What buyers really want

In attendance

Marc Beckers, head of Aon Benfield ReSolutions EMEA, managing director, Aon Benfield Securities

Johannes Bender, director of financial services ratings, insurance lead analyst, S&P Global Ratings

Johannes Martin Hartmann, chairman of the board of directors, VIG Re

Arno Junke, CEO, Deutsche Rück

Jens-Ulrich Peter, managing director, head of property underwriting EMEA, Swiss Re

Massimo Reina, CEO of Continental Europe and MENA, Guy Carpenter

How has the landscape for buyers changed in recent years?

Johannes Bender: A good place to start is the level of capital in the industry, which explains other developments in the market. In 2015, levels of traditional capital fell for the first time since 2008, and this happened without a large loss, which is somewhat extraordinary. In other years, such as 2002 and 2008, it has fallen—mainly driven by severe losses.

In 2015 capital has gone down but on the other hand capital adequacy—according to our measures—remained at the triple-A level for the entire industry, for all the companies we rate, which is a high buffer.

In 2015, the cushion was $26 billion of excess capital keeping the industry at the level of triple A, so there is a huge buffer the industry is currently carrying.

One example of the strength of the industry’s capital was when Hurricane Matthew hit in October. Even if Hurricane Matthew had been a 100-year loss event—so much more severe than Hurricane Katrina—this triple-A category would have remained.

When looking at alternative capital the story is a little different. In 2015 we still saw an influx of capital and Aon Benfield published a number of $72 billion of alternative capital—a record level. So there was still an influx, in stark contrast to the stagnation of capital on the traditional side.

This influx has come down in 2016. We have significant lower issuance of insurance-linked securities (ILS) compared to 2015. So far it’s around $5 billion compared with $7 to $8 billion in 2015.

That does not include structures such as hedge fund reinsurers. Their business model has difficulties both on the traditional side and with regard to the investment environment. But still, they are also creating overall pressure on the capital side.

All this capital explains the pressure we have on pricing and gives a picture of the options reinsurance buyers now have in the industry.

Massimo Reina: On the reinsurance side we are seeing some development of new, innovative products. Even in a traditional market such as Europe, buyers are becoming much more acquainted with these types of transactions and they are using reinsurance in a different way from the past.

Previously, reinsurance was mainly used as a form of P&L protection, as a means of capital preservation, or to manage capital more efficiently. Now, we are looking at these deals with a view to creating value and to enhance performance.

We are seeing a lot of different transactions, on the life side and on the non-life side, although probably not on the same scale as the US, but there is definitely an increasing trend.

Marc Beckers: I’m disappointed with the level of innovation we see in the industry. There is a lot of struggle going on but change is mainly driven by regulatory changes rather than reinsurers being innovative and coming up with new ideas.

It’s this regulatory change that is now driving new types of capital relief that we didn’t have previously. This form of innovation is simply a consequence of regulators being a lot more demanding than they used to be.

The regulator needs to be open to a discussion and thinking about what the commercial benefits would be and about what is really best for the industry to help innovation.

In my opinion, the current capital regulation doesn’t really help innovation. Maybe reinsurers in equivalent jurisdictions are better positioned to be a little innovative. We do see new products coming along, but most of them are driven by new regulations or by the changing state of the world, for example cyber covers.

Do buyers want a different relationship with their reinsurers?

Jens-Ulrich Peter: Clients are becoming more and more sophisticated in their reinsurance buying—most now have tiered reinsurance panels. As far as their tier 1 reinsurers are concerned, they expect much more than pure risk transfer, pure P&L protection. They want us to look at all their risks together in a much more holistic way, considering everything from earnings to volatility management, capital management, and capital reliefs under Solvency II, for example.

It is increasingly important for us to help them execute their strategies, and also help them to achieve their growth targets. In this respect, reinsurers could be more innovative in supporting clients and executing their strategy. Arno Junke: We have also seen a partitioning the reinsurance supply, with tier 1 and tier 2 reinsurers. But it is important to stress that reinsurance buyers are far from being homogenous. You have different segments. There are the very experienced, very savvy buyers of reinsurance capacity. Mostly these are very large international organisations which have a totally different view about what reinsurance is and can be used for.

