much simpler and becoming less a human endeavour than in the past.

In fact the market is becoming so competitive now and changing so fast that earning a crust, or enough return to cover cost-of-capital, by solely delivering on the core service of a re/insurer, is increasingly a challenge.

This challenge is only going to get more difficult.

There’s no sign of things easing so far and in fact the ability to charge what you used to for the services that you’ve offered for decades, may only become less viable as a strategy for going forwards.

There is a path along which risk passes to be matched with the capital that’s keen and able to hold or bear it.

This is the risk-to-capital value-chain, which is now so often discussed.

The risk should be matched with the right capital of course, the one that has the appetite and duration that matches the risk, the ability to absorb it, diversify it, hold it (in future trade it) and of course the liquidity to pay out when the worst happens.

The routes along which you (and the risk) can travel to achieve this matching of risk and capital are many and increasingly varied.

In fact while the ways of achieving risk issuance and transfer are increasing, they are also becoming more direct as well with fewer intermediary steps required.

The capital markets and insurance-linked securities (ILS) funds have led this evolution, along with the largest reinsurers in the game.

Now InsurTech promises to take this a step further.

As the technologically enhanced ability to analyse, understand, structure, price, underwrite, issue and trade or transfer risk, means it can pass through much fewer layers of intermediation and underwriting.

It means technology is going to replace steps in the value chain, from origination, structuring and issuance of an original risk, to the final diversification of it out into secondary, tertiary and onwards retro and capital markets.

Which when paired with the disruptive forces that are bringing capital structures closer to sources of risk as well, means increasing pressure for traditional business models.

Financial technology, as in the structures used to wrap up, issue and house risk, is also playing a role here.

With securitisation and capital market techniques offering new ways to aggregate and pool risk, to allow capital to attach to and absorb it efficiently (all for the payment of the proper return of course).

More efficient capital flows, which are seen globally as the fungibility of money has generally increased, have enabled risk to become an asset class in its own right, ultimately lowering the cost of protection and risk transfer.

In essence, the re/insurance market is becoming more advanced and technology driven, at a time when capital cost has decreased (largely thanks to ILS and alternative investors) putting the focus on margins and efficiency once again.

Largely, all the value-chain disruption we currently hear talked about is the removal of layers of intermediation and more direct connection to risk to capital, better margins and less waste being a key driver.

But is efficiency enough on its own, or is trying to increase efficiency even the best (only) strategy anymore?

It’s certainly one response to the challenges that re/insurers face.

Even the ILS fund managers, with their lower cost-of-capital and third-party investors, are having to look to efficiency (or scale and reach) right now.

Nobody is insulated or immune anymore.

But efficiency doesn’t even matter if you’re not focused on monetising the value (and expertise) you bring to the chain.

Getting paid for the value you bring to the risk-to-capital value chain is going to be the challenge of the next decade (or more) for re/insurers and everyone else involved in the transfer of risks.

Too many cooks is a phrase that comes to mind when looking at the insurance and reinsurance market value-chain right now.

Repetition of roles and responsibilities.

Huge companies are in some cases charging huge amounts for tasks that will be commoditised or cut out of the chain entirely by technology.

While increasingly efficient risk capital (and abundant access to it) will mean liquidity of risk trading rises as well.

No longer is the balance-sheet the best or only place to store risks and no longer is the equity investor the best backer.

No longer is a broker always needed or desired either (at least not in the way this market is used to).

The world’s a much smaller place with the way we communicate and trade today. Expect relationships to be direct, or increasingly platform based.

Getting in the middle of the chain staking a claim to your position in it and charging for it may not be as easy as it has historically been.

It’s all changing (to the chagrin of some in reinsurance) and this change is still in its infancy, we believe.

Expect further evolution of the risk transfer market paradigm as things begin to accelerate from here on in.

So, how to survive in a market where it feels like you need to be the biggest but in reality you may actually just need to be the best at what you do?

Here we mean the best at something that adds value to the chain, without adding expense or making the transfer of risk less efficient.

The best source of capacity, efficient, deep, elastic or however that is measured. The best at structuring risks. The best at trading risks. The best platform for risk issuance and transfer. The best way to pool risks. The best risk syndication channel or marketplace. The best at analysing risk. The best at pricing it. The best at holding onto it. Or importantly the best at finding risk in the first place and introducing it to the market.

So many roles exist in the value-chain and it’s time to identify what yours is and ensure you’re able to get paid for it.

Operating in multiple places in the chain may also be possible, at least for the biggest reinsurance and globally diversified re/insurance firms.

But even these industry giants can’t expect to replicate or own the insurance risk-to-capital value chain anymore.

They too will have to recognise where others can do things better, finding ways to add efficiency to their own business models as well.

There’s not much else to it.

The value-chain is about bringing together risk with the most appropriate capital.

That needs people and companies to make it happen, but only those that are essential to complete the chain in the most direct and efficient manner.

This market is on a constant course towards increased efficiency as well, so expect the value chain to continually adjust, meaning agility and flexibility will also be key.

In simple economic terms this is what the Internet era did to many industries.

Wholesale change occurred and it created a need to demonstrate true value and get closer to the customer, while making use of increasingly abundant data to drive intelligent decision-making as well.

If you have value and can demonstrate it, under the emerging re/insurance market paradigm of the risk-to-capital value-chain of the future, then you should be ok.

But ultimately you need to make sure you get paid for it and can sustain your business on the financial returns an open, fairer and more efficient market sets.

If you can’t demonstrate any significant value in your position in the chain, it’s only going to get tougher and tougher from here on in.

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