The innovative traditionalist

Despite its reputation as a slow-moving and traditional industry, it is rare now for a chief from the reinsurance industry to discuss the future of either the industry or an individual firm without referring to the need to innovate and explore the potential of emerging markets and risks.

Alex Moczarski, president and chief executive officer of Guy Carpenter & Company, is no different—except that while some companies’ strategies can be vague and theoretical, his vision is tangible and solid. What’s more, he cites many examples of what Guy Carpenter has done to make change and innovation a reality.

His background may play a part in this. During 14 years at American International Group, then under the leadership of the legendary Hank Greenberg, he spent a lot of time at the coalface of the industry heading up the company’s general insurance operations in Chile and Argentina.

Next, during a long career at Marsh, he variously headed up the Latin American operations, the UK, EMEA and international divisions. Again, he spent time face to face with clients analysing their risks and pondering opportunities. This, he says, makes him exceptionally client-focused and a big believer in traditional values as well. For all its innovation, he remains intent that Guy Carpenter never loses sight of the importance of this.

“I think that having served as CEO of a subsidiary of a global insurer provides me with a deep understanding of the needs and business challenges our clients face every day,” he says. “As CEO of Marsh’s international division, I gained first-hand experience working with companies often served by Guy Carpenter. I have been fortunate to have lived in a number of emerging markets and as the insurance industry continues to seek growth outside of traditional markets, I have been able to apply that knowledge to help our clients take advantage of opportunities.

“I believe this combination of experience provides me with a useful perspective that I continually draw upon. Reinsurance is a highly technical, as well as a relationship, business. I recognise the importance of our being fully engaged with our clients at all times. Guy Carpenter has a rich history of innovation, and in 2013 and beyond we will constantly challenge ourselves to draw on our cumulative expertise to address the most critical issues facing our clients and to help them succeed.”

Emerging markets, emerging risks

During his tenure so far, the business has strengthened its presence in several emerging markets across Asia and the Middle East, increased its headcount by 10 percent in Latin America and Asia and opened offices in Greece, Shanghai and Dubai. Most recently, it appointed a new CEO for the Pacific region, based in Sydney, Australia.

Moczarski sees these investments as mirroring the growth areas in reinsurance. “Since 2007, growth in reinsurance sector premiums has come from China, India, South East Asia, Latin America and Central and Eastern Europe—and will continue to come from these countries and regions,” he says.

But Guy Carpenter is not moving into these markets just to offer clients more of the same. Moczarski details an array of product innovations that will set it apart in these markets, and help it innovate and solve problems.

Some of these are in sectors, such as natural catastrophe risk, that you might expect Guy Carpenter to be actively investing in. In 2012, for example, the company invested heavily in its GC Cat Flood model, the upgrades for its Czechoslovakian and Polish models becoming recognised as among the most credible available.

Additionally, it has financed the Guy Carpenter Asia-Pacific Climate Impact Center, based in the City University of Hong Kong, which is helping to increase understanding of atmospheric perils using advanced predictive research.

“We are meeting the demand from our clients and prospects for new technology-enabled analytical products and tools. These solutions help them translate an ever-increasing amount of data into actionable business intelligence in order to help them gain a competitive advantage, reduce risk and maximise profitability,” he says.

Other targets are in areas you might not expect a reinsurance broker to be involved in. For instance, Moczarski identifies micro-insurance as an opportunity. He predicts the sector will double in size in the next decade and provide coverage for one billion people by 2020.

“Guy Carpenter has become very active in finding new ways to offer insurance in developing countries for low-income people who otherwise would not have access to commercial coverage yet face daily and catastrophic risks such as crop failure and illness,” he explains.

The industry must also plan for emerging risks, he says. In the Global Risks Report released at the World Economic Forum earlier this year, to which Marsh & McLennan contributed, the top five global changes most likely to occur were: unforeseen consequences of new life-science technologies, unforeseen consequences of climate-change mitigation, unsustainable population growth and mismanagement of population aging. Other risks the report cites are cyber attacks, data fraud/theft, terrorism, severe income disparity, irreversible pollution, and critical systems failure.

“Clients will increasingly need advice and guidance as new global risks, access to emerging markets, demand for technology advances, and alternative sources of capital entering the sector make the reinsurance landscape more competitive. Guy Carpenter is helping clients meet those challenges with our broking experience, analytical expertise and advisory acumen,” Moczarski says.

Convergence right now

Moczarski is also bold when it comes to his view of the way in which reinsurance and the capital markets will increasingly interact. Again, while many in the industry view this convergence as a gradual process, Moczarski regards it as complete now and a phenomenon the industry must embrace rather than ignore.

