As detailed in Part I, the reinsurance industry faces the task of partially reinventing itself to expand in those sectors where it can achieve growth. Property catastrophe coverage isn’t off the table, but it’s now an overcrowded field. Ever more complete and sophisticated models have made calculating risk exposures more accurate. As James Vickers, the Chairman of Willis Re International, said in Part I, underwriters in the 90’s “simply didn’t have sufficient analysis” to accurately gauge the risks.
Now they do. Underwriting is frequently described as “half science, half art.” When the science becomes dominant there’s less need for the art, and this seems to be the case in the U.S. and European property cat reinsurance markets. More reliable cat models, along with low interest rates, have attracted alternative capital from hedge funds, private equity firms, pension funds and other money managers. They back collateralized reinsurance, cat bonds and sidecars. In the near term, they’re in the market to stay.
Traditional reinsurers understand this. They aren’t, however, planning to withdraw from the property cat market, as their underwriting experience – the ability to analyze and price major exposures – will always be needed. But, if they want to grow, they will have to expand into other risk areas, both geographically and by line of business.
At present the only problem with capital is that there’s too much. The capacity glut has lowered reinsurance rates, especially in property cat, and is making it more difficult for reinsurers to achieve a reasonable return on equity (ROE). This has made accurate underwriting in other sectors increasingly important, but more difficult to achieve when there are fewer models to work with.
If Mike Van Slooten, the head of Aon Benfield Analytics’ Market Analysis team, and the division’s boss Chairman Bryon Ehrhart are right, an additional $100 billion will come into the reinsurance market in the near future. Finding ways to profitably invest that money, while avoiding unnecessary risks, is a huge challenge, but it’s also an opportunity.
Alternative capital likes to invest in property cat, because most of the risks are in the U.S. and Europe where they can rely on a number of sophisticated cat models to assess those risks. They can’t do this where there are no models, or inadequate ones; therefore they are reluctant to structure property cat coverage in un-modeled emerging markets. Developing those markets is therefore an opportunity for global insurers, reinsurers, life insurers, and local carriers.
A similar situation exists with new and emerging risks. These include those related to technology and the Internet, principally cyber liability/security, nanotechnology, global pandemics, contingent business interruption, fracking and the ongoing riots and uprisings in the Middle East and elsewhere.
Two risks, which are also difficult to model, have been around for a long time. Casualty coverage has been more or less flat for the last decade, but it does offer growth prospects. To some extent marine coverage has become more complicated, as it may be affected by climate change, rising sea levels, the construction of exceedingly large vessels, piracy and terrorist threats and the opening of sea routes through the Arctic.
“The [reinsurance] market needs to grow,” Van Slooten said; “it hasn’t grown in 10 years, so the priorities need to be restructured.” This requires reinsurers to change or enlarge some geographical orientations “from west to east,” specifically to target growth in Asia, Latin America and parts of Africa.
This isn’t a new insight. For several years people have been using the acronym “BRICS” (Brazil, Russia, India, China, South Africa) to refer to countries whose economies are expanding, where there’s a growing middle class, and therefore a greater demand for insurance products. They have more recently been joined by the “MINT” countries (Mexico, Indonesia, Nigeria, Turkey) that are also seen as offering investment opportunities and growth for re/insurance.
In a way history is repeating itself, as these developing countries reflect the origins and growth of the insurance industry, which traces its roots back to 16th century Italy and England, where newly wealthy merchants, dependent upon trade, sought protection from the risks that threatened their assets.
In a recent article the BBC found 10 businesses in England still being run by descendants of the families who founded them centuries ago. The oldest – RJ Balson & Son – Butcher – was established in Dorset in 1515. Historians at the Victoria and Albert Museum in London have traced the activities of the city’s goldsmiths through entries detailing insurance payments in ancient notebooks. The establishment of Lloyd’s as a marine insurance market in 1688 and its subsequent growth is well documented.
While it’s unlikely that it will take the BRICS and MINTs several centuries to reach full development, it won’t happen overnight, even in today’s computerized Internet world. Both Van Slooten and Vickers stressed that growth in emerging markets is closely linked to the growth of the middle class. They are the modern equivalents of merchants.
“Most emerging markets have underlying growth,” Vickers said. He cautioned, however, that each country is different, and that it’s wise “to diversify, and not to bet on just one.” Not only are the needs for re/insurance different in each emerging market, but also the regulations differ. Some countries, notably India, create so much red tape that it amounts to a barrier to entry, while others have simplified their regulations to attract foreign capital. He cited Indonesia, Malaysia and Turkey as good examples.