They are the ones—because of their wealth of their talent—which have the ability to strategically test the water on innovation.

Then you have smaller buyers, who are a little bit more removed from these sorts of ideas. A mid-sized or small mutual company somewhere in Europe certainly has different requirements from those of a big international organisation.

We tend to leave that outside the equation during discussions. We tend to focus on innovations and assume that these innovations would serve the whole reinsurance buyers’ market, which is not necessarily true.

It’s more a case of horses for courses. There are some that are very keen on experimenting, because maybe they’re driven by their shareholders. The others just want ‘hassle-free reinsurance’—no bells and whistles attached, keep it simple. Part of the job of the reinsurer is to identify these different sorts of demands and make a very learned decision on how to choose one’s own playing field.

Johannes Martin Hartmann: If you look for innovation, three areas are setting the scene. First, the factors driving capital into the industry and the relative attractiveness of our industry to other industries in the low-interest rate environment.

The low interest environment is ultimately not really the problem for us, because it’s known and we expect this to continue for the next few years.

Second, the regulatory side is creating much more concerns and some of these moves are not really predictable. It’s not only Solvency II and IFRS 2, it’s also consumer protection and many other areas. On the other hand it is regulatory changes that are nowadays the main driver for innovation in our industry.

Finally, technology is changing our society, and the pace of these changes is unprecedented. This is really the underlying game and this will drive the real innovation also in our industry. The risk landscape of the future will be very different. Nevertheless, our industry is lagging far behind in adopting these changes and understanding how to turn this into business opportunities. It is obvious that initially we will see the distribution model of insurance companies being impacted as well as data processing.

As to how this will impact the relationship with reinsurers, indeed only a few reinsurers have the capacity to accompany insurance companies on that innovation journey. It’s true that the large international groups are in general more sophisticated buyers, which make very informed decisions to use reinsurance to increase capital efficiency. For VIG, capital efficiency matters, but it’s not the main driver. What really matters for us is predictability on our underwriting results and a need for mitigating the underwriting volatility.

The current buyer-friendly market not only allows us to optimise value for money, but provides us also with the opportunity to pick and choose our partners and to optimise our reinsurance panel. We prefer to partner with reinsurers that will produce long-term value for us. This is what we are looking for.

So far we don’t engage directly in alternative capital, although some of our providers use alternative capital as an instrument. The reason we are currently not using ILS or collateral solutions is that the transaction costs of alternative solutions are still too high, as well as a couple of other disadvantages. Can we rely on this capital in five to 20 years?

How does the innovation that is happening influence growth?

Bender: That ties in with the relevance of companies. If the industry innovates enough to catch up with the long-term trends of societies, such as the protection gap and the development of primary insurance companies, growth is possible. Europe is probably one example of where there is still a lot of room for reinsurance companies to grow. But if reinsurers want to further penetrate these markets, they need to innovate.

Look at the topic of cyber risk: is the reinsurance industry helping to capture the risk from an insurance perspective? There are examples of where the industry has been innovative in short-term trends, and has been delivering capacity when needed. And an example on regulation has been mentioned, Solvency II is probably one growing example where opportunities for the reinsurance sector have risen very quickly.

If you look at UK longevity business, it’s hugely reinsured and reinsurers are helping the primary writers to write business. Looking at Germany, it’s not entirely related to Solvency II but the reserving requirements is one additional burden for the primary writers in Germany. So far it hasn’t hugely been financed by reinsurers but that could be potential.

A reinsurance company could play an important role in protecting the industry from financing this regulatory need. There are examples where the industry has been innovative in the short term, and in the long term, answers have to be given for the long-term trends, such as for the protection gap and cyber.

Beckers: The interesting aspect is that when you look at insurance companies, the innovation has to come from both sides. You can’t just expect the reinsurer to innovate if nobody’s asking for it.

There needs to be a bit of alignment between what an insurer’s needs are, and who they’re going to go to, and what the reinsurer can offer.

Are reinsurers still able to experiment with new products? Are they able to say “look, we’re going to try and test it out and see how it works out”? My fear is that in today’s environment, that’s no longer allowed.

From an accounting perspective, there used to be something called an equalisation reserve. It was a very simple concept but it allowed companies to experiment and think long term.

