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. What would you like to do?
What factors do you see currently shaping the market?
I think we’re only at the start of the consolidation phase that the market is going through at the moment.I don’t see how standalone reinsurers will be able to find a way forward in the current market, unless pricing dynamics substantially change. The position they’re in now is a result of the catastrophe pricing subsidy they’ve been using to support other lines – they’ve written a huge volume of long-tail business essentially at a loss, supported by profits from volatility business. Now we see pricing pressure on cat business, there’s a squeeze. There is no profit in the other business given the low interest rate environment, and they’re just being bled dry. I don’t see a point where the newer, more flexible and lower-cost means of bringing capacity to the market – the ILS funds – stop taking on an ever-larger share of profitable business.
Do you think reinsurers can compete by paring back their expenses?
It sounds like you’re describing an inevitable march of the ILS funds. I think it is an inevitable march of the ILS funds. I think reinsurers can make a saving today if they double the line size of every piece of business they have, but in an ILS fund you have only return expectations from investors plus a very minimal expense base on top of that.You can’t fight against that with the infrastructure of a reinsurer, particularly the larger reinsurance companies.
So how do you think this consolidation phase will play out?
I understand the mergers that take place between a reinsurance and insurance entity that are trying to balance their business across the market cycle. What I don’t understand are the deals that are just about cutting expenses – it makes no sense in the long-term because you’re still not being protected from the swings of the cycle. At Twelve, we’re active in ILS, we’re active in debt and we’re becoming active in the equity side as well. It enables us to position our investors across the insurance balance sheet to benefit from the best opportunities at any point in the various market cycles
Do you think M&A activity will spread to the fund market?
I anticipate a wave of consolidation that brings us a smaller number of more specialist managers. The standalone ILS funds have in some ways got the same problem as reinsurers – they’re also living or dying by a single market cycle, if all they can manage is cat business. If prices continue to decline, they too will struggle in due course because they won’t provide attractive returns to investors at current fee levels and will find their expense base further challenged.
Where do you see the market heading in the future?
I see a point where there’s less division between reinsurers and other types of finance providers.Primary insurance companies will be much more adept at managing the balance of equity, debt and reinsurance on their balance sheet around the market cycles of those products.
What keeps you awake at night?
Fortunately my sleep is sound at all times! However, while it is of course good for humanity that the world has not seen a major natural catastrophe in the last few years, this has had a major impact on the reinsurance business.My biggest fear for now is that we don’t have a major event in the next few years – that we just keep on with a relatively benign market causing a slow lingering death of the current reinsurance model.We need a shock to tidy things up and the event could just as well be further reserving or investment issues in the casualty market as much as a natural catastrophe. I would like to get people thinking about how to efficiently finance risk across the balance sheet rather than the current division continuing to exist and everyone meandering along producing ever-dwindling returns.
What do you think would happen after a shock loss?
There would be a hardening of rates but it would be gradual and reasonable. Then we’ll see a filtering of capital in the market, as we determine whose expense base can support a business in what then represents a “hard market”.I think that would be the point where we lose capital. It wouldn’t be immediately following the loss, it would be in the next couple of years as some people realise that the good times aren’t nearly as good as they used to be.What we will also see is insurers looking more closely at what is the efficient balance of capital for them – can they rely on quota share reinsurance in the volume they used to do, or are there other instruments that are more stable?
So you’re not a fan of quota shares?
There is far too much reliance on quota shares at the moment. It’s a short-term form of capital solving a long-term problem for primary reinsurers. For a well-performing company it would be more efficient to carry subordinated debt than to use quota shares. They have that capital for a longer period of time for more stable rates. This is the way to really build a long-term relationship with investors.The quota share should become extinct!But is it possible for ILS funds on their smaller expense base to access business in far-flung regions that they might otherwise get through quota shares?Yes – if you have the right analytics and a team who can source the business.
So where does this leave the role of reinsurance?
Reinsurance is not the one-stop shop for everything.There’s a place for what we do on the ILS or reinsurance side, which is to cope with the years where you get abnormal loss ratios, for taking away volatility. For non-volatility business, other forms of capital are far more appropriate
The Swiss investment manager, which operates both collateralised reinsurance and insurancedebt funds, argues that insurers operating under the Solvency II standard formula would makelarger profits and have better solvency coverage in a variety of scenarios, if they used debtrather than reinsurance to meet capital requirements.
12 January 2015-1
The firm engaged actuarial consultancy Towers Watson to build a model of a mid-sizedEuropean property and casualty insurer - a type of company that traditionally uses quota sharereinsurance as a capital management tool.
12 January 2015-2
The model projects the balance sheet and profit & loss over four years, and uses the standardformula to estimate the solvency capital requirement (SCR) at the end of each period. TwelveCapital ran four scenarios where the firm had a large underwriting profit, a small underwritingprofit, a soft period when there are underwriting losses each year and a single-event loss. Inall these cases, the debt-issuing firm had a better SCR coverage than the reinsurance-buyingfirm, and only in the case of persistent losses did the firm make more profit from reinsurance.The model assumed current market conditions for reinsurance commissions and debt interest.
