The recent run of heavy catastrophe years, plus the vast impact of Covid-19 on the reinsurance sector has put the industry’s focus firmly on volatility.
A number of composite carriers or other owners are looking to offload their reinsurance assets, tired of the volatility inherent in a business primarily concerned with large natural disasters.
The potential turning point brings up age-old philosophical questions about the most efficient and effective way of writing and housing cat business.
Could the market be about to enter another phase of deconsolidation after the pre-Covid period of integration of cat-heavy reinsurers into combined insurance/reinsurance composite carriers?
Reinsurer Deconsolidation: A Potted History
The last period of significant change in the ownership of cat reinsurers was just after 9/11, 20 years ago last week.
Prior to the terror attacks that had such a profound effect on the (re)insurance sector, there was a pervading view that reinsurance performed better as part of a broader carrier writing primary P&C cover and/or life.
However, after the event — which cost the industry $47bn in today’s money — carriers went through a phase of selling off their cat reinsurance operations in a bid to cut down their exposure to such volatility — similar to cycles that played out in the 1990s.
In the past decade or so, 17 reinsurers have been consolidated out of existence — hastened by the entry of third-party capital to the reinsurance market cutting down double-digit returns from property cat.
This year, the market finds itself looking back at five years of drastically elevated cat activity,with 2021 looking to be an above-average cat year as well thanks to Winter Storm Uri, Hurricane Ida and flooding throughout the summer in Continental Europe.
Tiger Risk CEO Rod Fox argued during a session at last week’s (Re)Connect virtual conference that the reinsurance market is now “running” from volatility, due to “cat fatigue” and a “psychological as well as economic” reaction to cat losses.
For some composite carriers, the efforts to reduce their exposure have been evident for some time.
Clearly, there is no easy home for catastrophe volatility after the past five years the industry has been through.
A prime example is Axa XL, where the reinsurance unit has always sat awkwardly with the annuity-style returns that the wider Axa group favours.
A commonly held view is that Axa bought XL, not for its reinsurance unit — the sale of which it explored before buying the carrier — but to gain access to the commercial risk it was exposed to via its P&C insurance lines.
It was unsurprising, then, when Axa set up a rated, Bermuda-based entity for its reinsurance operations, in an action that removed a major impediment to a future sale of Axa XL Re.
In contrast, Exor has made a number of moves to sell Bermudian reinsurer Partner Re — its only insurance asset — first through rumoured talks with Scor and later through a failed deal with Covea.
The attempts by the investment company could be taken as a sign that there is little strategic runway left for a standalone reinsurer such as Partner Re — or at least, that even private investors free of public market obligations may weary of volatility.
Clearly, there is no easy home for catastrophe volatility after the past five years the industry has been through. Even the ILS market, set up to offer cat risk as a diversifier to institutional investors, has experienced phases of stagnation in recent years.
Where Should Cat Volatility Sit?
There are a number of schools of thought about the best place to house cat risk, with its potential for significant upside in benign years, whilst protecting against the often dramatic downside.
Although in some ways reinsurance and insurance can be seen as two sides of the same coin, it can be said that insurance is a question of logistics — distributing a relatively simple product and organising the payment of claims —– whereas reinsurance is more akin to high finance. Does it make sense, then, to write the pair together?
Certainly, some insurance acquisitions can lead to cultural conflicts.
As Inside P&C explored in July, leading insurer AIG faces a raft of challenges due to its continued ownership of Validus, not least the way in which holding the reinsurance asset conflicts with the way in which AIG has moved to slash exposure to volatility in its primary business in the past two years.
It has seen a stream of underwriter exits from the reinsurance unit in the past year.
The Combined Benefits
But some argue that writing reinsurance alongside a book of primary P&C business helps a carrier to smooth out the volatility of the cat business when it comes to overall returns.
Subscribers to this view also believe that having a primary platform provides a coal-face view of the risks, loss developments and trends present in underlying business, helping to make smarter decisions on the reinsurance underwriting side.
