Brokers are credited with bringing facultative reinsurance back from the brink, and technology and improved analysis are powering increased global trading at a more local level. Fac also helps buyers to take a more strategic view of their needs
Facultative reinsurance – also known as standalone reinsurance – has evolved from being a tool used simply to buy or sell a treaty book of business to being an important product in its own right. In both the property and casualty standalone markets, cedants are increasingly taking a more strategic approach to their decisions when buying reinsurance: they are blending the purchase of treaty books with single risk cover used to plug any gaps.
Treaty purchases still dominate but these are complemented by fac buying. As treaties have become larger and more global, it has allowed cedants to buy facultative reinsurance with more accuracy than before, thinks Aon Benfield fac chief executive Elliot Richardson.
He says: “In the past people would buy fac and it would overlap with treaty. There was too much wasted buying. Now they’re buying it to complement their treaty and to protect their net, and they’re doing it consistently.”
This increasing sophistication in reinsurance purchasing has resulted in a competitive facultative reinsurance class, featuring a growing number of players and markets, and a competitive broker scene. “It’s more competitive than I’ve seen it in my 20-odd years in the industry, and fac continues to be headline news. The fact you’re writing this article would not have happened ten years ago,” says Miller Insurance head of facultative reinsurance Mike Papworth.
Two for one
For some buyers of facultative reinsurance, the soft market might provide an opportunity to gain new business, potentially from those who do not typically purchase cover from the standalone market. Depending on the risk, facultative cover can be bought on a more cost-effective basis, thinks Papworth.
“Because there is oversupply of fac capacity at the moment, there has been the re-emergence of very specific or opportunistic fac-buying, whereby somebody is offering capacity that is out of sync with others,” he says. “The deal sells purely because it’s opportunistic and not necessarily because it fits in with their overall strategy.”
Nevertheless, he sees a continuing move towards more strategic purchasing. Facultative reinsurance has become very much part of the reinsurance-buying toolbox,” he says. “When you’re looking at how to protect your capital, you look at treaty and various alternatives. One of them will now certainly be fac. This has created a lot of interest from brokers because it’s potentially seen as a good business. Buyers like it because it’s seen as a quick solution to a short-term problem.”
It’s dynamic, it’s enjoyable
The growing involvement of the reinsurance-broking community in fac distribution has seen a massive investment in talent, with competition becoming increasingly fierce. Entire teams have been poached, resulting in expensive legal wrangles in 2006 and 2007. This was when 20 senior members of Benfield’s facultative solutions team – led by Elliot Richardson – left to join Aon. The move cost Aon £9.5m ($15.1m) to settle, but it went on to buy Benfield in December 2008. Following this, Guy Carpenter’s dedicated unit GCFac lost its fac team – including Ron Whyte and Julian Samengo-Turner – to Integro, which was looking to establish a new wholesale and facultative division.
The battle for talent in the fac arena highlights its growing importance, thinks Richardson. He says: “Some of the best people in the industry are working in the fac market because it’s dynamic; it’s enjoyable and because you’re able to trade regularly, whereas some other areas of the business have become a bit more commoditised.
“Over the last two or three years there have been a few investments in the area of the broker market from certain large brokers who had taken fac seriously a little bit late.
“One of the large brokers has seen a huge departure in terms of talent,” he says. “The problem is that a decade ago people weren’t investing in talent for the fac market, so it’s difficult to conjure up a group of people that don’t exist. We’re investing in young talent and making sure we train them well, give them a sense of purpose and make sure they become the next generation, because if fac continues where it’s going, just hiring from each other and paying more and more money isn’t the answer.”
He describes how the market has evolved: “A decade ago most people felt facultative was a dying or dead product. It was very much the frontier end of the business and, as a result, a lot of people overlooked it. It was still popular with the line underwriters but senior management didn’t like the lack of control and the execution risk.”
He credits the broking community with bringing fac back from the brink. “Brokers really started to eliminate the execution risk. We also embraced analytics and technology – things like the quality of data and information. At the same time, treaty business was going a lot more global and, as a result, people were having significant retentions on their net positions. This prompted underwriters to look at fac as a way of protecting their net positions.”
