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06 MIKE MCGAVICKFUTURE RISK

08 CHRISTIAN MUMENTHALERREGULATION

11 DENIS KESSLERDISRUPTION

14 JOHN J. HALEYINNOVATION

16 HEMANT SHAHDIGITALISATION

18 INGA BEALESUSTAINABILITY

20 CORNEILLE KAREKEZIMICRO-INSURANCE

22 GUNTHER SAACKEILS EVOLUTION

24 STEPHAN RUOFFFUTURE PROOFING

26 ROB BREDAHLHEDGE FUND REINSURERS

28 STEVE HEARNLONDON MARKET

30 MIKE KREFTAINTELLECTUAL CAPITAL

32 GRAHAME CHILTONREINVENTION

34 JULIAN ENOIZITERRORISM

36 MARK E. WATSON IIIINVESTOR SENTIMENT

38 GRAHAME MILLWATEREFFICIENCY CHALLENGE

40 JOSÉ MANUEL DIAS DA FONSECABROKERS

42 WALEED JABSHEHMENA

44 FRANZ HAHNCHINA

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The insurance industry emerged from the financial crisis ten years ago looking like a paragon of

stability. Where the banks had been rocked to their foundations – or completely knocked for six in some notable cases – insurance companies showed themselves to be the real risk professionals.

While the financial crisis did result in risk based capital rules being tightened around the world, any last lingering doubts about the suffocating effect of compliance have largely dissipated.

Respite and a return to business as usual was short-lived, however: now the focus for CEOs has changed to existential risks.

Today there’s a growing sense that diverse, protean forces are beginning to crowd in on insurance and reinsurance companies.

Disruption and disintermediation, climate change and political risk: these are the big challenges facing all constituents of the global and regional re/insurance markets today.

To complicate matters, these forces are at play

when the market is awash with capital, amping up competition across all classes and lines, emphasising growth imperatives and the need for cost efficiency.

So much change is happening on so many different fronts that today’s insurance industry leaders need to be made of the right stuff to shape their businesses for success in the face of impending future shock.

Certainly, the wide ranging opinion editorials in this year’s CEO Risk Forum suggest that an

insurance industry leader requires the combined skillset of an investment banker, political analyst, tech guru and enterprise risk specialist – with a bit of futurologist thrown in for good measure.

You might not agree with everything that’s said here – and some pieces do raise more questions than answers – but I know that you will find these discussions endlessly stimulating.

www.reactionsnet.com 03

“Disruption and disintermediation, climate change and political risk:

these are the big challenges facing all constituents of the global and regional

re/insurance markets today”

Garry Booth, Editor CEO Risk Forum

ALL THINGS MUST CHANGE

INTRODUCTION m

www.reactionsnet.com04

m CONTENTS

6 Get ready for a risk renaissance If the insurance industry is to preserve its pivotal role in protecting society and the global economy it must embrace change and reinvent itself, says XL Group CEO Mike McGavick

8 Open markets – the key to enhancing societal resilience Swiss Re CEO Christian Mumenthaler explains why protectionism is damaging for developing market economies

11 Competitor or contester – there’s a difference Competitors play the game with the same rules, while contesters play by different rules. Denis Kessler, chairman and CEO of SCOR, says it is important to understand the difference

14 The power behind the technology wave How technology could disrupt a company’s place in the existing insurance value chain appears increasingly linked to the ability to generate analytics that help engage customers and capital providers, according to John J. Haley, CEO of Willis Towers Watson

16 The digital enterprise is the risk enterprise Radical digitalization will enable (re)insurers to create the operational liquidity they need to adapt and to remain relevant, according to Hemant Shah, co-founder and CEO, Risk Management Solutions

18 Maintaining momentum on climate change beyond Paris The insurance industry has a huge role to play in securing the future of the planet, says Lloyd’s CEO Inga Beale

20 Driving up Africa’s insurance penetration Corneille Karekezi, group managing director and CEO of Africa Re, explains how new technology and indexed based products are stimulating insurance take-up in Africa

22 Convergence 2.0– Is reinsurance going full circle? Gunther Saacke, CEO of Qatar Re, questions whether the ILS market can ever achieve more diversification by line of business and geography

24 How to stay one jump ahead Stephan Ruoff, CEO of Tokio Millennium Re, says that alternative capital is forcing reinsurers to look for ways to remain relevant

26 Hedge fund reinsurers operate under a variety of business models Third Point Re president and CEO Rob Bredahl discusses the varying business models of hedge fund reinsurers

