Convergence is a popular buzzword in reinsurance right now. It’s usually used in connection with the capital markets involvement in the sector. But actually there is a convergence of many different macro forces happening and it is shaping the future of reinsurance. Are you ready for it?
Capital markets competition.
You can’t beat them, you can either join them or wait to see if they lose interest (no pun intended). We heard at the big industry meetings how ILS is bearing down on catXL prices in Florida and that this signifies a coming of age. The third quarter of 2013 saw issuance of $1.4bn of non-life catastrophe bond capacity, which is the highest on record since 1998; if fourth quarter issuance is similar to that of recent years, the market will record its highest-ever issuance, surpassing the record set in 2007 of $7.2 billion. Some commentators believe this activity is a bubble that will deflate when interest rates rise. Everyone knows that ILS is here to stay however, so you have to either invest in the intellectual capital and ‘technology’ and offer ILS as a solution and/or emphasise the advantages of tailored protection, reinstatement and continuity in the traditional catXL offering.
Increasing retentions among cedants.
With the big multinational insurance groups really pushing the trend, insurers are buying less reinsurance in the working layers from fewer reinsurers. They are also centralising purchasing rather leaving LOBs or business units to do it. In Baden-Baden last month Allianz Re’s Amer Ahmed told me that assumed reinsurance from the group is growing all the time – and that is a reflection of an industry wide trend. Some reinsurers approve of this trend if it plays to their strengths as diversified cat reinsurers. Others see that they have to grow through diversification into new lines or new geographies to replace lost business. In some cases that means increasing knowhow in specialty risk exposures; for most cases it means engaging with the high growth economies of Asia and Latin America.
This is a double edged sword for reinsurers perhaps. While the cost of compliance is sapping resources at many reinsurers, it’s arguably worse for customer facing direct insurers, especially smaller ones. But the renewed emphasis placed on capital risk management and solvency by Solvency II and equivalent regimes should play to the role of reinsurance. It is perhaps surprising how little reinsurance companies and brokers are promoting their intellectual and capital resources in this area when so many insurers find it quite so challenging. Practically, tougher solvency rules around the world could increase demand for more stop-loss, multi-year, multi-line tailored reinsurance protections.
OK, this year has been relatively quiet for reinsurers, unless you were disproportionately exposed to Canada or Germany. But the reality is that losses from cat events are growing more frequent and more severe. Globally, losses have grown since 1980 as severe weather events have tripled over the period. Linked to increasing retentions among cedants, it means that peak risks are higher up the agenda for CFOs and CROs. Policymakers and politicians too. This is the convergence area where capital markets, solvency regulation and public/private partnership meet. Reinsurers that have the modelling capability, capacity and diversification to smooth out volatility can do well: diversification may be the hard bit.
Climate change or terrorism? Take your pick. Both are shaping up to be incredibly expensive for society and insurers. But the reinsurance industry can, and is beginning to do more than just stand on the sidelines. Again, public/private partnership might be where reinsurers can contribute and find opportunities that don’t leave them too exposed. But disaster pool solutions need more design work and that requires reinsurers to get engaged through more positive lobbying of the sort done by the Geneva Association. On terrorism, the industry is doing a good job making a case to Congress on Tria renewal, but it’s not a done deal. If the backstop is removed, insurers and reinsurers of risks in the US are going to have to radically rethink their approach, especially around sky’s the limit NCBR. Think about the Oklahoma City bombing and 9/11 and then add in a “weapon of mass disruption” such as a “dirty” bomb.
The ECB just cut the benchmark interest rate to a record 0.25%. Before long we’ll be paying the banks to hold our money. Is the low interest rate environment a challenge or is it simply the new status quo? Either way, adaptation is tough because reinsurers are hobbled in their choices by the natural need to match liabilities and to comply with solvency rule requirements. Nevertheless, some portfolio adjustment is necessary to put more emphasis on alternative investment classes. There might even be more attention paid by reinsurers to non-financial assets such as property and infrastructure. Doesn’t it make sense for reinsurers to finance and protect projects, designed to be resilient and sustainable?
Corporate risk innovation.
The popular opinion seems to be that the insurance business is failing multinational corporations and can’t get its head around the enterprise risks that concern them. Reinsurers have an opportunity here to partner with business insurers on projects (see what’s already being done in renewable energy) or on intangible risk solutions. The problem for reinsurers is not alienating direct insurers – they’re already alienating you. The problem is in persuading corporate risk managers they need to actually pay to transfer the risks they say they are so worried about.