As the brokers attempt to gain more presence in the market, business that was previously placed directly is increasingly fair game. The market is worth about $22bn, with $8bn placed through the direct market. One way of accessing this business is through electronic placements, something that Aon Benfield is trying through its FAConnect platform, which has recently linked up with the Lloyd’s Exchange and seen its users grow to 350 in 10 months.
Role of the broker
Richardson says: “Historically the broker market has been very good on larger risks, the more distressed business or heavily cat-exposed business, but it has not been able to find a way of placing smaller premium business into the broker market efficiently.
“The only way to do that is to go the electronic route. What we’re trying to do is give something to clients and allow them to trade freely on markets they wouldn’t otherwise see.”
The role of the reinsurance broker has evolved with changing distribution channels, thinks GCFac head of international facultative reinsurance Massimo Reina. As emerging markets have grown and big-ticket risks have been increasingly retained within them – from large industrial, mining and energy risks, to property and engineering, and through to specialty liability risks – direct and facultative writers require a more global presence to benefit from local opportunities.
“Distribution is changing and developing – not just with the brokers but very much also for insurers and reinsurers – and in this very difficult climate we are seeing insurers and reinsurers opening offices nearer to their customer base. It is a trend to have overseas offices in places such as Zurich, Singapore, Hong Kong and Miami for Latin America. The role of the broker in this trend is very important ... it shortens the placement chain and reduces the cost of placement, ultimately to the benefit of the client.”
The USA is still the most important market for facultative reinsurance, followed by the UK and Europe. But it is dominated by longstanding players and has proved a difficult market to break into. Emerging markets, by contrast, are fertile ground and provide lucrative opportunities for early movers. This is illustrated by Chaucer’s recent decision to exit the US fac market while opening an office in Buenos Aires and expanding its fac presence in Singapore. “The established players are very well established in the USA,” says Miller’s Papworth. “They know what’s happening and the market isn’t growing. It’s very difficult to go in there new and make money, because the existing players dominate that world.”
The London market, with its concentrated expertise and reputation for covering distressed risks, remains a major centre for fac, with risks entering Lloyd’s and the company market from around the world. But fac is going global, and electronic placements and an international network of offices will allow the major fac players to maintain their access to the business.
“We could place a US account in India nowadays – the market’s becoming more global and there is no one-size-fits-all approach to facultative,” says Richardson. “People are looking at writing business from wherever they’re based, and we need to make sure we’re there so we can place that business. Ideally face-to-face and then using the markets around the world to bring it alive 24 hours a day using the technology on the smaller business.”
The BRIC countries (Brazil, Russia, India and China) are proving increasingly popular for (re)insurers looking to diversify their portfolios geographically – a general trend among (re)insurers in recent years. The opening of the reinsurance markets in Brazil and China has seen rapid double-digit premium growth, and the influx of international (re)insurance companies wanting to establish a presence. Much of the focus in these markets is on providing facultative cover for risks that are too big to be placed in the local markets.
“Where the opportunities perhaps lie is somewhere like Latin America where 50% or more of the ceded reinsurance premium is written on a fac basis – clearly this would imply that there are more opportunities,” says Papworth. “The caveat is that while a mature market like the the US is saturated you must remember that they represent about 50% of global reinsurance premium. Latin America, despite all the inherent opportunities, is still less than 7% of global premiums. So if you’re basing your global fac strategy on less than 7% of the global premiums, of which half of that is fac, then you’re not ever going to make a huge difference to your revenue base.”
An essential purchase
There may be fewer opportunities for straight arbitrage, but fac is still an essential purchase, says Reina. “There are still some opportunities to arbitrage, but maybe not as many as we’ve seen as the past. But that’s not the only reason people buy facultative anymore – it depends on the class of business. In the past facultative reinsurance and treaty reinsurance were handled very much separately, but this is changing very quickly and we’re making increased use of analytics to find the best solution for our clients: whether that’s facultative reinsurance, treaty reinsurance or both.”
Reina thinks there are various drivers to a more tactical reinsurance purchase, including better treaty protection. “It’s partly driven by increased retentions – this is having an important effect on the purchase of facultative reinsurance and on a desire to protect the treaties – to safeguard the treaties from losses that are a little bit different from expected losses.
“I think that reinsurance is still considered by the buyers to be an expensive commodity. They want to make sure losses that can be reinsured by facultative reinsurance don’t go into the treaties, because this will result in an increased cost of reinsurance for them.” GR