28 Maybe London doesn’t matter Steve Hearn, chief executive of Ed and former chairman of the London Market Group, argues that London could be edged towards irrelevance in emerging markets as regional hubs become global centres of excellence

30 The role of the reinsurance underwriter – a gentle evolution Mike Krefta, CEO of Hiscox Re and Insurance-Linked Securities (ILS), says the next wave of underwriters must become masters of many trades if they are to remain relevant

32 The way we (must) do business now The insurance industry must head off the InsurTech disruptors by reinventing itself, according to Grahame Chilton, CEO of Arthur J. Gallagher International and founding partner of Capsicum Re

INSIDEEditor, CEO Risk ForumGarry Booth+44 (0)1986 [email protected]

EditorDavid Benyon+44 (0)20 7779 [email protected]

Managing EditorChristopher Munro +1 212 224 [email protected]

Senior ReporterJohn Hewitt Jones+44 (0)20 7779 [email protected]

US ReporterMichael Heusner+1 212 224 [email protected]

PublisherGoran Pandzic+1 212 224 [email protected]

Senior Marketing ExecutiveEva-Maria Sanchez+44 (0)207 779 [email protected]

Business Development ManagerBill Schauer [email protected]

Conference Producer and CoordinatorDavid McClure [email protected]

Production EditorEwan Harwood

Design & productionPaul SargentPeter Williams

Divisional directorDanny Williams

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Reactions is a member of the Audit Bureau of Circulations. Reactions (ISSN No. 002-263) is an online information service supported by a print magazine published by Euromoney Institutional Investor PLC. ©Euromoney Institutional Investor PLC London 2016. Although Euromoney Institutional Investor PLC has made every effort to ensure the accuracy of this publication, neither it nor any contributor can accept any legal responsibility whatsoever for consequences that may arise from errors or omissions or any opinions or advice given. This publication is not a substitute for professional advice on a specific transaction


CONTENTS m

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24

38

34 Bridging the gaps in terror cover The changing modus operandi of terrorists means that the industry must urgently rethink how terrorism cover works, says Julian Enoizi, CEO of Pool Re

36 What will happen after disaster strikes? Mark E. Watson III, CEO of Argo Group, believes that a big event will change everyone’s perception of value and margin

38 Breaking the value chain Grahame Millwater, CEO of reinsurance intermediary Beach, says the insurance value chain has become too long and too expensive

40 Death of the salesman? The reports of the brokers’ death have been greatly exaggerated, says José Manuel Dias da Fonseca, CEO, Brokerslink

42 Maintaining momentum in MENA Waleed Jabsheh, Jordan-based president of International General Insurance, stresses the importance of being grounded in local markets – and staying up to date

44 China – the growth market that keeps on growing China’s insurance market is expanding, albeit at a slightly slower rate than before – but it’s growing up in different ways, according to Franz Hahn, CEO of Peak Re


m FUTURE RISK

Albert Einstein stated some 70 years ago that problems cannot be solved with the same level

of thinking that created them. His advice is just as applicable today and we in the insurance industry would do well to take heed.

Given the speed at which technology is advancing, data is developing, and risk is getting riskier, there’s no way that we can keep up as risk management professionals without thinking and doing things differently.

It is anticipated that within the next three years the amount of data created in the world annually will reach 44 zettabytes which equates to 44 trillion gigabytes. Even more mind boggling, this is forecasted to increase to 180 zettabytes (180 trillion gigabytes) by 2025.1

Today only about five percent of the data available is used. But artificial intelligence and machine learning’s ability to delve into that data and work at a completely different rate of speed to discover real insight is transforming the world. We are an industry heavily driven by data and our industry is finally starting to embrace the opportunity that the data yielding insight is providing and realizing that this will profoundly change the way we insure things.

I believe that we’re on the cusp of six big changes that will redefine our industry and most of these changes while challenging will benefit us, those we serve and society at large.

Three of the six changes I view as very positive, two are changes that must take place, and one is downright terrifying.

Positive changeFirst of all, I believe the way that the insurance industry pools risk will change. Insurance is all about pooling risk. It’s about the theories that were developed in the last renaissance, in the time of the law of large numbers. And creating these risk pools has been our art for all of these centuries.

However, there are now about 10bn devices in the world - from machines to aircrafts, to our phones, to our refrigerators - that are now talking to each other and creating, as these sensors connect, new data. By 2020, it’ll have shifted from 10bn devices in constant communication to between 20bn and 50bn devices. This will change how we pool risk. Today we mainly concentrate on the owner of the risk. That ownership, I believe, of risk - not of the device, will shift to the service provider. And then the pools will be created around the service providers, rather than the owners.

