MORO 2014

Current State of the Reinsurance Market

10th June 2014

Current State of the Reinsurance Market

• Capital inflow

• Business models

• Impact on the (re)insurance market

• What does this mean for mutuals

2

MORO 2014

Capital inflow

Capital inflow - “Creative destruction”

“The Search for Creative Destruction”

• The notion of “creative destruction”

emphasizes that innovation can disrupt certain industries forcing established business models to either adapt or die

• A recent Goldman Sachs discussion report highlights innovations that are transforming businesses:

1) E-cigarettes 2) Cancer Immunotherapy 3) LED Lighting 4) Alternative Capital in Reinsurance 5) Natural Gas Engine Technology 6) Software Defined Networking 7) 3D Printing 8) Big Data

4

• The market is changing…

• Today we will shine some light on the economics behind these changes

• At the end of my address I hope you will share my view that this is – of a scale unlike anything we

have seen before – is going to significantly change

the way we do business now

Capital inflow - Why and from where?

5

Putting it in perspective…

• The Espirito Santo Plaza we are in today is 148.4m (487’) tall

• If this is representative of Global Pension Fund Assets…

• Global Reinsurance Capital would be just 1.48 m (4’ 8”) tall

Capital inflow - Why and from where?

• The (re)insurance industry creates cashflow

• Lack of investment opportunities elsewhere – A function of globally low interest rates – Reinsurance margins are attractive in

comparison

• Hedge funds and pension fund managers want to find new and non-correlating investments

– Reinsurance has become a defined asset class

• Studies show that non-traditional capital market

sources amounts to ~USD 50bn entering the reinsurance market

– USD 20bn cat bonds – USD 17bn collateralised reinsurance – USD 7 bn ILWs and derivatives – USD 5 bn in sidecars

6

• Only a small portion of total pension fund assets entering the reinsurance market can have a big impact

– Global Pension Fund Assets ≈ USD 40,000,000,000,000

– Global Reinsurance Capital ≈ USD 400,000,000,000

– Estimated new capital to date ≈ USD 50,000,000,000 ≈ 0.125% of Global Pension Fund Assets

Capital inflow - Who is buying?

7

• Sampling of 7 placements of $500M or greater • Average of 36% of limit placed with non-traditional markets inc. cat bonds • Conversely placements of $100M or less are placed 90%+ with traditional

reinsurers

Capital inflow - Why reinsurance and not insurance?

8

• A truly global industry which offers diversification

• Low barriers to entry – Regulatory – Distribution

• Skills in one territory are transferable to another

– Significant pools of talent in key locations (Bermuda, London, Zurich etc.)

• Relatively little “infrastructure” needed to start underwriting

– Reinsurance is low volume, high premium busines

• But is there too much intermediation capital and the original risk?

Esure • UK personal lines insurer • 1,500 staff in the UK • Wrote ≈ USD 800m of premium in 2012 • USD 0.5m / employee

Leadenhall Capital Partners LLP • UK based ILS fund • 11 staff • > USD 1.5bn funds under management

generating estimated $300m of premium • USD 27m / employee

Munich Re • German based reinsurer • 45,000 staff • > USD 68bn of premium in 2012 • USD 1.5m / employee

MORO 2014

Business models

Business models - Collateralised reinsurers

10

• An established reinsurance company – Offers traditional reinsurance products – Historically focused on property catastrophe – Typically prefer not to give reinstatement cover

• No rating, agency review or publically scrutinised accounts

– Offers Trust Agreement (collateralization of limit) or Letters of Credit instead of “promise to pay” – May engage a traditional reinsurance company to act as “fronting” for the transaction – Often seek commutation language within Trust Agreements

• Now starting to diversify

– Considering other lines of business – Establishing a foothold in the Lloyd’s market, US insurance market – Looking for insurance opportunities

• Example companies

– Nephila (Poseidon Re) – Aeolus Capital Management Ltd (Aeolus Re Ltd.) – Alpha Cat (Alpha Cat Re Ltd)

Business models - ILS Funds

11

Investing in insurance-linked securities (ILS)

• Not insurance companies

• Started life as specialist investors in catastrophe bonds

• Subsequently broadened their appetite as they have grown – Industry Loss Warranties – Derivatives – Traditional reinsurance

• Examples

– Securis Investment Partners LLP – Leadenhall Capital Partners LLP – Twelve Capital AG

How a (re)insurance policy is issued

• Fully Owned: Fund uses a wholly owned Special Purpose Reinsurer or Vehicle (“SPV”) with an appropriate licence

or • Third Party: Fund rents a cell (or

segregated account) in a protected cell company

or • Fronting: Fund engages a traditional

reinsurance company to act as a fronting company for the transaction

Business models - Capital Market / Reinsurer hybrids

1st generation • Offshore • Adequately rated (A-) • Hired U/W team, often

looking to minimise underwriting risk

• “Brand name” hedge fund with aggressive investment strategy

– Third Point Re – Greenlight Re – Hamilton Re (Sac Re)

12

2nd generation • Offshore • Adequately rated (A-) • “Piggy back” off existing

(re)insurer who rents out underwriting team

• Catastrophe focused or multi-line

• “Brand name” hedge fund or pension fund with aggressive investment strategy

– Pac Re – Watford Re

3rd generation ? • Offshore • Adequately rated (A-) • Combination of existing

(re)insurer and “brand name” hedge or pension fund with aggressive investment strategy

• Pension funds have long-term investment horizon so can assume volatility inherent in reinsurance

• Multi-line • Flexible: can grow and

shrink operations based on market conditions

Business models - Exit strategies

13

Understanding the capital providers exit strategy is important

• Many investors are looking for liquidity – They value the ability to move their funds every year, two years etc.

