Will Reinsurers be a thing of the past?
Recognizing we are in a soft market, it’s easy to knock reinsurers while they are down and trading close to tangible book value. So we have the following thought provoking questions:
- Is the low single digit Return on Equities (ROE) sustainable?
- Will Reinsurance be a product sold directly from a pension fund, hedge fund, etc. ?
- Will Reinsurers be acquired ? or Start merging with each other at a higher rate to protect themselves?
- The days of pure reinsurance companies like Renaissance Re, may become a thing of the past.
Performance/ROEs
The soft and hard market cycle of reinsurance fluctuates based upon supply and demand curves. The supply of capital in the industry vs. the demand of reinsurance protection or capital from insurance companies. In this low interest rate environment and low growth period, insurers balance sheets are stronger than ever. Fixed income securities (which are the majority of holdings for traditional insurance companies), FI securities market values are at all time highs.
Therefore in this soft market cycle, the Returns have been reduced. We have seen mid to high singled digit Return on Equity for the industry — during relatively low catastrophe years.
Is this is a sustainable model? Are reinsurance companies meeting their Weighted Average Cost of Capital or other return hurdles?
Capitalization
The insurance and reinsurance industry is very well capitalized and is seeing more alternative capital entering the market each quarter. According to the AON Benfield Reinsurance Market outlook, there is $565B in capital as of Q3 2015, and growing due to lack of major insured events. As well as growing Alternative Capital space, alternative capital climbed to USD69 billion and now represents over 12 percent of overall reinsurer capital.
Despite a slight decline in capital from catastrophe bonds, overall alternative capital increased 8 percent over year end 2014. Collateralized reinsurance continued its trend with more than a 10 percent increase to USD32.8 billion, now representing nearly 50 percent of the overall capacity provided by the alternative markets. Sidecar capacity made the most significant movement in 2015 ending Q3 with approximately USD8.5 billion in capital, an increase of close to 30 percent over year end 2014.
ILW increased slightly to USD4 billion and catastrophe bond capital decreased 2 percent through Q3 2015 ending the quarter at USD23.9 billion.
Value Chain
Reinsurance is a capital product, why is it offered in it’s own value chain when compared to Fixed income or equity. There is plenty of opportunity to use the Reinsurance product offering to broaden relationships within Investment banks and insurance companies.
Investment banking:
I’ve always said Reinsurance is the investment banking of the insurance industry. Reinsurance provides capital to insurance companies, not in the form of debt or equity — but it is occurrence or event driven. Reinsurance is a product that may compete with fixed income or equity investments in insurance companies. An investment banking model for supporting insurance companies, with Reinsurance as one of the product offerings may be on the horizon.
It will take costs out of the system, you won’t need two management teams, two industry structures, investment banking or capital markets arms of reinsurance companies, etc. You will only need the deal structurers & relationships (underwriters,claims & actuaries) and back office roles (accounting, finance, some senior management) can be supported by current Investment banking infrastructure.
Capital Allocation:
Investment banks, Pension funds, asset managers, or hedge funds would only have to allocate capital to the internal Reinsurance business unit. This faucet of capital could be easily deployed, turned on or off, and the product offering or relationship with the customer (insurance companies) could be broadened.
Diversification/Correlation:
The benefits of the premium “float” are pretty widely known and discussed.
Reinsurance products are not directly correlated with the capital markets, and have proven to be liquid during times of great uncertainty — like the Great recession of 2007–08.
There could be great benefits for this being an on balance sheet product for Investment banks, Pension funds, asset managers, or hedge funds providing non- correlated diversification in assets as well as operations.
Internal Startups and Talent:
If Financiers are not interested in purchasing an existing insurer/reinsurer- but like the idea of offering reinsurance as another product offering this will require an investment in talent.
The appropriate talent to achieve this type of product offering, market presence, scale, relationships, etc. will require someone that is experienced however, not overwhelming compensated via equity from traditional reinsurance or insurance co. Those professionals who are currently equity based compensation talent — may be tough to lure away from the current model. Also, may be less interested in disrupting a sector that has treated them so well.
The younger/mid career talent may be an area to convert, as they are not yet vested or over incentivized in the status quo.
Please note, anyone can read the output of an actuarial model — the true talent understand risk, risk transfer, and clients needs. Over time, machine learning will overpower actuarial science anyhow, so it’s important to search for true knowledge and risk expertise, not paper pushers.
Conclusion
It’s still too early to tell — what will happen to the reinsurance industry, and answer the question “Will Reinsurers be a thing of the past?”
But pay attention, as this dynamic market is starting to converge based upon low investment returns, easily and cheap capital, low catastrophe environment, new Fintech, etc. There is plenty of room for disruption and it’s only a matter of time before the landscape shifts or someone with industry insight works with a major capital or tech player to advance these ideas.
Questions:
- Will Reinsurance companies fight back? Moving into banking or financier type roles?
- Will M&A and consolidation of companies insulate and protect these firms?
- What size balance sheet is too big to be disrupted?
- Will insurers and reinsurers find a way to lower their expense structure?
- Will asset managers have the interest? is it worth the returns?
- Will the market ever return to the hard/soft market cycle?