Relief on hurricane losses ‘somewhat pyrrhic’ for reinsurers

While a lack of severe or market-changing losses as a result of some of the recent hurricanes including Hurricane Matthew will be a relief to many of the reinsurers attending Baden-Baden this week, this cannot mask the more fundamental challenges they face, Clive O’Connell, partner, head of insurance and reinsurance at law firm McCarthy Denning, told Baden-Baden Today.

“Some relief will be in the air. The insured losses from Hurricane Matthew have been lower than originally expected. But that relief is somewhat pyrrhic. The storm will do nothing to allay the greater threats the market faces.

“The market has to come to terms with the effect that the soft market is having and assess how long-term its damage will be.”

O’Connell pointed out that in any soft market, broking and underwriting discipline suffer. But the impact of such indiscipline will usually come to light only when the market turns.

“With underwriting returns minimal, investment income all but disappeared and reserve releases already done, cost-cutting is about the only way in which reinsurers can look to maintain profitability. Cost-cutting does not sit well with maintaining discipline,” he said.

One form of mitigation that reinsurers are adopting is the pursuit of new areas of business. Reinsurers are leading the charge into insurance-related financial technology, aka insuretech or fintech, he said.

He also warned that in so doing, they threaten to remove insurers from the value chain.

“While this is a demonstration of strategic thinking by reinsurers, it disguises a deeper threat.

Insuretech operates by taking data and applying technology to it in order to create an underwriting model which is more accurate than any human can be.

“The right risks can be written at the right premium. However, the very fact that risks are being modelled in such a refined way opens up a threat to insurers. Modelling opens the door to insurance-linked securities (ILS) products. Where there is a model there can be an index and from an index one can create a bond or derivative.

“Thus, while insuretech can allow insurers to perform better, it also allows the competition from alternative capital.”

O’Connell added that alternative capital is facing the same issue with respect to declining premiums and the same challenge in terms of obtaining investment income. As such, it too is looking to diversify in order to protect its exposures and to create new sources of income.

“ILS money is bound, unlike reinsurance capital, to investments that are very short term or liquid through tradability. They also require modelled risk and a form of index. And this is where insuretech can assist,” O’Connell said.

“As the basis of insuretech is the modelling of data, objective indices can be created from those models. Once an index is created, a product can be created and traded.

“The very mechanism that reinsurers are using to remove insurers from the value chain, could well be the basis for ILS markets to disintermediate not only insurers but reinsurers themselves.”