One for all and all for one
The underlying principal of (re)insurance is to spread risk. Arguably, no one has been doing that better than Lloyd’s whose syndicates and members have successfully been participating on individual risks for the last 400 years or so. This model remains firmly in place of course but there have been changes in recent years that have begun to challenge this collective sharing of risk. Most notably, reinsurers and insurers are getting bigger; better regulated; better capitalised; and, becoming more competent at managing and quantifying risk; meaning they are able to take on more of an individual risk than they may previously have assumed.
Couple this trend on the supply side with an increase in the ability of buyers to retain more of their own risk on the demand side, and the inevitable consequence is that fewer participants are needed to underwrite each risk – witness the decline in the overall number of syndicates at Lloyd’s over the years. For those smaller and mid-sized syndicates offering reinsurance however, there has been a turning of the tide with the comeback of the consortium in the face of a competitive onslaught from alternative capacity and the ILS markets.
A capital choice
Given poor investment returns elsewhere since the global economic meltdown, reinsurance has proved a happy hunting ground for a number of insurance linked securities (ILS) backed reinsurers – originating particularly from Bermuda and Switzerland – who, having achieved significant assets under management at their inception, needed swift access to large amounts of risk. It’s far easier to do this of course by completing a smaller number of bigger deals and the ILS model continues to write far larger average lines than most reinsurers in the traditional space. This development in turn has achieved greater efficiency for both clients and brokers. Why go to tens of markets when you don’t need to? More so if the actual limits you are buying are reducing because of your ability to retain more risk. For the traditional market this has meant the emergence of core or ‘top tier’ reinsurers, comprising more material, strategic partners, with the ability to write bigger lines that can compete with the ILS model. But it has also provided a major challenge to smaller reinsurance syndicates in terms of their ability to access premium. Reinsurance has long provided a big slice of the premium pie for many syndicates writing across insurance and reinsurance lines. Take that slice away and it has big implications for the rest of their business. In many ways it can drive further softening in insurance lines as syndicates ramp up the competition in other areas in a bid to prop up their gross written premium figures.
Back to the future
To remain relevant in the reinsurance space then, the answer for many of these smaller players is the consortium approach. This has the simple solution of enabling them to see business that they would otherwise be denied access to, simply because they can’t offer big enough lines. In many ways this is a simple reversal to the true Lloyd’s model; multiple participation in individual risks. However, it is an approach not without its challenges. In an age where the perceived commodisation of the reinsurance product is a real threat to the industry, a consortium limits each reinsurer’s involvement to that of being a capacity provider only. In a traditionally face-to-face trading environment such as Lloyd’s, the visibility between underwriter and the client/placing broker is lost. Does the consortium compromise one of Lloyd’s greatest strengths? From an underwriting perspective, why employ underwriters at all? The need to actively manage and staff a reinsurance account is greatly reduced, with no need to duplicate all costs within the consortium. It sounds efficient but can a consortium be comfortable with the risk it takes on if it can’t perform a fuller underwriting exercise? Is this taking on the ILS providers at their own game without the backstop of underwriting experience and nous that Lloyd’s has built its history on?
Capacity aplenty, but where’s the value?
Buyers might be pleased at the inexhaustible fluidity of capacity they can access but the pay-off might well be less access to the underwriting expertise that can bring real value aside from simple risk transfer. To counter this, other Lloyd’s players, Hiscox Re included, have pushed their relevance in terms of the size of lines they can deliver for a single risk through harnessing third party capacity as part of their brand (whether that’s through working with other quota share providers, traditional Lloyd’s names, retro and special purpose syndicates), all fronted and wrapped in a single claims and servicing model. This approach delivers the limits and efficiency without the complexity of dealing with the constituent capital providers and retains that all important opportunity to deliver value to client beyond a simple risk transfer exercise.
For the smaller and mid-sized Lloyd’s reinsurers, this option might not be available leaving the consortium approach the only game in town when it comes to trying to hang on to the premium dollars. There’s nothing wrong with that of course but the challenge must be how they can maintain the Lloyd’s/London underwriting skillset that can really differentiate in an increasingly commoditised marketplace.
*This article first appeared in Insurance Day 15/09/14.