“In 2012, the convergence of traditional reinsurance and capital markets solutions was complete,” he says. “We believe that alternative and traditional sources of capital will continue to grow together. In fact, we think the distinction between ‘traditional’ and ‘alternative’ is becoming less and less meaningful. They are complementary.”

His statement seems justified. Guy Carpenter estimates that the alternative markets provided 16 percent of the total $260 billion of global property catastrophe limit in 2012. And it estimates this could increase to 25 percent in the next three to five years as traditional and alternative sources of capital continue to grow in a complementary fashion. In addition, some of this capacity is backing casualty as well, he points out.

Moczarski is careful to distinguish between insurance-linked securities (ILS) and all forms of alternative capacity. While the ILS market remains relatively small (approximately $42 billion of limit if all property cat-exposed capacity including collateralised reinsurance, cat bonds, collateralised industry loss warranties [ILWs] and collateralised retrocessions are included), traditional reinsurers are also using the capital markets themselves to take advantage of alternative sources of capital.

“The structure of the dedicated reinsurance sector continues to evolve as new sources of capital and product innovation enter the market, influencing a change in reinsurance purchasing patterns.”

This means radical changes in the options available to cedants—something reinsurers must respond to. “The structure of the dedicated reinsurance sector continues to evolve as new sources of capital and product innovation enter the market, influencing a change in reinsurance purchasing patterns,” he says. “In the current market, larger insurers have moved to more centralised purchasing models as improved risk management practices and techniques have given them greater confidence to retain more risk.”

He says this represents an opportunity for Guy Carpenter in terms of advising clients. “The alternative capacity that is coming online in the wake of 2010 and 2011 and converging with existing capacity is an exciting area,” he says.

“Since we are agnostic about the sources of capital, convergence provides an opportunity for us to help our clients understand how to make the best use of these diversified capital market products in a way that maximises risk-adjusted returns. This influx of new capital offers companies the chance to build a more diversified balance sheet but requires a financially sophisticated approach, at which Guy Carpenter excels.”

He notes that the entrance of hedge fund-based and collateralised reinsurers into the market has especially changed its dynamics, particularly in property catastrophe where funds with deep pockets have teamed up with reinsurers able to offer expertise. But this too means opportunities.

“To maximise risk–adjusted efficiency of their reinsurance programmes, many companies are using these new sources of capacity to complement the more traditional sources,” he says. “However, these new sources involve different risks. More and more, companies need guidance from a knowledgeable intermediary that understands sophisticated alternative risk transfer mechanisms. The capital markets arm of GC Securities brings its expertise in those kinds of complex transactions to our clients, who are increasingly demanding that type of specialised knowledge.

“At Guy Carpenter, we are helping our client companies determine the best strategy and portfolio mix. Insurance and reinsurance now provide multiple means of entry for investors, ranging from the traditional fully capitalised company, to ILS funds, to third-party capital vehicles and, increasingly, direct participations.”

Moczarski says clients increasingly see the value of using an integrated approach. Large reinsurance buyers now view the whole range of products, whether they be indemnity or index-based cat bonds, collateralised reinsurance programmes, capital market sidecars or traditional excess-of-loss programmes or pro rata treaties, as part of their core reinsurance and retrocessional programmes.

“There are several advantages to considering ILS as an integral part of the reinsurance programme, including access to large amounts of capacity, collateralisation of credit risk, counterparty diversification and the provision of reinsurance capital for solvency relief or to support growth,” he says.

Invest and adjust

Guy Carpenter has responded to this changing environment in its own way, hiring people with specialist skills when necessary to boost various units such as within the capital markets division of GC Securities.

“We have significantly developed the GC Securities platform,” Moczarski says. “We have enhanced structuring capabilities and built a new secondary trading desk. In our mergers and acquisitions advisory business we have recruited, in the UK, corporate finance professionals with deep industry experience and successful track records in mergers and acquisitions, in particular in the Lloyd’s marketplace.”

He goes on to mention some of the other innovative products Guy Carpenter has launched. “Our work on the Kibou catastrophe bond programme received industry praise and recognition in 2012 for its innovative structure and strategic execution. In the US we launched GC ProfitPoint+, an integrated portfolio management solution that utilises powerful technology-enabled analytics to help insurers improve profitability, enhance underwriting performance and drive growth.”

Another example occurred in September 2012 when GC Securities served as financial advisor to Tower Group on its $75 million investment into Canopius Group. “This is an excellent illustration of how we were able to help a traditional US company grow through expansion into the international markets. We were able to leverage the intellectual capital of the entire Guy Carpenter broking and advisory platforms,” he says.

“Reinsurers are becoming more capital-efficient, offering more risk capital services and more managed capital, and pursuing new geographic markets. Traditional reinsurers are already using the capital markets to leverage alternative sources of capital and they will increase their underwriting for their own and third-party accounts and structure capital in new ways to meet the evolving needs of their clients.

