The ILS Markets and Traditional Reinsurance
I recently sat on an industry panel that explored how the Insurance-Linked Securities (ILS) markets differ from, and influence, the traditional reinsurance market, and I thought I would share the summary of my discussion.
Starting with the impact on traditionalists, it’s pretty fair to say thus far the impact has depended on whether your core business is, for example, North American Hurricane Risk (in which case the impact has been significant) or Australian Workers’ Comp (much less so).
Having said that, it is impossible to ignore the broader impact of the capital that has been pouring into the reinsurance space.
The wider effect, of course, has been a much wider range of choices for buyers, resulting in a more competitive landscape - and not only in the North American Catastrophe insurance market. Among other intrinsic factors of the business, reinsurers that are squeezed out of their core markets go searching for opportunities in other parts of the world.
However, here's another little-talked about impact that the influx of money has had on the traditional reinsurance market: the amount of capital that has been repatriated by reinsurers.
Often-quoted, USD 55 billion of new capital has cumulatively entered the market over the past few years and has been grabbing headlines. Not often acknowledged, however, is the partial offset of share buybacks by listed reinsurers over the same period, which totals just over USD 35 billion. That’s mostly the reinsurers' response to the lack of opportunities they see in the market for deploying that capital profitably.
Are the professional reinsurers, drawing on their experience over many years of taking risk, aware of factors that the new money is not? Could it be that the traditional markets better understand the returns that the exposures demand?
When the main differences between the ILS markets and traditional markets are cited, they focus on the disparities in the cost of capital and targeted returns. But from a non-financial benefit viewpoint, there are probably two questions that insurance company clients consistently discuss.
The first is the sustainability of the new capital. Insurers, like reinsurers, are in the business of making promises to honor liabilities that could be incurred at some date in the future. As such, the stability and consistency of their capital (of which reinsurance is a defacto form) is paramount. As the New Zealand earthquake experience of 2010-2011 has shown, Cat is not necessarily a short-tail class. Other lines that are purportedly being targeted by the new capital, such as Casualty, can settle over decades, and so a reasonable question is: Do the time horizons of the investors match the liability duration of the insurance companies?
The other question on everyone’s lips in this regard is, where will the capital flow when interest rates, currently suppressed by central banks to artificially low levels, return to normalcy? While no one can predict the answer accurately and definitively, I think it’s a fair question. Since the reason for the capital entering the reinsurance market was a search for improved yield, it’s only reasonable to wonder what will happen when more attractive returns become available.
The other difference that is widely discussed is the issue of relationship. I don’t mean relationship in the sense of doing a deal over a nice bottle of red before adjourning to the bar.
Rather, relationship is the product of many years, sometimes decades, of two parties coming to understand each other.
From the traditional reinsurer perspective, a good relationship involves:
- A deep understanding of the buyer’s long-term strategy and its risk management and underwriting philosophies
- Local presence and knowledge of markets and exposures
- The resultant underwriting skill that's shared with the client
- Claims expertise assisting in settling complex or unusual claims
- Transparency and clarity in the transaction
At Gen Re we aim to be a consistent market, offering terms that are commensurate with the exposures that we assume. We believe this strategy sets us apart from those that ride the market up and down. We look to differentiate the Gen Re offering, such that our clients understand that the consistency we provide is important to the quality of their promise to their own clients, their relationships with their distributors and the ultimate insureds.
Research conducted by Artemis shows that relationship and all it encompasses is still considered important by insurers, especially by smaller insurers but also larger entities.
In summary, while the full impact of the new capital has not fully played out yet, the two models clearly have differences. Buyers confronted with all the options that are available should choose wisely, depending on both their short-term and long-term requirements.