Traditional reinsurance model threatened by commoditisation

Reber argues that there is a case for change in the industry, as the old business model is hardly growing in terms of size but also in terms of financial returns.

Reinsurers are under pressure to restructure their business and innovate in order to differentiate themselves or may see their income dwindle, he suggests.

“You’ve got several things coming together: a low point in the cycle, and a soft market that just keeps on enduring because there is nothing that makes it hard,” Reber says.

The old traditional business model of reinsurers worked well for a long time. “If you had a regulated balance sheet, and if you managed your capital well to get an A- rating you were fine. You'd just go out there and you'd get a piece of the pie because you knew some brokers.”

Reber suggests this is still the way reinsurers operate particularly in the North American market, and slightly less in Europe, as the latter has a greater proportion of direct relations between the reinsurers and cedants than in North America.

He suggests that in North America, the ratio is 80 percent broker to 20 percent direct, whereas in Europe it is around 40 percent and 60 percent direct – or 50-50, depending on the segment.

A changing reinsurance market

In Europe, despite a soft market arguably making reinsurance more appealing to cedants, growth is slowing down, according to ratings agency AM Best.

For the 15 companies in Europe for which data was available, premiums ceded increased by 3.0 percent to €21.9 billion in the first half of 2016, while GPW decreased by 1.3 percent to €154.1 billion. In 2015, reinsurance growth was significantly higher. Total non-life premiums ceded by the 20 largest European cedants rose by 17.9 percent to €44.2 billion while gross premiums written (GPW) increased during this period by just 6.2 percent to €333.3 billion, according to the report titled “European Cedants Continue to Increase Reinsurance Buying but Demand for Cover Slows.”

Reinsurance growth in Europe is often coming at unsustainable low rates. Many reinsurers are recording combined ratios above 100 percent excluding prior-year reserve releases.

In the US, cedants are also changing the way they buy reinsurance. A Conning report suggested that a majority of the largest cedants did decrease the size of their reinsurance panels, among the top reasons being industry consolidation, a flight to quality, the expanding of capacity and services of larger reinsurers, the growth of alternative capital, a continued soft market, and a desire for more efficiency.

Though insurers are ceding more of their premium than they were ten years ago, reinsurers have not necessarily benefitted because more risk is being assumed by non-traditional risk bearing entities in various forms, according to research by Conning. One of its conclusions was that even though insurers are retaining less risk, the traditional reinsurance model has lost out to other means of risk transfer.

A commoditised market

In today’s re/insurance markets, a large chunk of what used to be ceded has become a complete commodity, according to Reber.

He suggests this commoditisation of the reinsurance market is making it harder for the old fashion reinsurers to differentiate themselves.

And in a broker-dominated market such as North America, cedants may end up simply going for an attractive price.

“Natural catastrophe today is a complete commodity, and that's still a bulk of the reinsurance industry. Motor has also become a complete commodity,” Reber says.

“Many customers just don't see the differentiation anymore. Customer expectations for all of those commodity covers are that they are just to get a simple solution for them that doesn't cost them a lot of money. So they are buying on price almost.”

This is exacerbated by the increased consolidation in the market, making way for larger insurance groups which can keep more risk in-house and have to buy less reinsurance.

“If you are a big insurance group you can basically keep it inside your various structured balance sheets. And that is made easier because there are more and more big groups that are being formed through consolidation.”

The need to innovate

The highly commoditised market is attracting alternative forms of capital, which is creating a greater need for the old fashion reinsurers to innovate in order to differentiate themselves, according to Reber.

Insurance-linked securities (ILS), for example, has been growing in recent years, driven by investors looking for yield in a historically low interest rate environment. In 2016 the total nominal amount of outstanding ILS was $26.9 billion, which compares to around $10 billion in 2006, according to a March Bermuda ILS Market Report.

Reber’s solution to the challenges reinsurers face is three-fold. Firstly, reinsurers need to be more innovative – and innovative in a number of ways in terms of what their product offering.

The second is that reinsurers need to be more innovative around how they use and leverage data, and how they make use of digitisation.

Munich Re, for example, is investing in IT and data analytics, hoping to boost the company’s revenues from services.

“This allows us to deal with large datasets and advanced analytical methods to dive into the datasets of re/insurers and detect patterns in customer behaviour in order to create new products,” Torsten Jeworrek, executive board member responsible for reinsurance, said during the company’s 2016 full year press conference. The technology is to be applied by Munich Re in its reinsurance operations to support medium-sized primary insurers which could not shoulder such an investment on their own.

Not only is there a developing trend towards tailored solutions, an opportunity seen particularly at Swiss Re, but some reinsurers are also moving into more fee-based models.

And thirdly – which Reber thinks for most players comes as a distant third – is for reinsurers to start to look at costs.

Costs are not something that is typically looked at, according to Reber, who suggests that reinsurance has never has been a very cost-driven industry.

He explains: “And most of the old fashion, classical reinsurers are convinced they are never going to win the game because of a cost advantage, but they start realising that they could lose it because of a cost disadvantage.

“If you give any reinsurance CEO the choice between cutting costs or investing into some differentiation in making use of digital, they would use the latter. They would rather invest into new ideas, rather than cut costs.”

Inefficiencies in the model

There has never been much of a cost culture in reinsurance, which is partly the reason there is ‘fat’ in the model and inefficiencies in the way reinsurers work, says Reber.

But Reber suggests that innovation has a much bigger impact than mreley cutting cost on old ways of doing business. “Inefficiency sounds like they could be doing the same things just in a more efficient way. But my point is its less about doing the same things in a more efficient way – for example taking costs out – and more about doing different things. This will eventually have a positive impact on cost as well."

A big reinsurance company with several billion dollars in premium income, Reber gives an example, an improvement in the combined ratio of 1 or 2 percent is huge.

“If you have 1 percent improvement of your combined ratio that can get you $50 million on a premium volume of $5 billion. Just imagine the kind of cost cutting efficiency programme that you need to run to get $50 million for a reinsurance company.”

Reber suggests that if a company can use insurtech or data analytics to improve its underwriting, for example, it can help to improve the combined ratio which has a much better bottom-line impact than squeezing out some costs.

But one thing Reber says to remember is that the reinsurance industry is one of the slowest changing industries in the world.

“If you are in a business where sometimes it takes several decades to know whether a particular transaction has been profitable or not, and if you think about an industry which makes transactions once a year, rather than every 5 minutes, then yes, change is very slow,” he concludes.