Bermuda roundtable: Seeking the best of both worlds
The evolution of the reinsurance business model, the risks faced by fronting carriers and why insurance business is a potential Pandora's Box
As Bermuda’s traditional staple of property catastrophe business has fallen prey to fierce competition and lower returns, the island’s reinsurance specialists have adapted their strategies, with varying degrees of success.
The companies hope to have the best of both worlds. They want to preserve their position in profitable property cat underwriting, at the same time as gaining a benefit from writing other lines, while adapting to the continued influx of new capital. Bermuda’s companies find themselves in a period of flux that is unlikely to settle for some time. Insurance Day brought together senior executives from the Bermuda market to discuss the challenges and opportunities facing the sector, consolidation, the role of third-party capital and avenues for growth. We would like to thank Axis Capital and Bill Fischer of Harrington Re for hosting the discussion.
Is the standalone reinsurer model viable?
Ross Curtis, group chief underwriting officer, RenaissanceRe
“It definitely and demonstrably is. While there are market challenges, RenRe has a long and successful track record with our focus on reinsurance, and we see that continuing.
“Add to this roughly 10% of our business is in insurance and written through Lloyd’s. We like insurance risk, but we’re far more of a reinsurance company. I think there’s a lot of value in the investments we’ve made in our platforms over the past few years.”
Do you expect a shift towards insurance business and away from reinsurance because of market conditions?
Ross Curtis
“Not in the near term. We think there are still opportunities within Lloyds to grow our insurance capabilities and access insurance risk, but not necessarily within a US onshore platform or an office network around the globe.
“We believe – and have feedback from our insurance clients to support this – that not actively competing with them is of increasing value.”
Kean Driscoll, chief executive, Validus Re
“I think a standalone reinsurer can exist. We’re strong proponents of the hybrid model for a variety of reasons. We write roughly $1bn of reinsurance, $1bn in Lloyd’s and $1bn pro-forma US insurance income.
“Specialty US insurance is the biggest market but it is also the most challenging market in which to make a profit. It requires a significant infrastructure and appropriate scale. Reinsurance generally is much easier to enter, to build infrastructure and to make a profit.”
At the moment, the specialty insurance side seems to be an area that’s growing?
Kean Driscoll
“Yes, I think there are a variety of different reasons for this. We like the permanence and the predictability of insurance earnings. On the reinsurance side, we’re very comfortable with the position we have and the relationships we’ve built with customers. But there are a lot of forces we’re dealing with, in particular insurance-linked securities [ILS], that are changing the earnings pattern of that business, so we’re seeking diversification.
“We’re also taking on board the messages we get from a lot of our investors that they’re more comfortable with the predictability of insurance earnings and the margin expansion associated with that.”
Conan Ward, founder, Conan Ward Consulting
“It’s nice to have a capability pick-up that may come from moving from being a standalone reinsurer to an insurer because there’s operational complexity in the insurance business that doesn’t really exist in reinsurance.
“That said, it doesn’t come without a potential Pandora’s Box. A reinsurer acquiring an insurance company must be able to deal with that operational complexity. You can have potential culture clashes, and if you don’t have the harmonisation around capital and capital usage they can spend a lot of their time fighting over resources and capital. If you’re going to move from a standalone reinsurance model you must have a very clear objective as to what you want to accomplish.”
Jeremy Pinchin, chief executive, Hiscox Re
“I think we’ve had most probably the most diversified model of the team here. I run a standalone reinsurer within a diversified model. Our gross written premium within reinsurance is only around 30% of the group but in a good year we generate nearly 50% of the profits, so the value of reinsurance is still huge to us.
“It’s interesting to seeing many reinsurers move into insurance as the operational complexity of running an insurance operation is not to be underestimated. Luckily we’ve had a 30-year head start, so we do feel protected being within a diversified group where if reinsurance needs to shrink because of market conditions we can do. But we’re not looking for that and we’ve been actively involved in the third-party capital space to make sure we continue to be a credible player within the reinsurance industry.”
