Pitch Perfected

If 2017 was a song, surely it would sound like the same old tune to reinsurers: fewer catastrophic events, low interest rates, tepid pricing, a gush of new capital and higher customer knowledge and demand. The persistent hits have combined to produce a familiar din, punctuated by the occasional sour note.

While reinsurers would surely agree there is little encouraging about the persistent conditions, those very drivers are encouraging new arrangements that may be able to coax a bit of harmony from all that noise.

Fundamental changes are unfolding, but that is not necessarily a bad thing.

The past is no longer the reliable predictor that it once was, meaning that new ways of addressing current conditions – including perils that have previously been underestimated – need to be explored and implemented.

Potentially, there is great creativity in disruption. Doing things differently could, perhaps, be completed on one’s own. More likely is that it will involve forging partnerships that allow for exploring how to be more responsive, efficient and customer-centric.

The overriding positive may be that reinsurance as a destination of choice continues to remain strong. That said, remaining relevant by being value-driven and focusing squarely on customer need may serve as a way to orchestrate a more positively sustainable future for the industry.

The imperative for reinsurers, if they have not already done so, is to start taking the lead now. Following is not an option in such a hyper-competitive and evolving space; that is an approach that will surely fall on deaf ears.

PRICE LOW DOWN

There is little argument: reinsurance rates are low. And despite the apparent logic of thinking that decreases must end at some point, global conditions offer few hints of relief.

“For the past few years, speculations were made that reinsurance rates have bottomed out. However, the market kept going lower on a year-over-year basis, outside of the Cat loss contracts,” reports Joseph El-Sayegh, president and chief executive officer of SCOR Canada Reinsurance Company.

When people try to explain pricing today, “they always tend to look at the past and try and extrapolate forward. There’s an assumption that the industry will respond in the same way, or a similar way,” notes Michael Van Slooten, head of market analytics at Aon Benfield Analytics in London. “And, actually, I think some quite fundamental things have changed and that, perhaps, things won’t necessarily play out in the way that has been seen in the past,” suggests Van Slooten.

Buyers of reinsurance today are usually operating in solvency regimes that require them to have a better understanding of the risk they are facing and the exposures they are carrying, he says.

“Rates continue to be challenging as competition to maintain market share continues,” notes Philipp Wassenberg, president and chief executive officer of Munich Reinsurance Company of Canada. “Surplus capacity is enabling cedants to negotiate discounts to expiring reinsurance rates, but they are still dictated somewhat by their past performance and size.”

Geoffrey Lubert, executive vice president and managing director of Willis Re Canada, sees negatives and positives. “Globally, the risk-adjusted rate reductions on short tail classes of business continued for both the January 1, 2017 and April 1, 2017 renewals,” Lubert says. “However, the rate reductions were mid single-digit rather than the low double-digit rate reductions experienced in 2015 and 2016.”

While “reinsurers are encouraged that buyers are purchasing more reinsurance capacity,” he notes, “reinsurance rates will continue to soften in the absence of a market capital event.”

Wassenberg says future cycles are expected to be more shallow. “This will challenge reinsurers to earn back large losses. Our continuing focus will be on insurance risks, safeguarding sustainable value creation,” he emphasizes.

“Reinsurance does not behave differently than other services/products in the market,” El-Sayegh points out. It follows “the law of supply and demand. As long as there is an abundance of capital, translated into capacity in the market, the supply was driving the prices low.”

Lubert would likely agree reinsurers will need to settle in for low rates continuing. Citing findings in a Willis Re study of a subset of 25 reinsurers, “20 markets experienced positive share price development in 2016 and through the first quarter of 2017,” he says.

“At the same time, the expense ratio for this subset of reinsurers increased modestly from 33.1% in 2015 to 33.2% in 2016,” notes Lubert. “Thus, with buoyant share prices and reasonable returns on equity, reinsurers will (grudgingly) support modest rate reductions to the benefit of reinsurance buyers.”

When overall demand is stagnant and capital continues to build, Van Slooten says the pressure is all one way.

“The downward pressure on pricing, very low interest rates since the financial crisis and new forms of capital coming into the industry have combined to create a very demanding situation for reinsurers and some are proving much more resilient to what’s going on than others,” he suggests.

“It’s all about relevance to clients at the end of the day,” he emphasizes. “It’s a very competitive market and it places a lot of pressure on reinsurers to provide bespoke responses in a way that hasn’t really been required in the past.”

Veronica Scotti, president and chief executive officer of Swiss Re Canada, says her company believes in differentiation and focusing its “efforts on value, not price. Despite continued attempts to commoditize our business, many clients have responded strongly to our trusted advisor model and the bespoke services and covers we can afford to extend to them,” Scotti reports.

ON THE HOME FRONT

Rates are generally low and going lower, but what is happening here at home? Are there particular developments that offer some hope of positive change?

With regard to excess of loss (XoL) Cat reinsurance, “market rates appear to have stabilized or hardened during the January 1, 2017 renewals,” Scotti says.

“We view this as a sign that the market at large is contemplating the increased financial risk in Canada due to previously underestimated perils such as wildfires, but also the apparent increase in frequency of climate change-related perils such as floods and hail storms,” she says.

“Canadian insurers continue to be cautious in growing their exposure of earthquake risk in light of potential accumulation and contagion risk. In the casualty market, we continue to see margin contractions and remain concerned with the underlying profitability of this line of business,” Scotti adds.

“I don’t believe the reinsurance market at large will be exiting the Canadian market,” says El-Sayegh. “It remains that Alberta presents the highest frequency of Cat losses and has the least diversification within the country. Having said that, the severity remains in the earthquake-prone zones,” he points out.

