CEO forum: new capital

How might the continued influx of new capital potentially reshape the industry? What is next for the traditional reinsurer and third party capital relationship? How will it affect your business directly?

Amer Ahmed, CEO, Allianz Re: “There is clearly substantial new capacity in the reinsurance marketplace, from both traditional and non-traditional sources. This has fundamentally affected, and will continue to affect, the reinsurance market. The pricing for catastrophe exposures, at least for the key perils, has moved to a different level as the supply and demand equation has been rebalanced which marks a major shift in the mechanisms of the industry.

"It is seems clear that this will be a permanent feature, although the quantum may move up and down due to relative attraction of other investment options.

"We can either say this is negative for reinsurers because it will continue to put a squeeze on margins, or we can look at the positive aspects of additional capital. I would look at this in two ways: first, if there is capital available which has a lower cost than the equity of traditional reinsurers then we need to find a way to make it available, ultimately to lower the cost of our product to the end customer.

"Second, there’s a lot of risk in the world which is not insured today. We should find ways to deploy the capital which has appetite for insurance risk to close this gap. Reinsurers have deep technical risk and underwriting knowledge. So, they have a vital role in bringing this to the table to match risk with capacity in a sustainable way.

"So, in our business I look at this as challenging because it demands some fundamental changes in what we do and how we do them, but also as a great opportunity because there’s a clear need from customers, current and potential future, and from capacity providers.”

Eric Andersen, CEO, Aon Benfield: “Looking back to 2014, the growth rate of alternative capital was around seven times that of traditional reinsurance capital. Moving into 2015, we have already witnessed a record first quarter for catastrophe bond issuance of $1.7 billion, with alternative capital remaining on course to reach our prediction of $150 billion by 2018.

"Over 15 years this capital has passed through the chronological stages of insignificance, competition and finally disruption, and forward-thinking traditional reinsurers have taken the decision to incorporate the value of alternative capital—acting as lower cost underwriting capital—into their client value propositions.

"In terms of Aon Benfield’s business, we are strongly placed to play a key role in utilising alternative capital, particularly with regard to the expertise and capabilities of Aon Benfield Securities, which for the past five years has consistently been ranked as the world’s leading reinsurance investment bank.

"Our teams are able to work with our clients to optimise their utilisation of capital, and offer a range of solutions from treaty, to fac, insurance-linked securities (ILS) and sidecars, depending on clients’ individual goals and objectives. Ultimately, this capital will provide more choice for our clients as they seek to grow their businesses.”

Dr Arno Junke, CEO, Deutsche Rück: “The number of market participants with a so-called ‘traditional’ business model is finite. Incoming new players pursue a different strategy. Often, the focus is on providing capacity for selected segments of business in a limited amount of time. At first sight this comes across as reasonable, sound and straightforward. It even suggests a degree of energetic determination and youthful dynamics which comfortably contrasts the purportedly dreary and at times unexciting image of ‘old school’ reinsurance.

"However, buyers of reinsurance should invest in a closer look and search for an alignment of interest for all parties involved in these kind of transactions because transaction costs tend to increase on balance over time for buyers of ‘new capital’ reinsurance.

"For most market players ‘new capital’ reinsurance will increase the administrative burden and add complexity to business models. In order to alleviate these effects, a plethora of providers will offer their services, which of course do not come at no cost.

"At the end of the day the total cost will outweigh the upfront savings by far. Of course new capital reinsurance promises to cover more risk at less cost than old school reinsurance. But the buyer will have to invest these upfront savings and more on the secondary and less spectacular front of administrating the business in the long run.

"The lifetime of reinsurance transactions can be very long and the compounding effect of a multitude of trading partners at different times can be intimidating. And rest assured, run-off services do not come free of charge either. As a consequence, new capital reinsurance tends to increase the cost of reinsurance over time.

"In our key markets we focus on direct client relationships. In our perception the proposed shift to new capital will not replace old school traditional reinsurance. The impact of new capital thus has no more than an attenuated effect on our business model. At the same time, we keep a very close eye on market changes as a buyer of retro capacity. There are always opportunities to use new capital reinsurance as a means to optimise one’s own risk structure.”

Nick Frankland, CEO, Guy Carpenter, EMEA operations: “New capital has already reshaped our industry: it no longer enters as a result of post loss trauma but simply enters to seek profit and diversification. Since Katrina, Rita and Wilma in 2009 new start-ups have occurred every year despite the sector’s over capitalisation.

"Not one, however, has been a long-term equity based traditional reinsurer—they have all been in the form of sidecars, collateralised funds or total return reinsurers (seeking to arbitrage underwriting risk against investment gains).

"These structure are easy to start up and easy to exit, either on a standalone basis or behind proven existing brands. Hence capital access is quicker, simpler and cheaper than ever before and, while the cost may increase over time, the non-correlated investment opportunity will always remain.

"All of this means new and alternative capital is here to stay and will complement the historic model rather than replace it, bringing greater stability to the capacity supply—meaning shorter, shallower pricing cycles and improved predictability. Thus reinsurance becomes a truly mature business, less prone to dramatic behaviours and increasingly sophisticated in its use of multiple financial instruments and handling the interests of differing investor pools.

"In such an environment the broker has to learn how to operate successfully across both the asset and the liability sides of our clients’ balance sheets and incorporating everything between.”

Torsten Jeworrek, CEO, reinsurance, Munich Re: “Due to the low interest rates and low spreads, there is a shortage of investment opportunities, and investors are looking for alternative asset classes that meet their return requirements. So a considerable amount of alternative capital is invested in vehicles that today predominantly cover top US natcat scenarios. In this area, alternative capital supports further diversification for very large accumulation scenarios.

