Reinsurers exist because the future is uncertain. That hasn’t changed, but better solutions are always being developed. Just as the Stone Age did not end due to a lack of stones, so reinsurers must continuously question their role if they are to remain vital to their clients. What questions should we be asking?
People talk about a global insurance industry as if it were one entity, but is it that simple?
The insurance industry is a leverage play on economic development – mature where economies are mature (revenues track GDP growth figures) but growing faster where economies are growing (a combination of increased purchasing power and investment income from reserves). With the US, Europe and Japan currently representing approximately three quarters of global premiums, insurance is a mature industry with some growth prospects.
The industry has for-profit and not-for-profit participants, who are highly but fragmentally regulated. In many territories, the top five – ten companies represent over 50% of total premium placed, with a significant ‘fat tail’ of other companies. There are a handful of global insurers but most are local.
This structure and composition is important because it determines the differing needs and reinsurance buying patterns of the different players.
Will consumers and corporations continue to buy insurance?
Yes. Insurance is designed to spread risk and to help protect assets and wealth from loss. This hasn’t changed, nor will it. There will always be the threat and occurrence of natural catastrophes. Other risks, especially to do with casualty exposures, are always emerging, acting as continuing reminders of the need for protection.
Changing technology and regulation will affect how protection is bought, and the continued rise of emerging economies will shift where the premiums are spent, but insurance itself has a secure future.
Will insurers continue to buy reinsurance?
Yes, but buying patterns will change. In the old days the buying drivers were a lack of capital and bad information. Now insurance companies are bigger and better informed. ERM helps them expand their ‘predictable’ universe, which can then be retained, pushing reinsurers to assume greater volatility. The price of higher volatility business will therefore rise, either directly through rates or indirectly through credit risk factors in ERM models and regulatory changes.
Collectively reinsurers didn’t help ourselves during the last soft cycle: our ability (insolvencies/impairments) and willingness (increased arbitrations) to pay were questioned, affecting demand. While recoverable haircuts have a similar effect on demand today, we have done a better job of reminding everyone of our continuing importance. During the financial crisis, when capital markets and alternative structures were (temporarily) unavailable, we were open for business every day.
However, to thrive we cannot only be the last refuge during crises, or the cheapest choice. We must be the preferred choice at all times, who insurers know through long term relationships that they can turn to when they want expert, impartial, professional advice on their risk transfer profile and needs. Otherwise we are collectively doomed to be volatility buffers.
So what will drive reinsurance transactions?
Rating agencies will be the first word, not the last word, as insurers use ratings as the starting point for their own analysis. Due diligence on risk partners will become ever more a two way street.
For their part regulators will rely on greater capital buffers to achieve ‘never again’ certainty after the last financial crisis. This may drive short term reinsurance demand, but insurers will expand their capital base to retain attractive business and fuel their organic growth.
Brokers will become advisors more than market makers, ever more closely aligned with their client, and offering a range of fee services. Expect to see (re)insurance broking develop along the lines of other financial services – from full wealth management to discount broking.
What about the evolution of distribution and reinsurance hubs?
Bermuda exemplifies the innovation we’ve seen over the past 20 years. It is a huge reinsurance hub that has been built through a combination of entrepreneurial spirit and government support, including but not limited to low taxes. However, local jurisdictions want to keep capital and income locally, which will be reflected in regulatory and offshore tax changes. Rather than another Bermuda, expect to see regional hubs – somewhere in the UAE for Islamic compliant structured reinsurance, which is growing strongly, or perhaps Singapore for non-China, non-Japan, non-India Asian reinsurance business.
Will insurers cede their reinsurance more widely?
Despite declining choice insurers have reacted to specific issues and general security concerns by expanding their reinsurer panels. Meanwhile the reinsurer universe has been shrinking: Reinsurance Association of America membership has dropped from 120 in 1980 to around 20 today, while a number of reinsurers are owned by insurers. The purpose of reinsurance is to spread the peak risks, yet things are moving in the opposite direction, with risks reconsolidated into ever fewer buckets. This is one reason why capital market solutions will continue to have traction.
But reinsurers will continue to sell capacity, intellectual capital, solutions and/or advice. And in the land of ERM, data is king – so the reinsurer who brings the best analysis to the table, and backs it with capital support will win their clients’ continuing support.
What are the implications for the development of non-traditional reinsurance solutions?
While we must retain our ability to be the fastest and most flexible form of capital (with our one year treaties compared to debt or equity) we must also strive to be the smartest form of capital – the data driven partner of choice. Alternative instruments serve a purpose, and will continue to expand. However, reinsurance partners offer more than just capacity. They identify all needs.
They identify areas where demand and supply overlap and agree terms. They can advise on alternative structures and how best to use that component of risk transfer. It is much harder to tailor programs with alternative products.
Insurers have data that is mostly a mile deep, and a yard wide. Reinsurers have data that is a mile wide, and a yard deep. When we talk about providing solutions to changing needs, it lies here, in our complementary data sets.
Better data analysis will reveal previously unknown aggregated exposures, comparisons to (and differences with) peer groups, and opportunities to improve the risk/reward profile of the portfolio. Data sifting will spark the questions that will drive the decisions that will separate the winners from the pack going forward.
We will be limited only by access to data, and our willingness to experiment with the insights we develop and share.
How will reinsurers earn an adequate return?
Having almost an entire industry trading below book value may suggest the outside world doesn’t have much confidence in our collective prospects. More likely, it suggests that potential investors are discounting our returns at a higher level than we are currently delivering. As competition for capital intensifies, we must deliver favourable, consistent returns to attract it: being simple volatility buffers will not be enough.
The market will always move in cycles: loss events trigger price rises, the arrival of new capital triggers price falls. At least property rates are in a cycle. General casualty prices appear to assume no inflation, little exposure, and nothing likely to emerge as the next big threat. From asbestos to Fen-phen, from Enron to the internet bubble, casualty pricing has mirrored the stages of grief – denial, anger, bargaining, depression and acceptance. Yet casualty pricing has never quite made it to closure.
Does reinsurance have a future?
It is an unfortunate truth that it takes crises to remind people why we exist. We must do better at explaining what we bring to the table through good times as well as bad, and we must deliver the whole experience if we are to maintain demand for our products and services during those times when chaos is not reigning.
The future of our business lies in continued underwriting excellence, which means better data analysis. We must continue to integrate underwriting, actuarial, claims and risk analytics, from both retail and wholesale perspectives, into cohesive ERM/ECM insights. Only together can insurers and reinsurers develop and structure our portfolios. Only together can we be as smart as we need to be to survive the future.
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