Bill Fischer, chief executive, Harrington Re
“Whether it’s London market specialty insurance or US specialty insurance, it tends to be a wholesale or heavily wholesale- type product, which is a step between true retail insurance and reinsurance. It makes reinsurers just a little bit more comfortable than a real retail model. Wholesale insurance is a lot like reinsurance.”
Kean Driscoll
“The persistency in wholesale is fundamentally different. The regulatory touch on the wholesale side is so much lighter than retail.”
Nicolas Papadopoulo, chief executive, Arch Re
“On the reinsurance side the way, we see two models: you have Swiss Re, Munich Re, Scor Re and Hannover Re, which are dominant players that participate across clients’ programmes, and you have companies that are more niche, specialty players. For speciality players, you have more flexibility to move into specialty insurance in search for new areas to grow. But if you’re a dominant player and you start to enter the insurance business you are competing directly with your main clients and that presents a bigger challenge.”
Mergers and acquisitions
Turning to M&A, what sort of deals are we likely to see in the short to medium term?
Conan Ward
“Traditionally, an objective of M&A has been increased market share. Given the number of targets that are out there, from a size standpoint, that strategy may well have run its course.
“At this point the other reason for M&A is to get capabilities you don’t already have. But I’m not sure how much actual M&A in pure reinsurance can go on, given the size of some of the players involved.”
Bill Fischer
“There is an appetite among re/insurers and investors in many markets around the world to diversify their businesses through acquisition. Sompo’s recent acquisition of Endurance points to a possible increase in M&A interest from Asian investors and insurers.”
Kean Driscoll
“The motivation for this M&A is that the Asians are buying capabilities that they don’t have and they’re willing to pay a significant premium for that. Scale is part of a reasonable rationale for doing a deal in this market but I don’t think it will motivate two companies to get together. Expense rationalisation synergies are clearly more important today than three to five years ago.
“At the end of the day, if someone has a premium that they can use to consume another company that adds capabilities or just capital you will see it done, but I don’t see anything in the wind that would indicate we’re going to see a massive wave of M&A.”
Jeremy Pinchin
“History says that a lot of M&A doesn’t work – it’s done for the wrong reasons. There will be exceptions, of course. The Japanese buying big companies for long-term investment might work. But there’ll be many deals that are only staying the inevitable and that aggregation actually serves no purpose but to just compound the problem."
Do you expect further major consolidation of Bermuda companies?
Jeremy Pinchin
“The market is tough. If it continues people will be forced to make some moves, yes.”
Conan Ward
“The typical Bermuda company is now a global hybrid participant that may or may not be domiciled in Bermuda, so there’s no catalyst per se that would differentiate Bermuda over London. You could probably make an argument that London is under more extreme cyclical pressure because of the expenses.
“It’s no small wonder that the syndicate sizes now are tremendous, they’re all buried within big groups because those are the only people who can deal with the expense of being in the market and have the scale long term.”
Do you think smaller, targeted strategic acquisitions are probably more likely to take place?
Nicolas Papadopoulo, Arch Re
“It makes sense, if you find something you don’t already have.
“The economics have to work, as do the social issues you have to deal with. How you are going to successfully integrate both operations is the biggest challenge.”
Alternative capital
Pretty much everyone has some sort of involvement with third-party capital, through various structures. Has the model reached maturity or is there a next stage of evolution?
Jeremy Pinchin
“Yes, I think there is a next stage of evolution. I think a number of factors that will impact it, including global macroeconomic factors and loss events. Broadly, the mousetraps to bring capital into the industry – the efficiency with which it can be used – are still there. There is far more demand for capital to be deployed in the industry than there is good business to provide it – and that will remain the case. That will have an impact on the industry, particularly through big loss cycles.”
Do you see the structures changing?
Jeremy Pinchin
“I think the industry will be ever inventive, but I would think the permutations are getting narrower.”
