Alleghany boss warns of cracks in P/C model; alternative capital ‘monster’ may not pay claims

Weston Hicks, the president of Alleghany Corporation, which owns TransRe, has said that cracks are starting to appear in the foundations of the property/casualty industry and stressed that the so-called alternative reinsurance markets remain untested in the aftermath of a big loss warning that the industry may have created a monster.

In his annual letter to shareholders, Hicks noted that the commercial property/casualty industry remained highly competitive in 2016, with prices falling modestly in most classes of business. Since the 2008-2009 Recession the industry has enjoyed good underwriting results - despite a lack of pricing power - as claims emergence has generally been favorable relative to pricing and reserving expectations.

But he stressed that while the industry does a good job of adjusting its prices to trailing loss experience, historically it has not been very good at calling inflection points in these trends. “In the second-half of 2016 cracks began to appear in the foundation of the industry’s underwriting account and loss reserves. We believe that these cracks will become more visible and more significant in 2017 as stress levels in the industry continue to rise,” he said.

“Companies that have been excessively focused on top-line growth by definition are only able to produce growth by pricing below market, and to do so requires that underwriters assume a continuation of the benign claims environment of the past 5+ years.”

He also called into question the reliability of the so-called alternative reinsurance market, which has taken an increasing share of the global reinsurance industry. In property catastrophe reinsurance in particular, non-traditional capital providers (pension funds, sovereign wealth funds, hedge funds, etc.) have invested in insurance risk pools through managed funds, catastrophe bonds, and other such vehicles.

“Faced with unattractive returns on traditional fixed income investments, these investors have turned to catastrophe risk as a diversifying return source. While highly successful to date, these new risk transfer vehicles have not been tested by ‘the big one,’” he pointed out.

“Will investors in these vehicles “re-up” after a significant, permanent capital loss due to a major loss event? Or have the models created a monster?”

He went onto argue that some new business models that separate the underwriting decision from the capital provider/risk bearer are, potentially, problematic because of a misalignment of incentives.

“The industry has demonstrated time and time again that “giving someone the pen” without tight controls and/or an alignment of interests is a bad idea, whether it be programme business or Lloyd’s prior to the creation of the Franchise Performance Director function in 2002. To the extent unaffiliated capital is used to assume (re)insurance risks, it is best done side-by-side with true risk takers who have skin in the game,” he said.

He warned that ceding companies using non-traditional capacity may discover in the aftermath of a big claim that this form of capital disputes the claim in a way that traditional reinsurers would not.

“While we are no doubt “talking our own book,” there are a number of advantages to the traditional reinsurance model or partnering with true risk takers. First, executives of a reinsurance company that receive their compensation from the underwriting results they produce on a long-term basis are more likely to consider what can go wrong and are also more likely to be cognizant of extreme risks,” he said.

He added: “Technology has allowed the industry to separate the risk-bearing capital provider from the underwriter who decides how much risk to take. The traditional reinsurance model keeps them together. Call us quaint and old-fashioned, but we like the alignment inherent in the traditional insurance and reinsurance company structure.

“To the extent investors allocate assets to insurance risk, we believe they should make sure they are partnered with a true risk taker that is, as they say at TransRe, battle-tested. While the alternative model is changing the playing field near-term, as long-term investors we believe TransRe’s commitment, discipline and proven approach will win out in the end.”

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