“In order to do business in emerging markets you have to first establish a presence on the ground,” Van Slooten said. “From there you can learn from local primary insurance companies, establish relations with them and thereby better understand the risks they face.” This requires setting up local subsidiaries and establishing local partnerships and convincing them that you are committed to growth over the long term.
Investments are necessary in order to do so, and Van Slooten pointed out that most emerging market countries “need to attract capital;” however, that in turn means companies “must model. Because there are risks everywhere, you need data modeling in order to attract investors.” This seems to create a “Catch-22” situation. You can attract capital, if you have some models of the risks, but you can’t do the models until you’ve attracted the capital.
Aon Benfield and Willis Re, as well as larger reinsurers, solve the problem, at least partially, by creating their own models. This isn’t easy. “You have very good data in the U.S.,” Van Slooten said, but “in emerging markets, that’s seldom the case. You have to go country by country and risk by risk.” He cited the 2011 floods in Thailand as an example. Although they completely disrupted a number of global supply chains, no one knew about the risk before the floods, as there were no models.
Aon Benfield’s Analytics team is working on one, but it takes a long time to gather the necessary data to construct a model. The most recent one they developed – for European windstorm – has taken three years, and Europe has very detailed relevant data in comparison to the BRICS and MINTs.
Despite the problems, geographical expansion of the re/insurance industry into emerging markets is taking place. Lloyd’s has a subsidiary in China; a number of companies are now in Mexico, headed by AXA. A number of insurers and reinsurers have established offices in The United Arab Emirates and Qatar, based in Abu Dhabi, Dubai and Doha. Singapore is a global hub in Asia for re/insurance. Brazil has attracted companies such as Swiss Re. As these and other regional economies grow, so will their re/insurance markets.
As mentioned earlier, casualty hasn’t grown that much over the last decade. P&C, as the acronym shows, are inevitably linked, but they are really distinct animals. In an interview at the Reinsurance Rendezvous Jayne Plunkett, Swiss Re’s head of International casualty reinsurance operations, explained that “you’re dealing with people, rather than nature, casualty coverage is a really a “social science,” rather than a “natural science.”
Swiss Re defines casualty as “motor [auto] plus all of the liability lines.” Plunkett said “it’s different in every marketplace, that’s always the hard thing about all of these coverages, but I think the world is constantly a more litigious place; you have economic growth in many countries.” This “drives demand for insurance in general and also for the liability lines.” It is a sector that should begin to grow; after all, one of the first things those BRICS and MINT rising middle classes buy is a car.
Due to its diversity and the long tail nature of casualty coverage it has always been considered difficult to model, which also makes it uninteresting for alternative capital investments. Plunkett said there had been some “discussions,” on modeling casualty exposures, but she also pointed out there’s “certainly a different element to the longer tail liability business. It’s very complicated; it’s complex, and you need to know how to underwrite those risks, and a very long tail.”
Similar strictures may be applicable to some of the other emerging risks, such as cyber liability/security and contingent business interruption (CBI), which are also –at least so far – difficult to model, and could be “long tail.” As these lines develop determining the risks involved should become more evident, but not necessarily easier to do.
Other factors also influence the global re/insurance market and will help to shape it in the future. Long sought co-operative agreements with governments may finally take off. While the industry has long been regulated by governments, they have been slow to seek out its expertise, mainly in preparing for natural catastrophes. With more and more people and properties at risk from cyclonic storms, tornadoes, floods and droughts, government’s role has increased and public-private partnerships to address these risks seem to make more sense.
While the “major players” are the main focus for growth initiatives, it would be remiss not to include smaller re/insurers, especially those concentrated in specialty lines. “Bermuda companies are “more nimble and less strict,” Vickers said. “They are the second tier capital providers, and they must use [invest] the money they have.”
In the final analysis the reinsurance industry must take the more difficult road if it is to achieve the growth necessary to survive and prosper in an ever changing world. Its future is in the hands of the men and women who work in it, just as it has always been. It has always managed to respond to changing conditions, to survive, and make the best of new opportunities. The growth of the global economy and its interconnectedness offers those opportunities. The 200 plus nations of the world are more closely linked than they have ever been. It’s now up to the industry, for its own good and for the good of all those people, to create ways to thrive in the 21st century.