Nicolas Papadopoulo
“We have gone from the cat bond, with $1 of investment buying $1 of the limit, to the fund structure where $1 of investment buys $3 or $4 of limit, so there is leverage built into the fund structure. That leverage is built on a mathematical assumption. How that plays out in the case of a major event will differentiate entities that do it right from those that do it wrong. I think there are people out there that are not doing it right; that will be the next shake-up of the ILS market. The fronting companies are getting paid a fee but are keeping the tail risk on their balance sheet, so when the big loss happens there could be some bad surprises.
“Natural catastrophes have always found ways to prove cat models wrong. In the event of a big loss, I think some of the capital markets will be fine but those fronting for the capital markets may face issues.”
How much scope do you think there is to bring third-party capital to new classes?
Bill Fischer
“Some of these markets aren’t big enough, so I think we have to be cautious about how much capacity comes into the non-catastrophe-related products.”
Kean Driscoll
“It likely needs to be a rated, levered model to be able to bring a lower cost of capital together with latency in the product. Managing collateral for longer-tail classes is fundamentally different to short-tail property where there’s a 12- to 24-month window. When you’re dealing with anything with latency, even marine liability, it becomes really challenging. There is a much more significant barrier to entry to establishing a rated vehicle. I think for that reason you’re going to see a much, much lower progression on the longer-tail possibilities.”
Bill Fischer
“We got a rating at Harrington Re before we started but it’s a challenge. We have one rating from AM Best, an A-.
“We haven’t started the conversation with the other rating agencies yet, as we have a lot of work to do to educate them on the specifics of our investment portfolio.”
Ross, do you anticipate RenRe bringing any of its other classes of business into third-party vehicles?
Ross Curtis
“Ideally, yes, we would. We are certainly getting a lot of investor appetite for that. For us, the opportunity has predominantly been around the property and catastrophe space, but there’s been a lot of discussions around how investors can access the casualty and speciality risks that we have in the portfolio as well. Our own portfolio is currently very capital-efficient, so there’s not necessarily the opportunities or the structures to that make it work, but I think over a longer timeframe that will develop.”
Hiscox’s Kiskadee funds have invested in other classes, not just property.
Jeremy Pinchin
“In the case of some of our specialist portfolios, we have started to. We’re bringing investors on the journey of giving them confidence not only in the type of risk but also in our underwriting ability to move either side of the traditionally modelled risk. That is a journey we are part of the way through and certainly we have investor interest in taking greater appetites in that area.”
Do you anticipate more total return vehicles being constituted?
Bill Fischer
“You have to find an asset manager, you have to find a group of investors. It is tough to raise funds after several companies have done so without proof of concept and that proof of concept takes some time to develop. So, in the very near term, I’m sure there will be people still trying to do this, but it’s not an easy thing to do and you have to have significant size if you are to be a credible counterparty. So, the answer is not many of material size in the near term.”
Nicolas Papadopoulo
“The two original ones haven’t done as well as expected. Now you have four of them. Because the first two did not do so well, investors are now questioning whether the model works. In my view the model only works long term if the underwriting combined ratio remains below 100% and therefore the underwriting float is not at negative carry.”
Kean Driscoll
“Yes, I’m sure there’s a credible case to be made for the aligned model such as Watford Re versus the standalone ‘hedge fund re’ model, as it is not a real start-up and it relies for its business on the underwriting platform of the sponsor. That is why it has proven less of a challenge to obtain an A- rating.”
Bill Fischer
“The model Harrington Re has and the model Arch has [with Watford Re] provide access to all the infrastructure that deals with reserving and pricing the original upfront business. I think that aligned model is the model that will work.”
What are the benefits of using a total return model?
Nicolas Papadopoulo
“For us, if you think of the aligned model we created with Watford Re, it is good for Arch too because the economics around the deals we do on behalf of Watford have a different set of economics from the deals we do on behalf of Arch, so for us it expands what we can do.”