“Despite those new capital structures, the traditional reinsurance product is an extremely flexible form of capital support and will continue to be the core element of the reinsurance programme. Many of the capital structures are, in fact, backed by so-called ‘traditional’ reinsurers.

“With capacity plentiful, successful reinsurers will need to sharpen their underwriting skills in soft markets. The adverse development in the combined ratios of accident years 1998 to 2003 highlighted the impact of less than robust underwriting and offers lessons on how to go forward.”

He does add, however, that the durability of the new sources of capital remains substantially untested by a large, single catastrophe event, or a high frequency of significant mid-sized events that have the propensity to surprise the market.

“Some of the new capacity may retreat when investment returns in other sectors recover and become relatively more attractive than reinsurance and insurance. It is worth remembering that during the most acute phase of the credit crisis in 2008, the reinsurance markets, almost alone, remained open to supply contingent capital,” he says.

“Convergence provides an opportunity for us to help our clients understand how to make the best use of these diversified capital market products in a way that maximises risk-adjusted returns.”

A need to innovate

Moczarski sees two areas that are driving innovation today. The first is around new capital-efficient re/insurance products being introduced into the market, and the second is technological advances.

As well as investing directly in offering better services and advice around ILS products, Guy Carpenter has also established applications that help companies get the most from the various options available to them.

“Reinsurance plays a crucial role in reducing capital costs but it is most effective when those costs are understood,” he says. “Guy Carpenter’s Capital Tranching framework is unique in the marketplace in the method it uses to calculate the effect of reinsurance on companies’ cost of capital.”

Unlike other approaches, the Capital Tranching framework introduces a priority order within capital in which the cost of capital can be thought of as an average of the costs of different ‘tranches’ or ‘layers’ of capital. In the capital markets, similar layering is done in collateralised debt obligation structures. “Guy Carpenter’s Capital Tranching helps clients measure and improve the cost of capital, sharpens the reliability of assessing whether a reinsurance purchase is cost-effective and, as a result, facilitates optimal coverage structures.”

Meanwhile, Moczarski believes the industry is witnessing a technology arms race that is occurring so rapidly that it will change the industry more in the next five to 10 years than in the last 50.

“We will see a migration to electronic platforms that will deliver not only business efficiency but the ability to transfer information in real time,” he says. “The concept of big data and the capability of technology-enabled analytics to harness, analyse, and prioritise massive amounts of valuable information is also transforming the industry. Data-driven analytics allow better decisions about risk selection, underwriting, pricing, marketing, and distribution.”

Recognising that demand, Guy Carpenter launched GC ProfitPoint+, a strategic portfolio management solution that analyses large amounts of rich data in a way that helps clients enhance disciplined underwriting, improve profitability and drive growth.

The advantages of these new high-tech tools are not lost on industry leaders. In a survey of insurance and reinsurance executives Guy Carpenter conducted last year at the Property Casualty Insurers Association of America, it found that more than one-third of the respondents said that if given a blank cheque to invest in their firm, they would choose to spend the additional funds on improving their technology.

“However, if executives within this industry adopt these technologies without first building an intelligent business strategy that meets the needs of their clients, they will miss out on the benefits of having these advances,” Moczarski says. “At Guy Carpenter, we recognise that the industry is at an important crossroads when it comes to technology. That is why we are at the forefront in the use of managing big data through analytics in ways that help our clients and propel progress and profitable growth.”

Clients come first

But although he is forward-thinking in terms of the way he expects the industry to change and keeping pace with this, Moczarski also holds traditional values. Despite the many structural changes the industry is going through, reinsurers must not forget the basics, he says.

“The priority for the reinsurance sector remains the same: to provide optimal cover for insurers at a sustainable economic cost. Re/insurers in the property catastrophe market are becoming more active managers of their businesses and are servicing and sourcing different types of capital. They are optimising their own balance sheets for their shareholders via share repurchases, dividends and acquisitions.

“Simultaneously, many risk carriers are also leveraging their existing expertise and infrastructure by acting as underwriting managers for other capital providers through sidecars, ILS and managed funds. Management teams recognise the changing landscape and some are evolving to become risk managers as well as risk takers. In doing so, they seek to adapt to the changing market dynamics and offer a differentiated proposition that continues to present an attractive return for their investors.”

Underpinning all of his ideas and investments, there remains a common theme: that the needs of clients must come first.

“We are singularly focused on our clients’ success,” he stresses. “Insurers are increasingly challenged to differentiate in a competitive market and we have responded. Our strategic advisory services have distinguished us in the market. We leverage our intellectual capital to deliver impactful advice and guidance to our clients and have been successful in helping them identify innovative approaches to achieving profitable growth.