This has profound implications, and it leads to the second big change. I believe that we should be able to lower the cost of insurance because we will be able to be more precise about the risk itself. We will have more real knowledge of the risk and more precise ability to analyse the state of risk at any given moment. So we can do much more to prevent loss, and when there is loss – make coverage more affordable. I see that both the frequency and the average severity of loss should decline because of this additional knowledge.

Thirdly, I think this will finally enable us to break through some of the most intractable insurance problems that face companies and frankly the world. There is a massive problem of under-insurance. And today our main response to what is new and challenging is to say, “No. We don’t understand it so we can’t insure it.” I think tomorrow the ability to use this new wave of insight to break through on these problems will finally enable us to say, “yes” more often, and to therefore be a more useful partner.

Rules of the blame gameThen there are two big waves of change that we must embrace. One is in liability theory itself. Clearly it is complicated, even today, to always figure out who is responsible for what. And therefore, in turn, to create the insurance that protects those who may incur liability in the course of their work. This is about to become much harder because the liability theories of today are not ready for a world where things are happening autonomously.

We will have to rethink where we attribute blame when things go wrong. Is it the writer of the software? Is it the servicing company? Is it the manufacturer? Is it the owner? Is it the person who’s nearest in proximity to the event? All of these things will need to be rethought. And across the world, I expect, in essence, there will be a complete update of the liability theory.

The reinvention of the industry is in its early days. Because the challenges I just described are so huge that they are not going to be able to be served by the capital of the industry alone. It will require entirely new ways of creating partnerships. It will generate entirely new ways of creating insight in order to rise to the challenges mentioned. This will have implications for the relationships between clients, brokers, insurers, and the whole ecosystem of how insurance is, in essence, manufactured and used.

The idea that there is a digital renaissance going on is not new. And most industries have already been subjected

GET READY FOR A RISK RENAISSANCEIf the insurance industry is to preserve its pivotal role in protecting society and the global economy it must embrace change and reinvent itself, says XL Group CEO Mike McGavick

to waves of so-called disruption. However, our industry has been immune to all of this – for several reasons.

Number one, the intensity of regulation of what we do makes us very slow to innovate. It creates a tax on innovation by requiring more capital, especially at a time when the world has been very nervous about financial services companies. And this slows down the rate of innovation. At the same time, we are by our nature a backwards-looking industry. We’re constantly looking at what happened and trying to imagine what that implies about what is insurable in the future. In a world with the rate of change that we have today, that is simply unacceptable. We must be look forward and be willing to take risk at the rate of change. And the data now available and now “harness-able” should enable us, finally, to break through and to become a participant in the digital renaissance and not simply an observer of what happens to others.

The second is the demand from risk managers. Risk managers are fed up with price competition over traditional risk and a willingness to just ignore the vast numbers of un-insurable risks that they face every day. If we as insurers don’t break through we will literally slow the rate of human progress.

Insurers have always liked to control everything at hand. It’s part of the business model. We want all our own knowledge, only our own underwriters, only our own risk engineers. That won’t work at the rate of speed and the depth of science that is required to make this work. So we as an industry are finding it is absolutely necessary to have knowledge-driven partnerships with true, core experts. For example, at XL Catlin we created a product in the new energy space to allow fuel cells to compete with traditional energy. It’s a genuine breakthrough and we’re seeing great growth in fuel cells as a competitor to fossil fuels because of it. That only happened because we spent three years in partnership with the fuel cell scientists themselves. And then were able to take our knowledge to create products that could make that breakthrough.

As in this example, it won’t just be one insurer’s capital that will be involved in the solution. Not simply in the sense of today, where risks are syndicated, but in the sense that it will be part of our job, if we invent a solution, to go find the additional capital necessary to provide the coverage. Because the amount of capital that will be required by the world I just described is vastly more than the industry has to offer.

Coalition of capitalWe’re already realising the benefits of the alternative capital markets which, despite a slowdown in growth, reached a new high of $81bn or 14% of total reinsurance

capital last year.2 So whether it’s pension funds, hedge funds – all those alternative capitals – it will be our job to create the coalition of capital that is large enough to meet the risk that needs to be solved. That implies huge changes in how we partner, in how we create consortiums – rather than just individual insurers – that can solve new problems.

This is an opportunity for sharing that is profoundly different from the information we share today.

