The global reinsurance industry is in good financial shape, but that is just as well - it faces one of the most testing periods in its history. Here, some of the market’s leading minds discuss the six big challenges facing the industry - and what can be done about them.
1. The global economic downturn
Insurance premiums and investment income continue to fall, while the threat of government defaults plagues the industry.
“From an investor’s perspective, the reinsurance business is comparatively resilient in the face of a very tough macro environment. You can see that because profitability is still good. Share prices are not high, but they haven’t been crushed into the ground as has been the case with many of the life stocks and the banks.”
James Quin, PwC
“Most of our clients have been adopting a defensive underwriting policy for some years now, particularly in the PIIGS economies, where we are expecting to see losses. Everybody has been managing their exposure to financial institutions in those areas. Everybody has de-risked their investment portfolios since the economic collapse in 2008. But the problem there is that there has been a flight to sovereign debt. As we have seen, these are not risk-free investments.”
John Cavanagh, Willis Re
2. Death of the traditional pricing cycle
Historically, the market has been dependent on large catastrophes to move pricing. However, despite more than $100bn in catastrophe losses in 2011, overall rates have failed to rise significantly.
“Very seldom have we observed a true global upturn in pricing cycle, so to predict its death is a misnomer. Most often we see segment or regional changes, and this is as much the case today as in the past. However, when there is excess capital and two-digit combined ratios being reported, up-tick in the cycle is sluggish and we should not be surprised. It is quite another question whether the true cost of risk is being factored into premiums - I would argue that it is not.”
Clement Booth, Allianz
“There were signs in Q4 2011 and Q1 2012 of some hardening, which has since waned. But I don’t think the cycle has died; the situation is one of an abundance of capacity chasing a pool of business that is diminishing owing to economic conditions.”
Robert Hayne, UIB
3. Competition from capital markets
Capital markets have traditionally played in the upper layers of reinsurance and retrocession, but the 1 June renewals showed appetite for business further down the food chain, putting pressure on traditional reinsurers.
“Markets will find the most efficient way of trading risk. As an industry we have to sell more product. At Aon Benfield, we look to source risk transfer across the risk spectrum, provided it is offered by worthy counterparties and motivations are understood. Multi-year, tail risk cover from strong counterparties at competitive excess of loss multiples is by definition often helpful and necessary to clients.”
Dominic Christian, Aon
“The opportunity here is for traditional long-term reinsurance players who provide very large capacities with a strategic long-term perspective. They become the cornerstones of every cat programme, as clients know that they can and should never depend on the opportunistic cat bond capacity”
Christian Mumenthaler, Swiss Re
4. Modelling and measurement
Despite sophisticated modelling, the industry continues to get taken by surprise. In 2011 the Thai floods caught even the most seasoned professionals off-guard.
“Last year was an outstanding cat loss year - in terms of frequency, losses in non-core markets and unmodelled perils. Unknown concentration of values, unexpected loss contributors and unmodelled perils inflated exposure and caused negative surprises. Measures have been taken to handle some of these factors going forward, but unmodelled risk rightfully continues to create concerns. Those of us who have been around for a while started out managing our books using aggregates, and maybe that is where we need to go back to, at least in those areas where models are not yet stable or even non-existent.”
Amer Ahmed, Allianz
“No matter how good we are, there is an issue of serendipity. We are in an environment now where El Niño is in effect, and in theory that should keep hurricanes away from the Florida coast, which is probably most insurers’ biggest exposure. But it only takes one hurricane to blow that all away.”
Don Kramer, former Ariel Re
“The reason capital markets are so interesting for investors is because they are not correlated with other market risks and thus have a diversifying effect within an investment portfolio.” Torsten Jeworrek, Munich Re
5. Solvency II
The idea behind Solvency II is sound, but in reality the regulatory framework lacks clarity, suffers from uncertainty on equivalence and persistent delays, and saps management time.
“Solvency II, along with much of the regulation that has occurred in the UK, has fundamentally pushed us into being a non-competitive market, and the amount of money that we have all spent over the last few years and ongoing is phenomenal. That would be fine to a degree if everything was on a level playing field, but they are not.”
Toby Esser, Cooper Gay
“If Solvency II is really seen through, and we go to a uniform and acceptable regime with companies that have dealt with rating agencies on a regular basis, that is not a problem. If it goes beyond that, and we see it being used as a way of executing market protection type of activities or becoming much more involved in the way you sell insurance products, then that could be a much more challenging regime to work with.” David Cash, Endurance
“This is very much a movable feast, with talk now of a further delay. But ultimately this should bring more opportunities for reinsurance underwriters and brokers, as there could be more business around as a result.”
Robert Hayne, UIB
6. Reliance on financial ratings
Financial strength ratings have proven an overall imperfect measure, yet the industry cannot wean itself off them. They remain a deal maker or breaker and will continue to divide the industry for some time to come.
“When it comes to reinsurance, I personally think the biggest limiting factor for the use of financial strength ratings lies in the fact that some lines of business are very long term. Last year, for example, the oldest claim we paid was from the 1960s. So the question for buyers is not so much what the current rating of a reinsurer is, but rather whether that reinsurer will be around in 50 years.”
Alex Moczarski, Guy Carpenter
“The bond market clearly doesn’t move on rating actions. You can see that in the sovereign bond market where, since the USA was downgraded from triple-A, US bond yields have gone down. That is a sign that people can do their own analysis and come up with their own judgments. Anybody looking at reinsurance security purely through the lens of the published rating is not doing their job properly.”
James Quin, PwC