Reinsurers seek alternative risk pools

Alternative capital has been taking a growing share, particularly in the North American nat cat market, pressuring pricing and forcing traditional reinsurance players to look for new business opportunities.

The reinsurance industry is under pressure to find profitable growth because investors may otherwise stay away from reinsurance companies, Tokio Millennium CEO Stephan Ruoff warned at a panel discussion at the 2018 Insurtech Insights conference.

“We’ve been disrupted,” Ruoff said. In early days, the cost of capital was 10 percent plus, today it is around 5 to 7 percent, he explains.

“Looking at that, you have to ask yourself what’s the future for your business? You may not find people to invest into your business because they can find returns elsewhere.

“We have either to find new risk pools that allow you to remunerate the balance sheet better, or you have to change your business model,” Ruoff says, adding that a change of the business model may indeed happen with the help of technology.

In the search for new risk pools, notes Adrian Jones, head of strategy & development at SCOR, reinsurers have the advantage of large balance sheets while knowing how to manage them. This puts reinsurers in a good position to supply capital to emerging new risk pools, Jones suggests.

SCOR sees opportunities in funding growth of managing general agents (MGAs) in order to find new risk pools. “A lot of those MGAs will find that over time, they actually need their own balance sheet,” Jones says. “They need to have their own capital and take advantage of reinsurance capital when it’s available,” he notes.

The French reinsurer is, therefore, mulling over how to supply MGAs with capital, which could happen through insurance or reinsurance, equity or convertible notes. In addition, SCOR is looking into how to transfer its knowledge and expertise to these MGAs and cooperate with them.

Insurtech opportunities

Reinsurers are also major investors in the insurtech space, which can create new business opportunities, Ruoff notes. He points to Munich Re, which is seen as a frontrunner in this area.

In order to take advantage of opportunities in the insurtech space, Munich Re has created Digital Partners to cooperate with potential disruptors in the re/insurance sector. In recent moves, Munich Re has backed cyber startup At-Bay; insured the fraud prevention solution of artificial intelligence startup Fraugster; and backed new blockchain-based home insurer Buzzvault.

“Reinsurers have been deploying risk capital into the insurtech space quite aggressively,” says Yann Ranchere of investment and advisory firm Anthemis Group. The fact that reinsurers operate on the basis of cooperation helps them in dealing with insurtech firms, he notes.

However, while the new risk pools are currently relatively small, they might grow exponentially and become very big in the future, he says. As reinsurance is a business that is generally very cautious, thinking about exponential growth rates which can already be observed in the market may be a challenge for the traditional industry, he suggests.

A risky business

US insurtech firm Lemonade grew its business by 1,000 percent year on year in the first six months of 2018.

Lemonade offers renters’ and home insurance policies and has, in the last six months, closed a $120 million financing round led by SoftBank, launched in 10 new states, rewired its claims team, reshaped the production team, launched an open source insurance policy, announced that it is going global, and shipped more than 570 product changes, the company’s co-founder Shai Wininger wrote in a blog in June.

The firm sold the equivalent of its 2017 total revenue in the first quarter of 2018 alone. However, Lemonade’s loss ratio is “still in the red, and about 60 percent higher than where we’d like it to be,” Wininger noted.

Thinking about exponential rates of growth can be alarming as businesses may pile up losses over several years, Jones notes.

“We haven’t seen a lot of insurtech, MGAs and carriers actually producing really good numbers,” he says. “The vast majority of what we’ve seen publicly has been loss ratios going above 100 percent. Are they actually going to be able to get that down before they hit that exponential growth curve?”

Ranchere suggests that capital markets may indeed be better equipped to take advantage of technological opportunities to target new risk pools, pointing to insurance hedge funds as an example.

But Ruoff contends that reinsurers are ready in terms of risk-taking and risk-shaping. “Reinsurers have always been at the forefront of taking on new risks that have not been assumed on balance sheets or being transferred before,” he says. Pointing to the marine industry in the 1800s he draws a line to the current cyber risk cover that is, to a large extent, carried by reinsurance capacity.

Munich Re, for example, held a 10 percent share in the global cyber insurance market in 2017 and increased cyber premium by 40 percent year on year.

The German reinsurer expects digitisation to expand the boundaries of insurability, for example through cyber re/insurance and embedded service solutions for cedants and insureds. The firm has high hopes for its cyber business, which in 2017 had gross written premium of $354 million while recording low loss ratios.