Kean Driscoll
“There’s a fee income element to it but fundamentally what’s more important is it the ability to add scale and relevance to your relationship with the customer and maintain more consistency through market cycles. People aren’t entering this business for fees, but the ability to maintain a more significant imprint in the market and provide more solutions for their customer base.”
Jeremy Pinchin
“Absolutely. We have more relevance through our third-party management of capital, and I have to say the fees have been an added bonus as well.”
Growth opportunities
Where are the growth opportunities in the reinsurance market at the moment?
Ross Curtis
“Mortgage reinsurance is a growing market and has been a growth area for us in the reinsurance space. In terms of insurance risk, it probably becomes harder to figure out exactly what those growth areas might be. Cyber is 1% of our business, but it’s one where we see there’s an opportunity for growth. Beyond the developed markets, at a simple level we break down the opportunity set to the uninsurable, the underinsured and the emerging markets. We’re always looking for ways to engage in each of these, either ourselves, or supporting our clients.”
On the reinsurance side, do you see opportunities in cyber risk?
Ross Curtis
“Some, yes, definitely some. The products can be different – how it’s deployed, how it’s underwritten – but I wouldn’t say the opportunities are legion at the moment.” > Hiscox puts a lot of emphasis on product development.
Jeremy Pinchin
“We do. It’s about trying to train an underwriting team to become a sales force and to operate in a soft market and that takes different skills and so we have set out to try and innovate. We are seeing opportunities as a result, and that’s been quite profitable. In fact, we’ve seen considerable growth since we formed Hiscox Re. We are taking measured bets in new classes and we are exercising caution as we move into cyber or mortgage.”
Kean, where is Validus looking for growth?
Kean Driscoll
“We have a pretty similar philosophy to Hiscox in that when we look across a spectrum of available existing products, our relative market share in a number of them is quite low, so we can achieve growth and still not be disruptive in the marketplace. Casualty, mortgage, political risk, some structured credit products – those are all areas where we’re investing in talent and analytics and that will help offset some of the areas where we are shrinking.
“One area the industry is doing a much better job in the past three to five years is this concept of public-private partnerships and looking to shift risk from governmental or quasi-governmental balance sheets into the direct market. We’re seeing some really positive trends in that respect, whether it’s at state level or at federal level in the US, or internationally, so Pool Re and Flood Re.”
Conan Ward
“With public entities, I don’t think there is an appreciation of the amount of risk they hold. Everyone loves the idea of a public policy solution that involves the government’s balance sheet until the event happens. So, if you think about something that can start to impact in a positive way the supply of business that is available for the market, that’s certainly fertile ground.”
Nicolas Papadopoulo
“We made an investment in a run-off carrier, because we think, based on the soft pricing we see, insurance companies are bound to underperform in some of their businesses leading to more discontinued operations. I think there will be more run-off opportunities or discontinued operations based on peoples’ profit expectations not being met. Run-off is more of a long-term investment and as the market hardens I think we’ll see entities reorganise their balance sheets to free up capital.”
Do you see opportunities in developing economies?
Nicolas Papadopoulo
“The difficulty of reinsurance in emerging markets is that you need first a strong insurance framework in place. It is only then that significant opportunities for reinsurance start. It’s hard to reinsure an underserved insurance market.”
Conan Ward
“It’s about capabilities and that’s a lot of what drives some of the acquisition activity you’ve seen.
“As a reinsurer, you have risk selection and risk management expertise and a big balance sheet. But there are limits to what you can do. To operate in developing economies, you need a degree of technology, you need to understand how products are currently distributed. As a reinsurer you need to own some different capabilities to do that.”
Bill Fischer
“To achieve scale in an emerging economy is difficult because of the influence that larger re/insurers already have within those markets. They have different time horizons from specialty re/insurers, which presents challenges when it comes to launching and scaling operations in those economies.”
Jeremy Pinchin
“The international space is the most competitive and it’s a time to go and extend yourself and put dots on the map and incur extra expense. Underwriters have a habit of wanting to underwrite when they go to these other jurisdictions and it’s not always the best risk.”