Sometimes it goes well, sometimes not. But the trend now is to push everybody to the short term. How is it possible today to be as innovative as perhaps insurers and reinsurers want to be?

Insurers are also struggling with regulation, which is on the consumer side as well as on the capital side, but on top of that you have all this technology. You sit with the existing teams that perhaps don’t have the same depth of talent as the Googles and the Apples of this world, so how do you tackle all of that? How do you have time to focus on thinking about innovation?

Even though I said that I don’t necessarily see as much innovation as I would like to, I don’t think it’s so simple to get that innovation in there because there are a load of roadblocks in front of us, which make it very hard for us to be innovative as an industry.

My fear is, where is the industry going to be in 10 years’ time? We cannot look ahead more than five years in time today—10 years ago there weren’t any iPhones and today they dominate many people’s lives.

Junke: Innovation plays out differently depending on how we value our position within the industry. Innovation in the re/insurance industry might be very much different from innovation in other industries. We have to be very aware of that, and refrain from misapplying benchmarks.

We can never be Google because that is outside our circle of competence, we can’t match the innovation standards of other industries. We have to set our own innovation standards. We’re the boring crowd. We need to be stable and safe; we do things slowly, but we have pretty good timing.

There are some big players in our industry who might not devote the capital or put it at risk, but they do thinktank and they do it very well. Not all of us are capable of doing that, but some do and there will be a certain positive spinoff in time.

In a sense, the core element of our industry is to protect, safeguard and maintain. When you are in that business you don’t go out and rethink the world too often. We have to be more lenient on ourselves in that respect, without being complacent.

Reina: To innovate effectively, you need to align the interests of insurers and reinsurers, and this can be a big challenge to innovation.

We can see that many reinsurers are trying very hard to come up with new ideas and new products, but very often these are not what ceding companies are looking for. It’s not just a lack of willingness—insurers may in some cases have a business model that doesn’t allow innovation to prosper.

This is a very big challenge for many insurers because if they don’t manage to innovate, there is a risk that their business model becomes redundant.

The other thing that is happening is that capital providers are to some extent frustrated by this lack of activity. As a result new capital is trying to access more primary business in many different ways: by going into Lloyd’s, by going to the primary markets as we have recently seen in the US, by accessing directly distribution networks, and this again is going to be a threat to the traditional system and business models. Innovation is positioned much higher on the agenda of many CEOs these days.

Peter: Clients have different reinsurance-buying motivations, they have different needs, preferences and buying behaviours. Some of them are looking for simple capacity, and others have different needs in this respect. It’s really important for us as an industry to listen to these needs and motivations and then adapt our solutions to that.

We have both. We have solutions for those who are just looking for hassle-free capacity. Other clients want to discuss with us other topics, for example, product innovations or how to deal with digital innovation and technology. It always depends on the client.
Hartmann: I have a slightly more critical view of the industry. I think we are highly inefficient. What we have been undergoing with our transaction costs, it just can’t be sustainable. There is a need here to reduce it massively—and it will happen. If our industry is not able to transform, it will be the victim and will have alternative models kicking in. This is a massive threat for the industry.
Junke: I believe that the abstract—the need to share and to transfer risk—will never change. Other aspects of the industry must change—anything that does not move will die.

How people view the world is changing. Their view used to be that big corporations are good: they give jobs, they enhance growth. Now they’re thinking “we can do it ourselves”. Look at the growth of the sharing economy with Airbnb, Uber and crowd-funding.

Something is happening, at least in terms of the highly industrialised world. Other parts of the world have totally different needs. But there it is, that’s a big push and it changes consumer behaviour. That puts pressure on our industry—how do we keep the lifeline to our consumers?

I’ll give you one very trivial example. In Germany we have an insurers association. Until now they’ve organised themselves by lines of business. Over the years they felt they were not satisfying the demands of members, and getting flak all the time.

Finally they reorganised themselves. You don’t find life and non-life any more—they have three fields of action, and they are totally consumer-oriented.

Life and non-life means nothing to most people—they don’t care. They just want to know what your job in society is.

Can we be more specific about the types of innovation?

Reina: I don’t know if we can describe the products we see on the reinsurance side as being particularly innovative because many have been around for a long time, but a lot of deals, as Marc said, are driven by regulators. Portfolio protections, ADCs, LPTs, retroactive quota shares: these are tools which help insurers to achieve their solvency margin targets, so they can be efficient from a regulatory point of view.