Ruoff stresses that reinsurers are “excellent balance sheet managers” but, he adds, they are also excellent matchmakers between capital pools and risk pools. He believes that reinsurers are set increasingly to take the role of facilitators and balance sheet managers on behalf of capital providers. Technology, in the form of distributed ledger technology—also known as blockchain, or data transmission technology—is likely to play an important part in turning reinsurers into more efficient balance sheet managers, he notes.

Processes need upgrade

The industry is currently exploring and testing the potential of blockchain through the collaborative initiative B3i. Incorporated in Zurich, B3i Services wants to provide insurance solutions on a blockchain platform that is set to improve efficiency across the value chain of the re/insurance industry—in some cases up to 30 percent, according to the organisation.
These solutions are expected to benefit insurance companies and customers through improved speed, transparency, quality, security, and cost.

B3i completed its first product, a blockchain prototype for property cat excess of loss reinsurance contracts, in mid-2017. Throughout October 2017, a group of 38 insurers, brokers, and reinsurers tested its functionality and robustness. The prototype demonstrated that transactions could become quicker, more efficient, and more secure than with current methods. The first live trades on the platform are anticipated by the end of 2018, with several other products being developed concurrently.

Reinsurers could indeed benefit from an upgrade to their processing systems, Ranchere says, noting that reinsurance businesses are still running a trillion-dollar exposure on papers, emails, faxes and scans.

Ruoff agrees that processes in the reinsurance industry may be outdated but explains that is due to the fact that they are at the end of the transaction chain and are therefore dependant on data standards that have already been transmitted a few times along the value chain. If a reinsurer decided to set its own innovative technological standards, it would be at risk of being sidelined if the rest of the value chain did not follow.

“What you define as your own data standard may not match what the front end is defining as standard,” Ruoff explains.

Efficiency levels in transaction processes are certainly a lever that this industry has to pull, he notes, but reinsurers are hesitant to invest in this space because of fear that the technology may not develop into a global industry standard.

“If you look at recent initiatives such as B3i, it does attract interest, but people are moving very carefully because they don’t know if this will become the industry standard,” Ruoff says.
Even if a clear industry standard for technology was to take shape, reinsurers would face further challenges.

“You can already see about 10 blockchain initiatives out there that are likely to be successful, but no-one really knows how to integrate these into the legacy systems,” Ruoff says. Replacing the legacy systems would, theoretically, be a solution, but could also create additional problems.

“We depend on huge data structures that are sitting in legacy systems for the reporting on the balance sheet required by regulators,” Ruoff explains.

Technology as a solution

Improvements in the processing systems may be needed if reinsurers are to take advantage of the potential of new risk pools, Ranchere notes.

Higher efficiency levels would create better risk coverage and enable companies to reduce the significant protection gap existing in the world, he explains.

Ruoff notes that new technology may also be a solution to excessively high transaction costs in the sector.

“Our industry spends close to 40 percent on transaction costs. This is way too high,” he says.

Technology in the form of internet of things (IoT), AI or predictive modelling may be part of the solution. Such technology may transform re/insurance products away from risk protection to services offering risk prevention, Ruoff suggests.

“If we can manage to turn insurance into a service that helps people to prevent their house burning down, or warns them when a hurricane is coming, or that can predict when nat cats are going to happen, then insurance becomes a much easier product to sell and turns it into a much more widely accepted product. This is something that technology can really drive,” Ruoff says.

Not all will succeed

There are likely to be winners and losers in the modernisation challenge the reinsurance sector faces, Ruoff suggests. “A rift in the industry is likely to emerge. Technology development is relatively expensive. If you start developing technology and you cannot scale it, the investment will not pay off,” he explains.

Furthermore, to absorb the volatility that comes with covering risks in emerging new pools requires certain capacity levels, Ruoff notes.
“When you look at the cyber exposures that are piling up and are being transferred into reinsurance balance sheets, only the largest balance sheets will be able to provide enough strength to absorb the volatility in the development of that risk,” he says.

In addition, reinsurers need to prepare for the prospect that the nature of risk is going to change, Ruoff notes.
“We are moving from tangible assets towards intangible assets. Protection for intangible assets will become key in the future,” he says.
To be among the winners in the reinsurance space in the future, companies need to have the right people in place who understand the future—as well as a very strong balance sheet, Ruoff explains.

Jones agrees that there will be a selection process taking place in the P&C reinsurance space causing the number of players to decline.

“If you look at the life reinsurance space, the business is concentrated among six companies,” Jones says.
“In P&C it’s around 15 or 18. We are going to be a lot more like life. A lot of what the industry is currently experiencing will result in the consolidation of the P&C space and we are seeing that already,” he says.

“In a few years we will probably see significantly fewer reinsurers in the world than today,” he notes.