Writing in both primary and reinsurance market also allows carriers to shift emphasis between the two depending on where market conditions are most attractive at any point during the cycle.
Some argue that writing reinsurance alongside a book of primary P&C business helps a carrier to smooth out the volatility of the cat business when it comes to overall returns.
Reinsurance pricing is on the rise, thanks to recent elevated cat activity as well as the impact of Covid-19 on property contracts.
High levels of capacity in the sector remain, however, and the double-digit returns on cat business seen 20 years ago are firmly a thing of the past. With its capital-intensive nature, some believe reinsurers simply cannot afford to write reinsurance only.
It is notable, in fact, that the majority of the crop of start-ups that have launched in the past year or so either already or aim to write a mix of insurance and reinsurance business, excluding pure play reinsurer Conduit.
Climate change is another factor cited by those who believe in running the two portfolios together. Given the risk of increased frequency and severity of cat events that bring with it more volatility on the reinsurance side, this may emphasise the need to diversify with insurance.
The Standalone Case
There are counterarguments to the theory that writing primary and reinsurance is efficient and effective, however.
First of all, some standalone reinsurers believe that they can sufficiently diversify their portfolio by writing a mix of long-tail, short-tail and specialty business, ensuring that each segment has different loss development characteristics and capital demands. This would negate the need for an insurance portfolio as well.
Another counterclaim to the theory that reinsurance and insurance are needed to diversify is the fact that in some cases, carriers writing both books at times have written very similar risks in each portfolio, providing no real diversification.
Blending insurance and reinsurance, then, is not a simple tactic in the quest to smooth out reinsurance volatility.
An example here is Swiss Re Corporate Solutions (CorSo), which is now in the latter stages of a vast turnaround project.
The primary unit of the world’s largest reinsurer came unstuck in 2019 after a series of large losses over the preceding few years, which was exacerbated by the fact that its excess property and casualty risk correlated closely with the reinsurance book.
This was due to a set of trends that affect both reinsurance and primary business, such as the increase in severity of secondary perils impacting both primary and reinsurance property, or social inflation hitting both primary and excess reinsurance in casualty.
By contrast, Swiss Re rival Munich Re attempts to ensure that its primary business Risk Solutions writes very different business to the lines that it reinsures, avoiding risk aggregation.
Blending insurance and reinsurance, then, is not a simple tactic in the quest to smooth out reinsurance volatility.
Neither is a reinsurance portfolio an easy fit with that of life insurance.
One of the main advantages of writing both P&C and life business is the ability to cross-sell P&C and then life to large corporate clients — meaning the synergy of such an arrangement lies between primary and life business, not life business and reinsurance.
The completely different return profiles and durations of reinsurance and life business could also be seen as a disadvantage, forcing a company to essentially pursue two different strategies with two different investment strategies for its life and P&C arms.
The Question of Ownership
If composite carriers are looking to tackle the question of rising volatility, it is reasonable to expect heightened M&A activity in the sector over the next few years, as carriers with lower tolerance for cat find suitors looking to get into the space.
However, straightforward M&A is not the only solution for a carrier troubled by volatility levels. At times, the glare of public scrutiny and the need to maintain steady share price growth can make life more difficult for publicly traded carriers than private.
One solution here is a take-private manoeuvre. In 2018, for instance, when Aspen faced the negative consequences of having grown aggressively into a soft market, the Bermudian carrier agreed to a takeover by Apollo for an equity value of around $2.6bn.
This allowed the carrier to make progress with a turnaround operation without quarterly shareholder scrutiny. In fact, the carrier said in 2020 that its portfolio remediation had been largely completed.
Earlier this month, Aspen CEO Mark Cloutier said the success in improving the company’s profitability under private ownership could set it up foran IPO by the end of next year.
It is highly likely that as cat volatility continues to increase, M&A in the reinsurance sector will take place, as the changing nature of insurance losses forces senior management teams and investors to reconsider their risk appetites. The question of where cat volatility works best, however, is still a matter for intense debate.