12 January 2015-3
"Purchasing quota share reinsurance is an efficient way to limit losses, but it is not a veryefficient way to manage the SCR coverage ratio," the report notes.Markus Stricker, a partner responsible for risk management at Twelve Capital, said thereport's conclusion - that debt is more of a capital management tool and reinsurance is more ofa risk management tool - might have been obvious to some, but it has not stopped manyinsurers from using reinsurance in this manner.
12 January 2015-4
He acknowledged that issuing debt was more complex than arranging reinsurance, but on theother hand the debt tends to last for 10 years while reinsurance contracts are usuallyrenegotiated each year. Reinsurance is more flexible but its pricing tends to be more volatilethan debt markets, "and when you need it most, the price of reinsurance will go up," Strickersaid.
12 January 2015-5
The tendency for insurers to use reinsurance to manage capital might be partly explained bythe lack of appetite among investment banks to get involved in sub-$100m deals that midsizedfirms would need, according to Stricker. This is a segment of the market that TwelveCapital is trying to tap with its debt funds.Stricker said Twelve Capital had considered a similar study for life insurers, but found toomuch variation between each country to be able to present a "typical" case study.
12 January 2015-6
Solvency II 1/5
Sihl I was meant to invest mainly in bonds issued under theSolvency I regime, i.e. broadly bonds issued prior to 2010. Those bondstypically do not have mandatory coupon loss absorption (only optional), andthose bonds that are intended to count as core or tier 1 capital typically haveno or insufficient principal loss absorption. In addition, the triggers forloss absorption were typically set at a lower level, i.e. minimum capitalrequirement breach, rather than solvency capital requirement breach.
Solvency II 2/5
Because of these features, these bonds do not comply withthe Solvency II eligibility requirements for tier 1 and tier 2 own funds(higher quality capital, more loss absorbency, more proximate triggers).In Twelve’s early years, large capital gains were made on ageneral market mispricing of these old bonds. It is broadly for this reasonthat Sihl I has a limit of 25% on the newer, Solvency II compliant bonds.
Solvency II 3/5
Since transitional measures were announced in spring 2014,the likelihood of the old bonds being called at par (generating capital gain)and refinanced in the near future has reduced. Core capital/ tier 1 Solvency Ibonds may still need to be refinanced, because under Solvency II they can countfor no more than 20% of tier 1 - a smaller bucket than previously. But subjectto this limit, old tier 1 bonds can be transitioned into Solvency II until2026, and ALL tier 2 Solvency I bonds can be transitioned until 2026.
Solvency II 4/5
To add to the mix, the precise Solvency II own fundseligibility criteria have been changing in the last months, forcing us torecategorise bonds from “grandfatherable” to “compliant” and vice versa. Themost recent change is that it is likely, but not yet confirmed, that dividendstoppers will not be allowed in any tier. If this is the case, some previously“compliant” bonds will need to be transitioned/grandfathered. Nicolas iscurrently looking at how many bonds this includes. This recategorisaiton maybring Sihl I to within limits again.
Solvency II 5/5
Conceptually there is little argument for the 25% limit, buta renegotiation of the IMA to change limits is a big task, which is why it hasnot been started yet. Bruno is looking at options.
Bloomberg Businessweek: Metlife 1/4
When fans at major sporting events look skyward, they often seethe MetLife blimp piloted by Snoopy, the insurer's lovable pitch-dog. JackLew and Janet Yellen conjure something potentially more threatening. MetLife yesterday sued a who's who group of regulators called the FinancialStability Oversight Council after the panel, chaired by Treasury chief Lew,deemed MetLife "systemically important." That's bureaucratic jargonmeaning the company is so intertwined with markets and other companies that itsfailure might crash the whole system.
Bloomberg Businessweek Metlife 2/4
- Here's why the case—predicted to take several months to litigate—matters:
- Chilling effect.The council, whose members also include Fed Chair Yellen, really wanted to avoid a lawsuit and got sued anyway. It spent more than a year scrutinizing MetLife in the final stage of the designation process. MetLife was the fourth nonbank named a systemically important financial institution
- (the others were AIG, Prudential, and GE Capital) and the first to sue. The council might move even more cautiously deciding whether the next company in its sights is too important to fail.
Bloomberg Businessweek Metlife 3/4
Blow to Dodd-Frank.The council was created by the 2010 Dodd-Frank law to helpprevent another financial meltdown. Dodd- Frank is under attack from the newlyemboldened Republican majority in Congress. Senate Banking Committee ChairmanRichard Shelby, an Alabama Republican, said yesterday he will do whatever hecan either to repeal or to change it. The FSOC was set up to have broad powers.A successful lawsuit would weaken the council and Dodd-Frank.
Bloomberg Businessweek: Metlife 4/4
- The cost of insurance. MetLife argues that Fed oversight could force it to increase prices, stop offering some products altogether, and shed investments that support the company's life-insurance operations. The rules the Fed would use to
- oversee MetLife haven't yet been completed, so it's unclear exactly what the costs will be. MetLife has been fighting the systemic tag under the assumption that Fed oversight will increase its costs.
- The standoff heads next to federal court in Washington, which will decide whether MetLife the company is as harmless as a cuddly cartoon beagle or represents something more menacing to the economy.
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