Transforming The Nature of Reinsurance
Mark Brockmeier
Mark Brockmeier is solutions director reinsurance, in the Stamford, Conn. office of Computer Sciences Corp.
Reinsurance companies are taking on more risks as a result of pressure for stability from corporate risk managers-and reinsurers’ own willingness to seek out new opportunities.
Many people debate the meaning of alternative risk transfer (ART) and what it has meant to the primary markets and reinsurance industry since its introduction more than a decade ago. But few can dispute the wide and varied impact these new products have made on the business, accounting, and regulatory fronts. ART has pulled Vermont, Bermuda, and any number of dominions and island countries to the fore of financial management services, thanks to their favorable business climates and tax laws. It’s a new game in many ways for the traditional players-and an exciting game for new entrants. ART has forced both types of companies to make fundamental changes in their approach to the market.
Several compelling events assisted this change. The lack of primary and reinsurance capacity in the mid-‘ 80s for certain lines of property and liability led to a rush of captive formations and exploration by corporations into group purchase and pooling arrangements.
Similarly, Hurricane Andrew in 1992 forced a new look at property reinsurance capacity and can be directly blamed-and thanked-for the rise of the Bermuda catastrophe insurers. The troubles at Lloyd’s in the mid-’90s forced companies to revisit the stability of the world’s oldest and most reliable exchange. Indeed, Lloyd’s formerly unlimited liability for virtually any risk now sports conditional liability and corporate sponsors.
So where are ART and the reinsurance market going? Gazing into the crystal ball has never been easy, but some trends appear likely to continue while others are simply in their infancy.
Changing Nature of Risk
Corporate boards are recognizing the importance of good risk management and are seeking to mitigate their exposures as they expand globally. In response, many corporations are devising risk retention strategies. Risk managers have gained access to software and financial modeling tools allowing quantification of once unquantifiable exposures, and from this information they are retaining more first-dollar liability. Obviously, thus greater sophistication in risk management is both a blessing and a bane for the insurer.
Insurers now face sophisticated buyers with whom they can develop new programs and brand loyalty. But as first-dollar liability dries up, so does the premium. In such an environment, both primary insurers and reinsurers now seek new product opportunities and have formed new subsidiaries with such names as “global accounts,” “new markets,” “risk management,” or “risk solutions.”
The imperative of these new divisions comes not only from meeting the new risk management need, but from developing dedicated product offerings and replacing a revenue stream once met by a standard commercial general liability and excess/umbrella policy.
Risk managers are indeed in a fortunate spot with increased access to risk program design tools and a continuing soft insurance market. This allows them the enviable choice of buying or retaining, or so the conventional wisdom would have us believe. But it’s more complicated than that.
In a word, risk managers want recognition-recognition that their program design and risk retention strategies are as valuable as that designed by a broker. Recognition that there are alternatives in groups, pools, captives, self-insured retention, large deductible, outsourcing, securitization, and a number of other arrangements in program design. Recognition that the prices charged by insurers and reinsurers don’t reflect risk managers’ forward thinking in their risk program and claims experience. Recognition that in some areas they are as sophisticated as their broker/agent and capable of dealing with companies directly.
New Competitive Landscape
Risk managers seek stability in their program design, manifested in multi-year commitments from their business partners, and the primary companies try to make sense of these arrangements when the client company is requesting coverage for a different exposure/peril profile. Reinsurers have been the traditional stalwarts of multiple year and long-term agreements, focusing on relationships with clients rather than pricing of a single program. Reinsurers realize that, with proper guidance, retention level and exposure management, even the most adverse exposures can be profitable. But reinsurers do not always seek underwriting profit from a given insurer or firm. Rather, they make their money off the float, or the amount of time between the underwriting and payment of premium and the ultimate loss.
Primary insurers’ traditional focus has been for the losses incurred in the single underwriting year. But the combined pressure for stability from the corporate risk manager and the reinsurers willingness to fill the need has forced them to bear additional risk and become, in some estimates, more committed partners to a company’s business. Overall, the trend for risk managers has been a positive one, in which: the several markets of insurance, reinsurance, captives, brokers, and fronting companies are competing for the risk manager’s attention.
