Thursday, 27 July 2017

Softening the blow

Xceedance EMEA head Justin Davies talks about the realities of a perpetually tough market

Not long ago, the accepted market wisdom was that insurance and reinsurance pricing moved in cycles. But the era of fairly predictable market cycles has expired, and few observers would bet on a return — certainly not in the form we have previously recognised.

The ongoing soft market is making life extremely tough for insurers and reinsurers. In Baden-Baden last month, there was a fair amount of — perhaps overly-optimistic — talk that the floor may have been reached in pricing, certainly in some lines of business. In its global reinsurance review this September, A.M. Best was more downbeat, maintaining its negative outlook for the sector for longer than its normal range of 12-18 months. It noted: “The market headwinds present significant longer-term challenges that industry players need to work through. The companies that are not proactive will not lead their own destiny. It is likely that several franchises that exist today will be sporting the logo of another brand by the time this soft market has run its full course.”

With rates squeezed and investment returns wafer thin, insurers and reinsurers have a number of options.

All insurers and reinsurers claim to focus on underwriting discipline and careful risk selection — that is to say, not writing premium just for the sake of volume, but conducting sophisticated analysis on all business opportunities and only writing those that will generate a decent return. The reality is different, of course. Many companies have been able to compensate for their poor underwriting performance by delivering healthy profits on the investment side. Yet, that cash cow has been drying up for years as historically low interest rates across the globe have made it extremely difficult to make a reasonable return on investments.

So what options do insurers and reinsurers have? Clearly, pushing up premium prices is not feasible. For example, in the soft market, cedants have come to expect cheap reinsurance, although in Baden-Baden there was plenty of talk from reinsurers about pushing back against unsustainably low prices and deteriorating terms and conditions. In fact, many reinsurers seem to have done a decent job at holding the line.

Weight on shoulders

 

With rates squeezed and investment returns wafer thin, insurers and reinsurers have a number of options. They can write more business to increase revenues. This entails developing more stringent underwriting controls and becoming much more focussed on managing risk. They can expand their channels, improve distribution and expand client services. Whilst a new raft of InsurTech options is being brought to the attention of senior decision makers, the reality suggests most companies are still hampered by legacy technology, which could take years to replace before substantive gains are realized. Inevitably then, organisations have been looking to cut costs and improve the efficiency of their business. But most have already refined their existing processes through countless iterations and are now squeezing the pips. The law of diminishing returns reigns supreme.

There has been proliferation of new MGAs in London as entrepreneurs see gaps in the market

Of course, running an insurance or reinsurance company is an expensive business. It involves a wide range of support services such as staff recruitment, personnel management, document storage, claims processing, IT support, and catastrophe modelling. In addition, London is one of the world’s most expensive cities with sky high office costs, the threat of increasing business rates and increasingly high wages.

Most companies in the London market seem to follow a standard operating model where 30-40% of staff are revenue generators, with 60-70% of employees supporting them. This looks like a very unbalanced and expensive business formula, particularly when margins are tight in a soft market and investment returns are so low.

As the insurance capital of the world, London has a well-earned reputation for innovation, demonstrating time after time that it can adapt to underwrite the rapidly-changing risks faced by businesses and the public sector. The latest of these challenges is cyber risk, and although the market is still in its early stages, I have no doubt that insurers in London are up to the task of creating robust cyber protection policies.

There has been proliferation of new MGAs in London as entrepreneurs see gaps in the market to provide the niche insurance products that our evolving economy requires. Refreshing as this is, I feel certain that even more companies would be opening up in London if the cost of business was not so high. Meanwhile, among businesses looking to reduce costs and increase efficiency, one interesting trend is to outsource some of their non-revenue generating functions to external business partners, and particularly to those with insurance expertise. High fixed costs associated with factors such as recruitment, training and office accommodations can be reduced. Partners can much more easily manage staffing up or down in response to market shifts. Also, leaner businesses can be nimble enough to quickly and cost effectively develop and launch new products in response to market opportunities. Indeed, one relatively new entrant in the London market took the view that it would retain as few non-revenue generating full time staff as possible locally — a strategy which has resulted in strong growth and profitability very early in the business cycle.

The soft market will be with us for the foreseeable future. It will be interesting to observe which insurance organisations are able to adapt effectively to this difficult trading environment. Some companies will need to innovate and transform like never before, in order to avoid the fate that A.M. Best warned about of being swallowed up by more profitable competitors.

Justin Davies is the London-based, EMEA Head of Region for Xceedance

 

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