The true meaning of innovation

In the annual Intelligent Insurer roundtable in Baden-Baden in association with S&P Global Ratings, senior executives from reinsurers, brokers and buyers debated how the buying landscape is changing in Europe and what the definition of innovation in reinsurance should be.

In attendance:

The changing strategies of buyers in Europe against a backdrop of market and regulatory pressures and an increasing availability of new forms of capacity and alternative risk structures was the theme of discussion at Intelligent Insurer’s annual roundtable in Baden-Baden this year.

Sponsored by S&P Global Ratings, participants from reinsurers, brokers and the rating agency debated how buyers have reacted to this changing environment and what forces are driving change and innovation in the market.

Johannes Bender, director of financial services ratings, insurance lead analyst at S&P Global Ratings, kicked things off by giving an overview of capital levels in the industry. He said that in 2015, for the first time since 2008, levels of traditional capital in the industry decreased slightly, which is unusual in the absence of a big loss.

Nevertheless, he said, capital adequacy in the industry remains at the triple-A level with a capital buffer in place of around $26 billion. He said that even if one of the recent hurricanes to hit the US had become a one-in-100-year event and caused severe losses, the industry’s overall capital level would have likely remained at around the triple-A mark.

Bender also noted that although issuance levels of new insurance-linked securities (ILS) have dropped in 2016, the prevalence of the so-called hedge fund re players is contributing new capital to the industry and continuing to put pressure on pricing, while also giving buyers more options.

Massimo Reina, chief executive of Continental Europe and MENA at Guy Carpenter, said he had witnessed a change in the dynamic between reinsurers and buyers, with an increase in the development of new products and an increased focus on using reinsurance as a tool to create value. He said that while the trend is not as prevalent in Europe as it is in the US, an increased movement is notable.

Marc Beckers, head of Aon Benfield ReSolutions EMEA and managing director at Aon Benfield Securities, said he had so far been disappointed by levels of innovation in the reinsurance industry, arguing that new product development that has occurred has been driven more by regulatory changes and the search for capital relief than it has by a desire to innovate in the industry.

He stressed that while regulation has inadvertently driven some innovation by forcing insurers to rethink the way they use reinsurance, regulators also hold it back because they have become increasingly inflexible in their approach.

“They used to be open to considering the commercial benefits of something new; now, they have adopted more of a tick-box approach, which does not help innovation,” Beckers said.

Jens-Ulrich Peter, managing director, head of property underwriting EMEA at Swiss Re, argued that innovation must be a two-way street whereby the buyer has a desire to do something different and the reinsurer is able to help.

He said that some clients have become very sophisticated in the way they use reinsurance for a greater variety of purposes ranging from earnings protection to volatility management to capital relief. “Our aim is to help them execute on those strategies,” he said. “In this respect, reinsurance could be regarded as being more innovative.”

A varied picture

Arno Junke, chief executive officer, Deutsche Rück, made the point that while in recent years the industry has become fixated on the idea that reinsurers can be split into tiers, while this is correct, the buyers themselves are far from homogeneous and there are many types using reinsurance in many different ways.

He said there is a tier of very savvy and sophisticated buyers who have the depth of expertise to use many different forms of risk transfer and test the water when new solutions and innovations emerge. “They have the talent and ability to work in that way,” Junke said.

“Another layer of buyers also exists who are not so sophisticated. A mid-sized mutual player, for example, has very different requirements compared with these big organisations,” he said. “Innovation does not serve all buyers well. It is very much a case of horses for courses. Some just want hassle-free, simple transactions and to keep things simple.”

Martin Hartmann, chairman of the board of directors at VIG Re, who is also responsible for buying reinsurance for VIG Re and therefore could speak with a buyer’s perspective, stressed the wider pressures that are facing the industry including soft rates and low interest rates compounded by rapid changes in society and disruptive forms of technology.

He said that VIG Re finds the market very favourable to reinsurance buyers at the moment and VIG Re tends to seek more long-term partnerships that deliver long-term value. He said the company has looked at using alternative risk transfer arrangements and new forms of capacity.

While the transactional costs make them uneconomical at present, he can foresee a set of circumstances whereby traditional capacity was not so prevalent and such instruments might be needed.

“If the landscape were to change, we know we have tested the ground by looking at these, but they are not suitable for us just yet,” Hartmann said.

Beckers at Aon Benfield noted that due to the short-term nature of regulatory requirements, reinsurers do not seem to have the ability to test new ideas and forms of innovation which may benefit them long-term in the way they used to. This can stymie their ability to innovate.

Bender at S&P said that forms of innovation could be seen in the way the industry has moved to tackle cyber risk and offered cedant capital solutions since Solvency II was implemented.

Junke agreed and argued that the industry should not be too critical of itself since the benchmark for what constitutes innovation in reinsurance cannot be compared to that in other more fast-moving industries.

“Innovation in the re/insurance industry is very different from that in other industries and we should refrain from applying benchmarks,” he said. “We can have good timing but we are fairly slow to adjust and change, which is not necessarily a bad thing.

“Our core purpose is first and foremost to protect and be safe. There are some initiatives ongoing that I think will result in some good things but we need to be more lenient in the way we judge ourselves on innovation.”

Reina at Guy Carpenter added that many reinsurers try hard to innovate but that some cedants have business models that do not allow innovation to prosper. He also warned that there is also a risk that without innovation the business models of some insurers and reinsurers could become redundant. A key change in the future will be the way distribution networks are accessed, he said, arguing that some capital providers will try to get closer to the source of risk, a trend that will threaten the traditional system.

Different needs

Peter at Swiss Re said that, in his experience, cedants have very differing needs: some simply need capacity, others want more complex solutions. He said it is a question of listening and adapting to their needs and demands. Swiss Re can offer hassle-free capital or innovative solutions, he added—the reinsurer has a ‘lab’ which it uses to experiment with new solutions in a controlled manner.

Hartmann at VIG Re warned that the industry is at risk from fundamental disruptive changes that will present both great challenges and opportunities.

The discussion moved on to mergers & acquisitions and the issue of whether a smaller number of larger reinsurers would be a good thing for the industry or not. The panellists generally agreed that buyers would prefer more options and a greater diversity of markets but that both regulatory adjustments and changes in buying patterns combined with wider market pressures make further consolidation almost inevitable.

In their final remarks, the panellists raised some other important topics. Beckers noted how different the reinsurance programmes of similar insurers in the same market can be but also pointed out the trend towards the use of more multiline and multi-year programmes.

Peter at Swiss Re said the industry should not neglect the importance of attracting the best talent to help it adapt; Reina at Guy Carpenter said the industry will need to address the costly value chain between the risk and the ultimate capital provider, warning that capital providers, insurers and reinsurers could end up competing in the same space. Again, he said, the key will be the distribution network.

Junke said there seems to be a clash of regulatory systems, which is not healthy and must be resolved. Hartmann said the industry risks heading into a crisis if it does not adapt, while Bender at S&P warned that, while he disagrees that the industry is headed for a crisis, many players risk not achieving their cost of capital in 2016/17, which could prompt a rethinking of pricing and their business models.