Take for example mass lapse protections on a life portfolio: this is not really a P&L protection, but it is an efficient mechanism from a regulatory perspective. We are seeing a lot of these products, but I’m not sure if this is the innovation we are looking for.

What I regard as innovative from a reinsurance perspective is where buyers are thinking in different ways. One global buyer was quoted the other day as saying that in the past they would just pull risk together, hold it and try to keep as much as they could, get rid of the peaks, and that was my job done. But now they’ve done that, they said that they needed to consider what trades they could do in order to enhance the performance and the returns of the group through capital efficient products or mechanisms. These are the solutions our clients are looking for and at Guy Carpenter we devote a lot of time and energy to analysing portfolios and balance sheets and coming up with innovative solutions.

There can be a regulatory issue in developing new solutions, where the regulator is not familiar with the type of transaction in question. As Martin was saying, you can never be certain that the transaction will be accepted, you can’t ask for an opinion before the transaction is conducted—you have to carry it out and see if the regulator will accept it, and in which form they’ll accept it.

Sometimes this makes it very different for certain companies: the larger groups can manage this, but the small companies find it very difficult to go through a whole process and then maybe find that the regulator will have a different opinion. Peter: Part of the innovation we can bring to the table is about combining the existing well known components in a customised way. If you really understand the client’s problem, the client’s issues, then the innovation can come through a smart combination of all these different forms of reinsurance, traditional as well as non-traditional.

It might be also suitable to have an ILS component/structure, if it makes sense from an efficiency perspective. By combining these things we can also offer new perspectives.

Regulators will learn more about such things which will help to expand the overall set of available products/solutions. Of course this will take time, but we also have a couple of instruments available.

Will M&A change the buying landscape?

Bender: M&A is always very interesting from a ratings agency perspective because usually we rate the buyer and the company that is being acquired. 2015 was a very big year for M&A on the reinsurance side globally, and that was a main theme last year at conferences. In 2016 that had paused a little bit, but now it has regained momentum and we are seeing some deals as well.

From an industry-changing perspective, consolidation we expect will go forward especially towards more concentrated business models. We expect a further softening of the market in 2017 as well—more moderate than before but still softening.

The question is whether that will change the overall landscape.

We looked at how successful M&A transactions in the overall insurance industry have been in the last 15 years. And from a credit perspective, only two-thirds of the companies that had acquired other companies, did not improve their credit score.

M&A is on the agenda, it can be a very effective tool to improve competitive position, but our empirical data show that not all have been successful, and maybe the initial goals have not been filled on a large scale.

It appears that more diversified companies—not even a matter of size, rather a matter of lines of business—are better prepared to withstand the issues facing the industry because as there can’t be opportunities arising from different lines of business and those companies can service their customers in different aspects.

It’s a matter of diversification and it can help, but it’s rather a question of whether it creates value. If you look at the cost of capital, you have different costs of capital. Asian capital is currently also going into the primary reinsurance market in Europe, for example. This reflects that reinsurance companies are still attractive investment opportunities for investors from different capital perspectives. Reina: Buyers want and need diversification in their reinsurer panels. They need a well-diversified marketplace, and it would be a big problem if the current market contracted to such a size that you couldn’t consider it a market any more.

However, on the flipside, if we look at recent buying patterns, these have tended to favour consolidation and the reduction in number of reinsurers. Less premium and more volatility have been transferred to reinsurers over the last 10 years, and this is an issue for the industry.

The market, however, is composed not only of traditional reinsurers, but also of different kinds of fund managers, ILS funds and other forms of capital—I suppose it’s a positive thing and a benefit for clients, as well as being an opportunity for brokers who can support their clients more effectively through having a greater range of products and solutions.

Beckers: The clients definitely want to have more diversification, that’s important. Regulation is not helping. Rating is far more important than the number of counterparties that you have—which is strange, because I think most people would intuitively say I’d rather prefer to have 10 A-rated companies than one AA-rated company. But that’s not the way the regulation works.