• Each transaction represents a subtraction from a limited pool of assets

– Funds can be rolled over from one year to the next – …but become tied in or lost in the event of a possible loss or confirmed loss

• Renewal capacity can therefore be dependant on additional investments into the fund

MORO 2014

Impact on the (re)insurance market

Impact on the (re)insurance market - Historical perspective

• Mid 80’s – new capital (Bermuda, etc.) in response to US commercial liability crisis

• Additional capacity following major catastrophes – 1992 (Hurricane Andrew) – 2001 (9/11) – 2005 (Hurricane Katrina)

• Since then the (re)insurance market has experienced M&A / consolidation

• Remaining companies all seeking to diversify to the “new model”

– Insurance / reinsurance – Multi-class / multi-line – Global footprint – From “specialist” to “generalist”

• Positive cash flow generated by reinsurance underwriting used to fund acquisition and expansion

• Is this what is next for new capital…

– Evolution of new global brand?

15

Impact on the (re)insurance market - Property catastrophe

• Recently completed 1st June renewal season saw savage price cutting – Often 15 – 20% reductions on loss free programs – Psychological impact bled into Japan and Australia renewals

• Sustained pressure on other conditions

– Event definitions broader or dropped – Broader terrorism coverage sought

• Traditional reinsurers caught in the middle

– New capacity seeking a participation in placements – Placements shrinking as retentions on global accounts continue to

increase and less cover bought

16

Impact on the (re)insurance market - Other lines of business

• Shortage of opportunity and declining prices have pushed reinsurers to deploy capacity elsewhere – Traditional reinsurers and – New capacity entering the market

• This has been seen most clearly in the Casualty market

– Significant overcapacity becoming visible in specialist lines of business – Many MGA’s are finding new capacity available – Significant influx of capacity into the US E&S market

• Examples such as Watford Re potentially transformational

– New capital able to offer long-tail capacity – Offer clients a lower cost of capital, or an improved investment yield, or both

17

MORO 2014

What does this all mean for mutuals?

What does this all mean for mutuals?

• Impact on the primary market will be disruptive – Be ready for a seismic change in insurance market conditions

• This will impact your members directly

– What will you do when your competition is 25% cheaper than you?

19

What does this all mean for mutuals? - What does this mean for the member?

20

Who offers the most “employee per policy”?

• You could view this as an inefficient way to generate investment opportunity

OR

• As unrivalled service to your members with a

personal touch

Esure • UK personal lines insurer • 1,500 staff in the UK • Wrote ≈ USD 800m of premium in 2012 • USD 0.5m / employee

Leadenhall Capital Partners LLP • UK based ILS fund • 11 staff • > USD 1.5bn funds under management

generating ~$300M of premium • USD 27m / employee

Munich Re • German based reinsurer • 45,000 staff • > USD 68bn of premium in 2012 • USD 1.5m / employee

L'Assurance Mutuelle des Motards • French motorcycle insurer • 429 staff • Wrote ≈ USD 110m of premium in 2012 • USD 0.26m / employee

Differentiate yourself!

What does this all mean for mutuals? - Universal qualities of mutuals

21

Focus and homogeneity Focus on one market segment

No incentive to move in and out of product lines

Highly motivated to remain relevant to membership

Extraordinary focus on product and service when compared to

commercial market

Unrivalled service Tailored products, adapted as needed

Intimate knowledge of, and direct communication with members

The “for profit” market serves multiple constituencies and cannot match

service level

Consistent value over time Maintaining coverage and limits at lowest

sustainable price Reduced loss costs through cutting edge

loss prevention Reduce claims costs with specialist

expertise For profit markets have moved in and out

at whim

Commitment to Policyholders Unrivalled product and customer support

Long term perspective

Maintain availability of appropriate limits

Realistic pricing – often in the face of bitter commercial market competition

Dividends when results exceed expectations

What does this all mean for mutuals? - When it comes to buying reinsurance

• Highly favourable conditions for reinsurance buyers… – Reduced pricing – Improved terms and conditions – Opportunity to use reinsurance to support expansion – There is a lot here to be positive about

• But, difficult to balance short term market dynamics / long term reinsurance relationships

– Core reinsurance partners may not be as flexible as new markets – Will you be put at a competitive disadvantage by not chasing the cheapest deal?

• Questions over longevity of new counterparties?

– Is your relationship with underwriting manager or capital provider? – They may no longer the same – Who will be there in 5, 10 or 15 years?

22

What does this means for mutuals? - Your reinsurance program

Consider multi-year coverage • Significant capacity now available • Lock-in favourable pricing • Formalise long-term relationships

23

Look to the strengths of the movement • Latin American Reinsurance Group • ICMIF member reinsurers • Shared Catastrophe Purchases • New opportunities

– Africa Risk Capacity Insurance Co

Seek a closer fit with your policy conditions • Many mutuals give “non-standard” coverage • Reinsurance shouldn’t restrict what you give to

your members • Some reinsurers (still) don’t understand what

you do

Leading edge analytics are vital • If you don’t have it, your broker should! • No longer just for property – casualty & other

lines as well

Reinsurance remains the most flexible source of capital for mutuals