The role of the re/insurer has evolved in recent years from that of pure risk taker to a provider of financial and risk management services. In the future, re/insurers will provide value-added services and become trustworthy partners with their clients only if they are able to extend their capabilities in integrated capital and risk management, and market them as corporate finance instruments.

Currently, these instruments are often referred to as alternative risk transfer (ART) products. However, the term ART is very often used to characterise alternative risk carriers, the inclusion of non-insurable risks in a coverage or the securitisation of risks to the capital markets. In other words, ART has become a term for all kinds of product- and technique-related aspects of a client solution. For this reason, Swiss Re New Markets has developed a new meaning for ART - the “Alternative Reinsurer's Toolkit” - which is geared towards supporting the client from a corporate finance perspective. The objective is to offer financial and risk management instruments for the customers' benefit over the entire life cycle of its business.

Let's take a look at today's characteristics of the insurance business. Insurers (both stock companies and mutuals) are confronted with challenges on many fronts. In the past, there have been different re-positioning patterns and demutualisation of European market players.

Among the trends are:

  • several players exiting the saturated non-life insurance markets and buying into more promising life insurance businesses and/or acquiring asset management franchises in order to stay on track for growth;

  • other insurers retaining only their non-life operations and accelerating their efforts to improve the size and quality of their risk portfolios in order to achieve their operational performance goals;

  • a few market players positioning themselves as financial service providers by adding banking facilities to their franchises; and

  • many companies initiating expensive e-business and e-commerce strategies to improve their efficiency and/or enhance their distribution networks.

    The run towards life insurance in Europe can be shown through a compound annual growth rate of life premium income of 8.9% compared to a modest 3.1% for non-life business1. During the same period, corporate restructuring through M&A activity2 resulted in 33 to 50 deals each year.

    At the moment, the capital markets clearly prefer insurers with a strong growth track record in life business and compelling e-commerce strategies with clear steps for implementation. Investors and rating agencies have been closely watching the continuous deterioration of operational performance, i.e. the weakening of the combined ratio in non-life operations. Market players that do not show rapid improvements in these areas will face continuous erosion of their share prices. Mutual companies, on the other hand, react when policyholders express concerns about the prospects and the security of their franchises in similar terms.

    Considering these market dynamics and the continuous competitive pressures in all industries worldwide, corporates and insurers more often require a long-term partnership with their re/insurers. A re/insurer must be able to offer advice and instruments in financial and risk management over the client's entire life cycle, including:

  • demutualisation and subsequent support in capitalisation and protection of the P&L account;

  • strategic partnership with (minority) shareholding, such as during a start-up phase;

  • acquisitions and divestitures of business entities, certain product segments or client portfolios; and

  • improvement and stabilisation of operational performance and financial strength.

    By applying corporate finance-driven instruments, the customer can influence its financial and risk position in a favourable manner:

  • earnings per share growth stability and volatility;

  • hybrid equity financing and impact on return on equity;

  • creditworthiness through capital provided by a financially very strong (for example, ‘AAA' rated) reinsurer;

  • risk-adjusted capitalisation reflecting the company's total risk profile;

  • debt service capability and interest coverage ratio;

  • protection of P&L statements of start-up operations or acquired companies;

  • ring-fence liabilities of legal entities to be divested;

  • avoid over-hedging through integrated risk management solutions covering hazard, financial market and credit risks; and

  • secure a sound track record in operational performance and efficiency.

    In order to deliver such state-of-the-art advice and solutions to corporations, the alternative re/insurer's toolkit must embrace value propositions in the following areas of interest. This example shows the requirement for insurance companies:

    1. re/insurers must be in a position to partner with a client to explore new pathways in strategic co-operation. This may include, for example, taking a minority stake (capital injection) in an insurer which wants to leverage its capital base to fund further acquisitions or distribution channels;

    2. with the strong performance of the financial markets over the past three years and the subsequent gains in value of insurers' assets, insurers' concerns have increasingly moved away from natural catastrophe risks towards hedging strategies and asset-liability management of investment portfolios. Therefore, the alternative reinsurer's toolkit must contain analysis tools and solutions in order to provide an integrated view of clients' total risk profile and the resulting volatility of earnings and downside risk;

    3. taking this holistic perspective, the insurer is in a much better position to consider alternative strategic moves and their impact on key parameters such as capitalisation, bottom-line growth and volatility as well as risk diversification. In particular, the insurer can decide on asset allocation taking into account the term structure of its liabilities, which is of particularly high importance to life insurers (asset-liability management);

    4. such innovative financial models capture all financial, credit and hazard risks an insurer faces, both on the asset and liability side of the balance sheet as well as off-balance sheet risks (e.g. hidden reserves, reinsurance). This comprehensive view enables companies to eliminate over-hedging of risks and benefit from the low correlation (independence to a very large extent) between man-made and natural catastrophes on the one hand, and financial market risks (such as interest rate movements and stock market fluctuations) on the other. As a result, insurers reduce their overall downside risk in the most cost-efficient fashion; and

    5. finally, insurers can optimise their capital base and debt/equity ratio in an integrated fashion. Effective protection against the company's downside risk is provided, and the scope and trigger point of the protection is structured to match the client's risk appetite and capital strength. Furthermore, additional capital funds can be raised to optimise the company's capital structure, financial leverage and total costs of capital. These decisions will finally show in the insurer's financial strength, creditworthiness and security, which are monitored by rating agencies and regulators.

    In order to provide the above value propositions, the professional re/insurer of the future must understand the different risk categories, the interactions between them, the impact of these on downside risk and capitalisation, effects of risk aggregation and diversification, and the resulting volatility of earnings. Furthermore, it is of great importance to have strong insight as to the way investors, rating agencies and regulators tend to assess organisations and insurers. And finally, in order to be considered a trustworthy partner for a long-term period, the professional re/insurer needs to offer superior financial strength and security towards its clients.

    The availability of professional advice and solutions in finance and risk management are of vital importance to every corporation over the entire life cycle of its enterprise. With a toolkit of the above kind in his hands, the “alternative” re/insurer will find itself in an excellent position to partner up with clients in a way that will allow both parties to secure their competitiveness in a challenging marketplace over time.

    John Decker is an associate director in global marketing for Swiss Reinsurance Co, Zurich.

    1 1995-99, Swiss Re analysis

    2 Fox-Pitt, Kelton, M&A Monthly, Swiss Re Economic Research & Consulting.

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