The reinsurance business is changing rapidly. The walls separating insurance, banking, investment banking, and securities are crumbling. Those who grasp the opportunities change brings will be winners. Tal P. Piccione reports.
Consolidation continues to be the name of the game in the reinsurance market as merger mania grips the industry.
On the company side, the number of reinsurers reporting results to the Reinsurance Association of America (RAA) has shrunk to 38 from 149 in 1982 and 74 in 1989. On the brokerage side, the giants have gobbled up regional and smaller brokers that had been doing business successfully for generations.So, we ask ourselves: “Is bigger better?” On the company side, “maybe.” On the broker side, “not necessarily.” Larger reinsurance companies with more capital provide greater security as we see a continued “flight to quality.” However, a reinsurer does not require $500 million of capital to provide secure reinsurance. Between $250 and $500 million is completely adequate in the large majority of situations. The demand for excessive levels of capitalization is driven by the “haves” trying to keep the “have nots” out.
Consolidation of brokers into giant organizations has come in some cases at the expense of clients. The giants can be slow to respond to clients' needs in this challenging market. The few remaining independents who operate on a global scale like my company, U.S. RE, can be more nimble, more focused, and our top executives are often more readily available to clients. As consultants, we take a holistic approach to our clients' needs and offer solutions that range from conventional reinsurance to alternative risk products, to capital market solutions - all tailored to the protection and balance sheet requirements of the client company.
We expect the consolidation movement will continue, especially in the international arena. For both companies and reinsurance brokers the major focus of consolidation over the next few years will be among the mid-sized and smaller companies. Already, the top 12 reinsurers write about 60% of global reinsurance premium.
In the fiercely competitive - some say cutthroat - market of the last few years, mergers and acquisitions became a convenient substitute for organic growth. However, the benefits usually last only two or three years. After that, growth will depend on product innovation, the pricing climate, expertise, and professional service to clients.
A metamorphosis is taking place in the business of reinsurance. Survival of the fittest, not the fattest, will be the result as our business evolves in the new millennium. The lines between insurance, banking, investment banking, and securities will continue to blur. More competitors will enter our business as the wizards of Wall Street invent new products to securitize risk.
Winning companies and brokers will be those who expand their horizons beyond traditional reinsurance to participate in the convergence that is taking place in the markets. At U.S. RE we have become a financial services group of companies built on a solid foundation of reinsurance. Through the group we offer traditional and non-traditional reinsurance, multi-year finite products, captive and cell-rent-a-captive facilitation through our Bermuda companies, wholesaling and underwriting management, venture capital investments, asset management, and risk securitization through our subsidiary, U.S. RE Capital Markets, Inc. Our recent acquisition of a majority interest in AMG Quadrant, the marketing affiliate of Assurex International, gives U.S. RE a strategic relationship with the largest global network of independent insurance brokers. We believe this multi-faceted strategy will be the key to success.
After years of punishing competition that sent reinsurance prices down to the point of driving players out of the business, we're beginning to see some encouraging signs that the market may be turning. The inflow of capital and the lure of investment income created the longest running soft market on record. Some fear that premium generated at current price levels in some lines may not be enough to cover potential claims.
This concern, along with shareholders' demand for profits, may be bringing some realism back into the market.
The first signs of hardening are evident in the London retrocessional market. Over the last year traditional retrocessional capacity has shrunken significantly. This is already creating a strong market for alternative coverage. At U.S. RE for example, demand for our alternative retro product has doubled over the last year, rising from just over $250 million of aggregate limit to more than $500 million today.
We recently introduced a multi-year retro product to protect reinsurers in the 1999 hurricane season. It provides surplus relief to U.S. GAAP-filing companies in the year of a loss up to 70%. The loss can be amortized over four years. Most multi-year covers in today's market only offer a two-to-three year maximum spread. Demand for the product has been brisk.
A number of reinsurers are now also beginning to move into the finite risk arena. This is a precursor to a perceived tighter market with more realistic pricing. We also see indications of hardening in the primary market beginning with directors & officers and professional liability coverages. We also saw prices move up daily while placing coverage last July for companies writing Florida homeowners business.
Looking ahead to a tighter market, we've been advising our clients to buy multi-year catastrophe excess-of-loss protection at today's lower prices. We led the way in converting traditional 12-month programs to 36-month programs with a provision for cancellation by the client only. We're telling clients “the longer you can lock in pricing, the better.” The next major catastrophe could cause substantial withdrawal of capacity and sharply higher prices. Regulators look with favor on our multi-year products because they provide stability in the marketplace.
Prospects for a hard market with more realistic prices and improving profits may be lessened by the potential impact of risk securitization. In the current soft market, insurers with major catastrophe exposures can obtain protection through reinsurance at considerably less cost than in the capital markets. That's why we're seeing so few announcements of new deals. Multi-year, finite reinsurance can provide the same protection for less money than cat bonds right now. However, if reinsurance prices rise to the level where cat bonds can compete, the capital markets may become a major force.
Also, if recent experience is any guide, hard markets have a much shorter life span than soft markets. The prospect of improving profits will attract capital into the market and the cycle will turn once again. After Hurricane Andrew and the California quakes we witnessed a sharp reduction in capacity. Then investors came roaring back into the market. Bermuda became a world reinsurance center. Competition heated up and prices came down. We'll be surprised if the harder market lasts more than a couple of years.
So, what does all this mean for reinsurers and brokers? Perhaps most important, we must understand that our business is changing rapidly. While we expect the consolidation movement to continue, merger mania will die down. Independent brokers and niche companies will succeed by offering specialized expertise and responsiveness to clients. Those who grasp the opportunities change brings will be winners. Those who continue to do business in the conventional mode will fall by the wayside. We see a convergence of traditionally distinct financial services. The walls separating insurance, banking, investment banking, and securities are crumbling.
For those of us who were brought up in the reinsurance business, the changing environment means we must adapt. We must revise the way we do business. At U.S. RE for example, we approach our clients today not as reinsurance intermediaries but as strategic consultants. We study their exposures, their balance sheet requirements, and their need for asset protection. We consult with them to determine the right products to cover their risks. Solutions can range from traditional treaty and facultative reinsurance to multi-year finite protection, to various forms of alternative risk transfer, to capital market mechanisms. As consultants we work with the client to develop a strategic plan for risk protection but most importantly we have within our organization the expertise and facilities to implement all elements of the plan.
We believe the successful reinsurance companies and brokers in the future will be those who broaden their expertise to provide their clients with the full range of risk protection services available in the market from plain vanilla reinsurance to catastrophe bonds. This is the holistic approach we've been hearing so much about. We're convinced it's the wave of the future.
Tal P. Piccione is chairman and ceo of U.S. RE Companies, Inc.