Consolidaiton and Convergence
This combination of factors has led the insurance and reinsurance industries to rethink its business alignment. Primary companies, once trying to be all-things:0-everyone conglomerates of commercial and personal lines, are shedding their noncore operations as they decide which Lines are their. core business. Recent examples include Cigna’s sale of its property and casualty operations to Ace and he recent decision by CNA to sell its personal lines book to Allstate.
Such market changes were anathema to primary companies who focused on heir brand recognition and growth of market share rather than the profitability of a given class of business. But the 90s have changed the rules. The fact that many corporations have exercised control over their own books of business and abandoned less of the decision and design power to the brokers/agents has meant decreasing premium for insurers. combined with a range of factors–from rising long-tail liability, soft pricing in most casualty lines and the ability to raise additional funds through the capital markets–companies need to be leaner to be meaner. Notice the stock prices of the leading insurers over the last few years. The expensive cost of capital or these players means it’s cheaper for someone else, namely banks and reinsurers.
Reinsurance has had an excess of capacity since at least 1996 and probably earlier, due to the noticeable lack of anther Hurricane Andrew or Northridge Earthquake. That’s not to say that major vents don’t happen. They are simply not impacting the reinsurance industry because of the lack of large primary layers underlying the covers. Environmental and product liability suits, for example, are still subject to appeal years after the original verdict, until the plaintiffs have long since exhausted resources (environmental lawsuits) or the nature of the underlying litigation has changed (tobacco lawsuits).
Hence, as long as the primary insurer does commit to cover a “loss for which it is legally responsible,” the reinsurer is off the hook and the money sits comfortably on Wall Street making double digits in Internetwhatever.com. The large capacity of the reinsurance industry, however, is its double-edged sword. The very ability to absorb such large “shock” losses to the primary market in a catastrophe can lead to intense pricing wars and competition in the absence of such a catastrophe.
Reinsurers are pursuing a consolidation strategy in their industry, as ceding companies and corporations seek to build relationships with only a few, stable companies and not the myriad medium and small-sized players present in the early 1990s. Most industry observers believe that by 2010, only 20 large companies will control more than 85 percent of the world’s reinsurance capacity in P&C. This is already true in the life reinsurance business, where a virtuous underwriting cycle is encouraging 30 percent to 40 percent annual growth in reinsurance premiums.
Investment banks are even seeking to get into the reinsurance game. Securitization of risk is sweeping across the news in the last few years, and only the stellar performance of Wall Street has kept it from becoming a viable investment alternative. Nonetheless, investment banks have been acquisition targets (for example: Fox-Pitt Kelton by Swiss Re, Scudder by Zurich), and certainly reinsurers seek to offer investment-bank expertise even as the investment bankers seek to enter reinsurance transactions. (Lehman Re and Goldman Re are among the first to venture into Bermuda’s reinsurance market.)
Investment and commercial banks, however, are limited by their very nature. They see indemnity risk as almost gambling. They view both primary insurers and reinsurers as not doing their homework before underwriting a risk. The investment and commercial bankers have more capital than either the primary insurance or the reinsurance industry, but their small appetite for risk has limited them to the finite risk market and SPVs (special purpose vehicles), items considered to be the closest to sure things as possible due to their well-quantified exposures and limited timeframes.
Indeed, most industries have experienced such trends, and reinsurance is no different. Companies that were once niche players become larger through their own growth or acquisition and, while they thrive for awhile, often begin to suffer from their own success.
Ace faces this challenge after its phenomenal rise to prominence since its formation in 1985. GE Capital and Swiss Re continue to acquire companies and face challenges to integrate operations and culture as the parent organization swallows up more and more entities. Old stalwarts such as General Re/Berkshire Hathaway face the challenge of remaining competitive despite their own deep pockets.
One thing is certain, however: There is a company somewhere in the Western Hemisphere that sees itself as the next Ace, Zurich, ERC, Swiss Re or Munich-American, and it is ready to capitalize on the next market trend. Some little fish eventually will grow up to be a big fish, regardless of the size of the pond.
What those little fish that survive are destined to be called–investment banks, primary ART market specialists, or reinsurance niche players–remains to be seen. The only certainty is that complacent corporations die, dynamic ones survive, and whether or not the financial reform of H.R. 10 passes has little bearing in the long run on the competitive environment. Excellence demands adaptability, and reinsurers are well-poised to survive in the 21st century. The only question that remains is: In what form?
COPYRIGHT 1999 Axon Group
COPYRIGHT 2004 Gale Group