"I expect that the more qualified pension or hedge funds will stay in the market even after losses, and even if interest rates increase but—as in any other industry—less experienced investors will tend to disappear over time.

"In the given environment, Munich Re’s strategy is twofold: first, we will continue to write business only at adequate prices, terms and conditions. As a well-diversified reinsurer with extensive know-how, we are well positioned and able to offer tailor-made solutions, for example multi-year treaties (occasionally incorporating cross-line and cross-regional covers), retroactive reinsurance solutions, transactions for capital relief, and the insurance of complex liability, credit and industrial risks.

"Second, with our technical expertise and risk knowledge, we are in a position to support rapidly growing industries and to judiciously extend the boundaries of insurability with needs-based covers. That means we emphasise innovation.”

Ulrich Wallin, CEO, Hannover Re: “First, it increases competition. The first wave of alternative capital that entered the market in the form of cat bonds extended the reinsurance business being bought because most of the early cat bonds were not replacing existing reinsurance, so the new capital actually enlarged the market. When it comes to collateralised reinsurance, it’s no longer the case.

"Right now, the new capital is bringing a lot less business to the market, but then it wants to take out of the market, which intensifies the competition, which we haven’t seen in the past.

"The latest thing is hedge fund reinsurers. This is a different challenge as the higher investment return that hedge funds can generate can be utilised by their partners—large reinsurers—to gain access to those higher returns. This is not easy for the traditional market to compete with because our investment returns are falling and a gap is created.

"It’s not an easy business model, but it will be an interesting place to watch.

"For Hannover Re, what we like about the competition in the reinsurance market overall is that we are competing with entities that have a necessity to make money, and broadly diversified reinsurers that work in a fragmented industry. Our diversification advantage reduces the capital that we need to create an earnings stream so we feel that we are reasonably well positioned to compete in this market.”

Ingrid Carlou, CEO, Patria Re: “For one thing the spread in prices between alternative risk transfer and traditional reinsurance has tightened enormously. Reinsurers have driven prices down and have broadened the covers they offer for the same price paid. Collateralised transactions and ILS have lost some of their flair as the market is mostly differentiated by pricing.

"The end of quantitative easing in America with a possible hike in interest rates could have interesting effects on the interaction between traditional reinsurers and third party capital deals. For one thing, an increase in interest rates will increase the cost of opportunity in the ILS market and push their prices up. At the same time a larger contribution of the financial margin will bring relief to traditional reinsurers allowing them to reduce further their technical margin, and thus further tighten the spread.

"Having said that, Europe has launched an expansive monetary policy that will have the opposite effect. The dollar has strengthened worldwide and the price of oil is creating its own ripples. In this context geopolitics are acting as both cause and effect and thus the outcome of the whole situation is difficult to predict.

"Without major losses prices and conditions will sustain a soft market. Third party capital has become an accepted asset in the financial markets and will not go away. The appetite for financial markets and pension funds to invest further will depend on the cost of opportunity and the losses sustained by such transactions.”

Denis Kessler, CEO, SCOR: “The influx of alternative capital has been a real challenge for the traditional P&C reinsurance industry for a while now, putting pressure on reinsurance tariffs for the whole market. At SCOR, even when the consequences include capacity increases and pricing pressure, we have opportunistically benefited from alternative capital.

"SCOR has issued instruments such as low-cost cat bonds and purchased less expensive retrocession for our own protection. SCOR issued its first cat bond in 2000—making us one of the first issuers. Since then, we have also combined ILS with traditional capacity. We do not see the situation as ‘ILS vs traditional’. ILS acts as a complement to traditional products. We value both and view them in a very holistic way.

"Reinsurers will definitely continue to use ILS, as they bring diversification in terms of capacity. Using ILS is even more attractive in the current market, as the cost of capital coming from pension funds or ILS types of capacity is lower than the average cost of capital for a traditional reinsurer, making this protection in many cases less expensive for insurers and reinsurers.”

Michel Liès, CEO, Swiss Re: “Alternative capital is a new form of competition, but our industry is used to competition. I don’t foresee that such new capital will reshape the industry fundamentally. It certainly won’t put the diversified business model of a large reinsurer like Swiss Re into question. We have entered into a phase of coexistence in which there is a difference between pure capital providers and strategic partnerships.

"The influx of new capital marks the value of a company like Swiss Re and makes it even clearer. We are a long-term business partner for our clients today as well as in 50 years from now. We don’t just offer capital, we offer knowledge, value-added services and a strategic partnership. In addition, the durability of alternative capital has yet to be tested in case of a rise of interest rates, financial market volatility or large insured losses. One has to keep in mind that alternative capital typically covers remote events, the like of which have not occurred in recent history.”

John Cavanagh, global CEO, Willis Re: “We view the influx of additional capital from non-traditional sources as a positive thing, and it creates a lot more fluidity of capital. It will do so particularly after an event where historically capital flows have been sluggish, and the market has been reliant on new ‘bricks and mortar’ insurers to meet increasing demand.

"Accessing capital more quickly post-event can only be good news for our clients. The problem we currently have is that there is too much capital and not enough demand, hence the pressure on pricing, which is also a by-product of the continued period of low cat severity. However, in the long term, the arrival of non-traditional capital is a positive for clients. It ultimately provides more width and diversity, and brings our clients more options.

"The traditional reinsurers are moving from being fully integrated risk takers to a combination of that and third party capital managers. It seems most reinsurers have elected to go down this road to keep their options as open as possible.”

Click here to read part three on innovation.