“We have integrated a powerful combination of analytics, reinsurance broking expertise and strategic advisory services and have built a cohesive management team. Organisationally we have focused our resources to ensure personalised and customised service to each client, whether operating in one country or in many. We have reinvested in our business and continue to be the industry employer of choice.”

The client focus at Guy Carpenter is paying dividends. Guy Carpenter has achieved 16 consecutive quarters of underlying revenue growth, increasing by 5 percent in 2011 and 6 percent in 2012. Total annual revenue for the company surpassed $1 billion in 2011.

And it seems it is a case of more of the same for Moczarski going forward. “Our priorities at Guy Carpenter will be centred on the needs of our clients as the reinsurance market continues to evolve and becomes more competitive. We will continue to offer our extensive broking experience, analytical expertise and strategic advisory insights to our clients who now face new global risks, seek to access new sources of capital, enter new markets, identify merger and acquisition targets, improve their technological infrastructure and develop new product and distribution channels. Our strategic advisory services will continue to play an important role in these efforts.

“The GC Securities platform will help clients navigate a more complex and sophisticated environment that has resulted from the convergence of reinsurance and capital markets. Guy Carpenter will also continue to invest in research and development to create innovative, technology-enabled products such as GC ProfitPoint+. And we will continue to attract the best and the brightest people to develop those products and solutions.

“We also recognise that our regional clients in the US are facing several distinct challenges including the cost of technology, capital management and profitable growth. In 2013, Guy Carpenter will commit significant capital and intellectual resources to develop leading reinsurance solutions, new capital models and innovative portfolio management tools that address those client concerns. We will also continue to support our clients across the globe with our capabilities as the industry expands into emerging territories.

“Guy Carpenter will accomplish all this by using the cumulative value and wisdom within all the operating companies of our parent, Marsh & McLennan. Our foremost priority will always be our clients. So we will continue to invest in our company and in our people in order to deliver the best advice, products and solutions for our clients.”

What lessons should the industry learn from the catastrophic events and losses of 2010/11?

“There are significant lessons to be taken away from 2010 and 2011. One of the key lessons for re/insurers from 2011 is that it is diversification of profit—not premium income—that makes economic sense. It is too early to tell if 2011 was an exceptional year.

“However, if you are a catastrophe modeller, these accident years provide a rich stream of information to review and analyse. One of the foremost things to remember is that our world is globalising. This has clear, if not yet fully understood, implications for risk distribution and risk modelling. The sector as a whole still needs to integrate these lessons into its underwriting practices. We at Guy Carpenter are doing all we can to help the sector get there.

“With our catastrophe modelling tools, we provide our clients with access to all of the major earthquake and hurricane models as well as proprietary models that analyse other perils—such as hail, tornado or flood—and focus on the risks of specific regions.”

What are the biggest challenges facing the reinsurance market over the next two years?

“The next two years will be crucial. The macroeconomic environment continues to challenge insurers and reinsurers. Persistent low interest rates are having an adverse effect on reinsurers’ returns and should not be underestimated. Non-underwriting income as a source of pre-tax profit has largely vanished.

“Another source of profit that is coming under pressure is reserve releases, which are likely to be lower in the future than they have been over the last six years. Consequently, they will cease to provide meaningful contributions to earnings after 2015 and could require strengthening as early as 2014.

“At the same time, global insured losses are increasing at a rapid rate and are becoming more volatile. In accident years 2010 and 2011 large international losses were experienced in Chile, New Zealand, Australia, Japan, and Thailand. Previously, the industry focused on the ‘big four’ peak risks: Japan quake, North Atlantic wind, Europe wind, California quake. Re/insurers must now have a solution for ‘mega-cats’, for instance, a Chinese typhoon, an Eastern European earthquake or a large, South American flood event, which are, in many cases, new and less well-modelled. These events pose greater risks and demand new products and solutions.

“Another area with potential for growth is the significant gap between the cost of economic and insured catastrophe losses. This suggests an unfulfilled demand for catastrophe insurance and reinsurance. We saw this with Superstorm Sandy, as the US Congress approved an additional $50.5 billion for economic losses. The industry will increasingly provide solutions to fill that gap.

“Last year, Guy Carpenter met one such unfilled insurance need by launching Project Noah. This new flood risk reinsurance pool uses digital mapping and land data intelligence from Landmark Information Group to identify and calculate the flood risk of every residential property in the UK.

“Finally, there are many little-understood, or as yet unknown, risks that could be mitigated through insurance and reinsurance. Technology, science and medicine continue to develop at an exponential rate creating new assets and businesses that need to be insured and social costs that need to be funded, as was pointed out in the 2013 Global Risks Report conducted by the World Economic Forum.”