It’s also interesting to see how many new reinsurers we have seen recently—and it becomes harder to meet the capital targets. S&P does a lot of analysis on that as well, but if you look at the return on equity and how it’s evolving for the reinsurance industry, it’s challenging.

For more diversified groups, there is a benefit. If you want to become a niche player, it becomes harder. We as an industry—definitely as brokers—would favour having more diversified counterparties so we can help companies fit the capacity with the demand. Hartmann: Definitely we will see consolidation, and that really matters to us. We see that as a certain threat going forward. In a five, 10 or 20-year perspective, you might not have a panel of first or second tier reinsurers that you’d really like to work with. We are looking very closely at what is happening on that side, for us reinsurance is a long-term thing.

This is also a sign that the softening of the market is maybe coming to an end. In the past you may have only had Swiss Re and Munich Re and you could not avoid them. But now you have a selection of a reasonable panel, and you do not have to depend on one partner, who might be in financial trouble, may change its strategy, and may withdraw from that segment. To have a good choice is extremely important. Today we are in a favourable position, but we see a certain trend, and that could be a turning point.

What are your final thoughts?

Beckers: When you look at the different markets in Europe and you see the type of programmes that they are buying, you see enormous differences.

You have these differences in such a small region with the same counterparties reinsuring those different treaties. Whether it’s cultural or something driving the buying—what you see now is a trend to combine some of these lines of business. I do find it fascinating to see how that changes by region, and how not every country in a region changes in the same way. I’m looking forward to the next few years of reinsurance.

Data and analytics will play a key role in shaping the industry over the next couple of years. Peter: It’s important to keep the diversity in the industry. Variety is the spice of life. Different stakeholders in the industry can learn from each other, driving innovation and also the required change of the industry going forward.

There is one important topic we should keep in mind. Our ability to innovate and change the industry depends also on our ability to attract the right talents. We need to look for completely different profiles of skills and competencies in order to become even more innovative. Reina: Inefficiency in our industry is a real issue. The difference between the premium which the original insured pays and the premium which the ultimate risk carrier receives is too large, and this inefficiency cannot last. As a result the chain between the ultimate risk carrier and the original insured is getting shorter all the time. I could see a situation where capital providers, insurers and reinsurers all compete for the same space. This is quite a worrying trend.

One of the key differentiators is going to be the distribution network. This is one of the main challenges for the industry: whoever gets this right will have a massive competitive advantage.

Junke: We all know about the benefits. Whether we like it or not, there are still a couple of unsolved issues around regulation out there. One certainly seems to involve what I would call the clash of regulatory systems. That’s not healthy, but it will be interesting to see how it is resolved. I cannot see a situation where in a global international industry, the regulations become an element of protectionism. Regulation obviously is a must, but I hope it does not develop into something which basically defines protectionism.

Hartmann: From my perspective, I think the industry is in a crisis. The numbers do not properly reflect the real underwriting performance. We face a challenging interest environment. The current business model is not sustainable, and change is driven by economics, politics and technology. We will have a different client interaction going forward. It will be very interesting to work out how to manage the crisis. There will be a need for alternative risk transfer and different products.

Bender: We probably wouldn’t call it a crisis from an S&P point of view, but rather weak business conditions. However, our ratings outlook for the rated industry is stable. The industry in that environment in our view has had some counterbalancing measures which at least help the industry to balance.

In the short-term scenarios, we talked about how the industry has used alternative capital instruments to give some pressure to the capital markets, to increase the proportions, the book of business and also to brighten primary business counterbalances.

Therefore our view is still stable for the ratings. We wouldn’t call it a crisis but we would say it is a very challenging environment.

We still believe in 2015 the industry has earned the cost of capital, but in 2016/17 maybe in a more normalised cat environment that might change—and then it will be a question of how the industry reacts to that. Potentially they are not earning the cost of capital any more.

At some point in time, if there is a normalised claims and interest rate environment, then it is likely that the cost of capital will not be bad for all companies. At that point in time there will maybe be a rethinking of the pricing environment.

With regard to innovation—we would also monitor how the industry finds long-term solutions to these challenges. In the short term there have been examples of where the industry has been innovative and was also able to develop growth and opportunities.

Although the margins are shrinking, this industry appears to be very effective relative to others. Therefore it may be a challenge, but compared to others it’s not that bad.