“Reinsurers need to look outside the box to find profitable business; to look beyond the current RI (reinsurance) model is the challenge. This could include non-modelled solutions for wildfire or flooding,” Wassenberg suggests.

El-Sayegh’s take is that reinsurers need to look at the underlying products rather than the reinsurance market. “In Canada, the personal lines are under stress and the margins are shrinking. The insurance companies should react and improve their profitability in order to see their impact on the reinsurance results,” he says.

“All parts of the reinsurance value chain are feeling the pressure. Operational efficiencies and disciplined underwriting are no longer enough – something has to give,” Wassenberg says.

NEW VIEW OF BUSINESS

“Over the last few years, we’ve seen people come into the market with some new ideas, some new business models, more of the sort of total-return reinsurer, where they’re trying to make money on both sides of the balance sheet,” says Van Slooten. These reinsurers are “looking to make more money on the investment side than a traditional reinsurer would typically make,” he explains.

“Reinsurers are getting closer to the risk, either by writing directly or understanding better,” El-Sayegh suggests.

“Given the low reinsurance rates, we have been investigating more and more the primary market to understand where the losses are coming from and working closer with our key clients to manage these exposures by various mitigation measures,” he says. “The need to understand the primary market, its terms and conditions is becoming a bigger necessity than prior years,” he suggests.

“With more capital in the market, the ultimate winner should be the insured client as this drives down the cost of insurance,” Robert DeRose, vice president of A.M. Best, notes in a statement releasing Best’s Special Report: Innovation: The Race to Remain Relevant. “But it is the long-term value proposition that really matters for all parties involved and that outcome is still very unclear,” DeRose contends.

Scotti’s view is that “the Canadian insurance and reinsurance market is on the verge of a number of considerable transitions, which, ultimately, benefit the insureds.” These transitions include the following:

• digital distribution channels are starting to make the consumer experience more flexible to individuals’ needs;
• new analytical abilities have started to enhance risk-adequate rate-setting and make risk drivers more transparent, thereby creating incentives for consumers and businesses to put in place measures that reduce their vulnerabilities; and
• development of new, competitively priced, on-demand and customized insurance products where insurance assumes more service-like characteristics will eventually lead to higher insurance penetration and help make society more resilient.

“These are all value-driven, customer-centric and non-cannibalizing sources of growth for insurers and reinsurers alike,” Scotti says. “The closer insurers and reinsurers partner on these endeavours, the more promising the outcome will be as investment can be material and skills complementary,” she adds.

“As reinsurers try to adapt to changing market conditions, we’re seeing more firms looking into more advanced business intelligence and modelling solutions, and replacing core systems,” Mitch Wein, vice president of research and consulting for Novarica, says in a company report on business and technology trends, released this past January.

“As the saying goes, ‘Necessity is the mother of invention,’ or perhaps in our case, the driver of innovation,” says Wassenberg. He sees adopting disruption and innovation concepts as crucial to redefining the RI business model.

“Embracing new technologies and redeveloping core capabilities in partnership with clients and non-traditional entries (insurtech, data analytics) will guide future success,” Wassenberg says.

“But, again, it’s all about being relevant to clients. You’ve got to be able to deliver something different to what’s out there at the moment, because there are a lot of very strong companies doing a pretty good job in terms of bringing product to the market and selling it at an attractive price,” Van Slooten adds.

INNOVATION DRIVER

El-Sayegh reports that SCOR has been active in insurance technology for many years, including having roles in initiatives focused on open-source modelling, process automation and blockchain.

“As we move deeper into digitalization,” Wassenberg points out, “roles will change. The insurance value chain will be disrupted. Creativity in developing customized, client-specific products will push increasingly specialized know-how as well as improved responsiveness.”

There is plenty of interest and investment – including from reinsurers – in insurtech right now, Van Slooten says. “They want to see the technology and the people behind these companies and what they’re trying to achieve,” he says.

“Not since the Industrial Revolution has insurance seen such rapid change in risk and new technology. Understanding how these risk trends will affect your portfolio is crucial to understanding how to measure your risk,” Wassenberg says.

Driverless vehicles, the Internet of Things, blockchain, wearable technologies, robotics and artificial intelligence are all trends that will have an impact on the industry, he says. “As much as we think these trends are futuristic, that future is here – and it is imperative we understand how these will impact our risk.”

Likely the biggest driver of insurtech, though, is “that the industry has a cost issue,” Van Slooten maintains. “There is a big problem with cost in the industry and I think a number of these insurtech initiatives are aimed at driving cost out of the industry in a way that maybe the industry hasn’t really come up with itself,” he says. “The reality is that there is still a lot of paper-chasing and form-filling and process that sits behind the insurance and reinsurance industry.”

HOLD THE COURSE

“Fundamentally, what’s going on here is you’ve got a client base that is being more demanding because they’re operating in a much more complicated world, and that’s forcing reinsurers to raise their game,” Van Slooten says. “It’s one of the reasons we’re seeing consolidation in the industry, because it’s about ending up with an organization that is equipped to respond to changing client demands,” he points out.

“Our business is about risk,” Wassenberg says. “It will always be about risk. But risk changes, evolves, grows and shrinks. We have to be nimble and respond to these changes,” he notes.

“It’s no longer enough, as a reinsurer, to be a following market, just supplying capacity,” Van Slooten contends. Rather, people are “looking for answers to strategic issues that their organization is facing and they’re looking for technical support and know-how from strategic partners that can help them to accomplish their goals.”