Allianz Re chief executive Amer Ahmed on how his reinsurer does things
Since the signing of the first reinsurance contract in 1370, reinsurers have played an essential role in the health of the insurance industry. Many primary insurers rely heavily on reinsurance capital as a major source of overall capital essential to their sustainable and efficient operation.
The importance of reinsurance is particularly evident when it comes to exposures to natural catastrophes. A recent World Meteorological Organization (WMO) report revealed ‘weather- and climate-related disasters have caused $2.4tn in economic losses and nearly 2 million deaths globally since 1971’. While only a portion of this total economic loss is insured, according to a 2012 report in the BIS Quarterly Review, ‘reinsurers usually bear 55–65% of insured losses when a large natural disaster occurs. Without reinsurance, it’s conceivable that the hurricane events of both 2005 and 2011 could have resulted in the insolvencies of some, if not many, primary insurers. But how do reinsurers protect themselves?
Retrocession, as reinsurance for reinsurers, has existed for as long as the reinsurance industry itself. The concept has come a long way from its beginnings as ‘an instrument only grudgingly utilised if the ceded risk was too large’. (The Value of Risk: Swiss Re and the History of Reinsurance; Borscheid, Gugerli and Straumann). In the 1920s and 30s reinsurers were reluctant to retrocede as it meant sharing both risk and profit, but now retrocession forms an essential part of reinsurance capital and volatility management plans.
This reluctance to cede risk and potential profit is now a growing trend within large insurance groups which are major clients of reinsurers. In the current economic climate, several factors are pinching at insurance companies and contributing to this:
- The OECD’s Global Insurance Market Trends 2013 lists global economic downturn, high unemployment rates in many areas of the world and heightened competition as some of the reasons the industry is ‘following a survival strategy’.
- Many of the larger groups have grown their geographical footprint which means they have more diversified portfolios and can retain more risk with the same capital base.
- Over recent years many insurers have taken a more enterprise view of risk rather than an individual line of business view - so where perhaps 15 years ago many reinsurance purchasing decisions were made by individual line underwriters these are now increasingly left to a reinsurance department
As a result of these developments reinsurance buying strategies across the industry are evolving. The Insurance Intellectual Capital Initiative (IICI) report Beyond borders: Charting the changing global reinsurance landscape highlights the shift as ‘Global and large regional cedants are centralising their reinsurance purchasing, with shifts in premium from local programmes to bundled global programmes and an increase in central retention’.
Allianz, among other global insurance companies, has done just that by consolidating and centralising its reinsurance buying, completing a group-wide initiative which began in 2004. Viewing our portfolio on a global level reveals an inherent risk diversification that significantly reduces the volatility management requirements from external reinsurance for the group. Our operating subsidiaries continue to need reinsurance for their local balance sheets which we manage by intragroup reinsurance.
The principle we use for reinsurance purchasing, both for our subsidiaries and for the group, is that the motivation and purpose should be clear. Essentially we consider three risk-driven purposes:
- protection for earnings volatility
- support for capital management
- provide an attractive economic trade
We view the first two purposes as strategic and core uses for reinsurance. The third is rather more transactional and driven by market conditions. With this framework we can assess the reinsurance needs for individual subsidiaries and provide the necessary reinsurance, based on the local risk appetite and capital position, within the group from Allianz Re. Then in turn we can judge the requirements for the group and buy retrocession from the external reinsurance market. This approach allows us to ensure the needs of local subsidiaries can be met but we optimise our reinsurance buying based on the group portfolio and risk appetite.
Another significant factor in the reinsurance market has been the growth of non-traditional or alternative reinsurance capital in the last decade or so. Scor reported that outstanding alternative capital was up from about $5bn in 2002 to $46bn in 2013. This, among other factors, led to the recent Moody’s downgrade of the reinsurance industry to negative.
But what does this really mean for the reinsurance industry? Is the net effect of these changes cause for concern? Will the current landscape alter in any real way?
There have been many studies looking at the impact alternative capital may have on traditional reinsurance. McKinsey & Co’s Could Third-Party capital transform the reinsurance markets? begins by looking at the growth of the third party industry: ‘Today, 16 percent of the approximately $300 billion in catastrophe reinsurance capacity worldwide is provided by third-party capital, up from 2 to 3 percent of the market in the late 1990s’.
While the figure has grown, this still places more than 80% of capacity with traditional reinsurers. The McKinsey report envisions 3 possible scenarios for the future of the markets: a peak and plateau at current levels; a scenario where third-party capital disrupts the status quo and grows to account for up to 35% of capacity; or the ‘dislocation’ scenario where third party capital accounts for, or exceeds, 40% of capacity.
However, the report also points out the potential issues with third party reinsurance capital: ‘[It] may not be as permanent as traditional capital. If the provider of third-party capital withdraws (or fails to reissue) due to a large catastrophic event or a more favourable interest rate environment, primary carriers will be compelled to turn back to traditional reinsurers to purchase protection—and they will do so with a weakened negotiating position’.
Perhaps Nick Hawkins summed up these reservations best. The CFO of Insurance Australia Group (IAG), which writes AUD$11bn in premium each year, was quoted as saying: “We worry about this new money that’s coming in and, yes, we do trade with it a little bit. But we don’t want to have some new best friends in a hedge fund that next year when interest rates go up decide they want to be a bond trader and not a reinsurer anymore.”
While Hawkins did go on to say the trust could be built up over time, he described IAG as “still very much a user of traditional reinsurers.” Similarly, of the risks Allianz reinsures or retrocedes the large majority is with traditional reinsurers. We do, and want to, have the full range of risk transfer tools and instruments available, including cat bonds and swaps, as this provides a range of providers, structures and durations for us to be able to access.
The traditional reinsurance market has continued to grow in parallel with third party. In their 2012 Global Insurance Market Report, the International Association of Insurance Supervisors (IAIS) made this statement: ‘In 2012/2013 the review of gross premiums written (GPW) by region of domicile shows that over the last five years GPW of selected large reinsurers have steadily grown from $157bn in 2007 to more than $180bn in 2011. This represents a 19% increase for the period and may be used as an estimate for the overall market growth’.
Munich Re’s 2014 Insurance Market Outlook envisaged continued growth for the reinsurance markets to 2020, in parallel with – albeit slower than – primary insurance growth, as penetration increases in emerging markets: ‘In the long term we expect real growth in global reinsurance to average just over 2% up to the year 2020’.
It is also important to look at what reinsurers provide to their clients beyond capital and volatility management. As Allianz made preparations to centralise reinsurance buying, it was critically important to both Allianz Re and our operating entities across the group that for intragroup reinsurance transactions a market price was maintained, and that the local operations would continue to benefit from the relationships, knowledge and expertise they had enjoyed with their key local and regional reinsurance partners.
We value the strong relationships we have with our core reinsurance partners - they provide deep expertise, knowledge and also vast data stores that can allow better product innovation – increasingly important in emerging markets and in the face of rising natcat exposures. So as our reinsurance buying strategies are changing to fit with the needs of Allianz, our relationships with our core reinsurance partners are also evolving … I expect the ceded volumes will be smaller, the ceded results probably will be more volatile and so likely more profitable over time - the relationships will be no less important than in the past, they will just be different.
Swiss Re’s Essential Guide to Reinsurance makes this summation: ‘Reinsurers have established a reputation as trusted advisors to the insurance industry, lending their support in pricing, product development, and geographic expansion…the reinsurers’ intellectual capital is an important complement to the financial strength they provide’.
This is something Allianz, and indeed every primary insurer, can ill afford to lose.