May 24, 2011 by Daryl Angier
An oversupply of the product, declining prices and a long-term trend of steadily shrinking demand. Those in the business of selling reinsurance could be forgiven for viewing the current market conditions as a kind of perfect storm. But that’s not how Don Callahan of Guy Carpenter Canada sees things. Since he took over as CEO in 2002, the Canadian arm of the global reinsurance intermediary has doubled its share of the Canadian market to 40%. It has also grown its revenues by 70% over the last five years in a market that has contracted by over 20%. Although reinsurance broking is a unique world of its own, the underpinnings of Callahan’s business philosophy are very similar to the approach of successful brokers in the primary insurance space.
“My goal is to be an indispensable partner to an insurance company,” he says. “It’s not just to sell reinsurance. It’s to make sure that we can help them with their strategy, with their deployment of capital, how they invest their money, all of that. It’s what we have invested in.”
By moving away from a transactional approach and making the focus about providing actuarial and management expertise, the company builds long-term relationships with its insurer clients who view Guy Carpenter as a trusted advisor, says Callahan.
“If we treat the client properly, if we service them with creative solutions, financial ideas for them, we’re going to get revenue. If we ever start designing things so that it’s for our benefit, then we have a problem.”
To be sure, Guy Carpenter has had to face the same challenges as its competitors in the last few years. “We are for the most part linearly attached to the premium in terms of our income,” explains Callahan, and gross written premium in the Canadian reinsurance market has been declining steadily over the last decade (see Decade in Review sidebar here).
There are a few reasons behind the trend, including a global oversupply of capacity that has put downward pressure on pricing and a movement away from proportional reinsurance. Another reason is industry consolidation of primary insurance companies and “one plus one never equals two,” says Callahan. For instance, both GCAN and RSA were/are Guy Carpenter clients, both with good management teams, but the merged company won’t ultimately require the total amount of reinsurance as each did individually.
“When you put two companies together, their capital base increases, their need for reinsurance decreases. Also, the level of sophistication of a consolidated company tends to be higher. It definitely reduces the amount of market that’s available to us.”
The recent regulatory change that removes the 25% limit on unlicensed reinsurance would seem to be another blow to the local market. However, Callahan thinks it will have little impact, noting that it mostly benefits the handful of global companies that prefer to cede reinsurance back to their parents in the UK and Europe rather than buy in the local market. But while Guy Carpenter may advise those clients on a global basis, Callahan’s ideal clients in the local market are the small-to-medium players who also happen to be some of the biggest buyers of reinsurance.
“I far prefer to deal with the mutuals and the Canadian-owned groups because they need us and they’re stable. The decision-making is local. The big global players will move the business in and out, often to their detriment.”
Other recent regulatory change around reinsurance plays into Guy Carpenter’s strengths, says Callahan. OSFI’s B3 guidelines on sound reinsurance practice do a “very good” job of formalizing what boards should be doing in terms of a reinsurance risk management plan, he says.
“They’re great for us because we have all those tools. We can go to boards and educate them and get closer to them.”
In Canada, Callahan was the main driver behind Guy Carpenter developing the kind of actuarial and management expertise that companies require to implement the B3 Guidelines. Shortly after becoming CEO, Callahan hired a highly paid actuary with an FCAS (Fellow of the Casualty Actuarial Society) designation, the gold standard in actuarial science.
“My boss said ‘you want to spend a lot of money on an actuary, we’re not in that business.’ But I brought him in and I took him on as a broker, and he had instant credibility because he had the brainpower and the analytical skills that the client was looking for.”
Since then, he’s hired three more as well as 10 MBA graduates. Having this kind of expertise available gives the company the ability to go beyond reinsurance recommendations and analyze an insurer’s financial strengths and weaknesses top to bottom, explains Callahan. As illustration, he relates the story of a client that came under OSFI’s microscope after its minimum capital test (MCT) dropped dramatically with the collapse of the equity markets in 2008.
“We modelled the MCT, we did an independent study of the claims reserves to make sure that they were adequate. We did sensitivity analysis on all sorts of aspects of the balance sheet. We looked at the investment portfolio. They ended up buying more reinsurance, which wasn’t necessarily our goal. We ended up writing a book, almost 300 pages with lots of exhibits and material they really appreciated. And we don’t get compensated on that per se. But we probably have that client for years to come because they feel that we helped solve their problem.”
Similarly, the analytic and management skill set that Guy Carpenter Canada has built up has helped it develop new markets for reinsurance products in previously untilled soil.
Years ago, the Ontario government set up Agricorp to protect farmers in the province from risks such as weather-related production loss (e.g. drought, hail) and unstable market conditions. In 1997, a senior member of the Guy Carpenter team approached the crown agency and advised it of the volatility of potential payouts it could be facing in the event of a major drought or other event. Sure enough, the agency was facing substantial losses a few years later.
“It was bad for the reinsurers in a way, but good for the business, because it showed that Agricorp had prudently purchased reinsurance to protect itself against that volatility,” he says. Shortly thereafter, Manitoba invested in a similar reinsurance program and other provinces have followed.
“It brought actuarial science into it in a big way to look at the variability of commodity prices with crop mix. You see corn, for example, these days is going through the roof. And if we were to model the loss that took place five years ago, it would be a very different loss today.”
Callahan goes on to point out that agriculture subsidy programs aren’t the only area where governments face weather-related risks with reinsurance potential. For example, most major municipalities in Canada have a snow removal budget. “What happens if there’s way too much snowfall and their budget is totally inadequate?”
When asked if he sees these government-tailored programs as an emerging market, his answer takes a much wider view.
“Risk is an emerging market. That’s why B3 is interesting. People haven’t generally assessed very accurately their risk; not just in the insurance business but in every business.” He points to the spectacular conflagrations at companies like AIG and Barclays Bank to prove his point. “I think there’s a huge opportunity in the emerging industry of quantification of risk and managing that risk.
“A lot of people think reinsurance is dead but I think it will be there; it will evolve.”
“Be totally willing to do all the grunt work. I still do it. I’m in there on Saturdays watching the printer churn out submissions. Never think that anything is beneath you.”
On reinsurance specifically: “Have a first-class education, preferably a post-graduate one. I went in through the insurance end, which is a very good way to empathize with your client. My first year in the business I was inspecting fire worthiness in restaurant kitchens.”
Copyright 2011 Rogers Publishing Ltd. This article first appeared in the March 2011 edition of Canadian Insurance Top Broker magazine.
This story was originally published by Canadian Insurance Top Broker.