But it is a little bit scarier because it goes to the core of how companies compete, and it is a little bit unusual to think of working so closely with our insurance peers. Those old barriers

to deeply understanding each other’s needs and risk are going to have to fall away. The level of

collaboration will have to rise massively. That is a huge challenge to the jobs we do today. And

it’s particularly – and I say this with great empathy - difficult for risk

management organisations.

Risk connectionsThere is one thing that I think is terrifying about all of this. It’s a new risk that is already amongst us but will become even more profoundly difficult for us to

overcome – and that is interconnectedness itself. It leads to all kinds of avenues for people with ill intent to access and to pervert what it is that we’re trying to achieve. So whether it’s the hacker who is doing it for money, or the hacker that is doing it for terrorism, or the hacker that is doing it for fun, the competitor that is stealing insight – it doesn’t matter which dimension we take it in. There’s going to be more and more points of access for those people, and when they get in, interconnectedness creates more opportunity for them to infect more activity.

This is an astonishing level of interconnected risk. So while we see massive benefits from the world that’s coming, we also see new risks emerging for which our current tools are simply not sufficient as connectedness accelerates. I think we are only beginning to scratch the surface of what this risk implies for all of society’s institutions. This interconnectedness creates all kinds of new risks that we will collectively need to overcome.

In order to do this, the risk manager’s role will need to grow in understanding the risks and in creating the mechanisms previously described. In other words, the current attitude towards risk management has to change to enable the knowledge transfer that will enable the partnership that will enable the products that are really needed. That’s a big mind shift, and it’s starting to happen. The question is will our industry get there before it is too late?


FUTURE RISK m

GET READY FOR A RISK RENAISSANCE

“So whether it’s pension funds, hedge funds – all those alternative capitals – it will be our job to create the coalition of capital that is large enough to meet

the risk that needs to be solved”

1 From International Data Corporation’s August 4, 2016 annual mid-year IoT review webcast2 From Aon Benfield Report – April 2017


m REGULATION

On the heels of the Eurozone crisis, it has been a turbulent time for political risk – beginning with

the Brexit referendum last June, peaking with the US elections in November, and continuing into a European election round that has rattled established political parties. These developments have reminded investors that politics influences all markets. They have also raised the spectre of economic nationalism in the world’s largest, most open, and most lucrative economies.

A particular concern is that G7 governments could weaken their decades-long support for international institutions and standards that promote the free flow of trade and finance – or worse, replace them with localised and politicised regulations that would distort

OPEN MARKETS – THE KEY TO ENHANCING

SOCIETAL RESILIENCE

Swiss Re CEO Christian Mumenthaler explains why protectionism is damaging for developing market economies

markets and disturb efforts to close insurance protection gaps. Such developments would also trigger setbacks in emerging and developing market economies, some of which have made significant steps in liberalisation and others that still struggle.

By acting as an insurer to primary insurance companies, reinsurers help their clients balance their portfolios and provide them with capital relief. They extend protection to a broad range of risks, including those otherwise uninsurable. In doing so, they support societal resilience, economic growth, and development. At the same time, however, the reinsurance business model only functions sustainably under three conditions:

c Freedom of contract, and contract certainty;c International risk transfer and free capital flow;c Capital requirements that reflect a reinsurer’s

individual risk profile.

The ideal policy environment for internationally active re/insurance groups is a unified global market that enables maximum risk diversification, permitting reinsurers to provide more coverage with less capital.1 That is, the economic value of insurance and reinsurance lies in the spreading and diversification of risk, rather than the generation of premium within national borders.

Regulatory fragmentation, which can range from a lack of comprehensive international standards to more extreme forms of localised economic nationalism and distributive politics, hinders the diversification potential and capital efficiency of cross-border reinsurers. It also harms local primary insurers and the local economy. Restrictions on foreign branch offices of cross-border reinsurers deny cedents the benefits of reinsurers’ entire capital strength, while high local capital requirements ultimately drive up the price of reinsurance services. Countries that impose barriers to risk transfer will bear a larger portion of catastrophic losses, whereas countries without such restrictions may benefit from global risk diversification. Where few to no barriers to cross-border reinsurance exist, the impact on local markets is softened by using reinsurance.

Consider the New Zealand Christchurch earthquakes of 2010/11. The direct total economic loss was estimated at US$32 billion, of which roughly 80% was covered by insurance and reinsurance. Of the two-thirds of insurance claims carried by reinsurers, 95% came from foreign reinsurers, corresponding to nearly 10% of New Zealand’s GDP, or US$3 000 per New Zealander. It is almost certain that New Zealand would have suffered lower growth in the period following the earthquakes had it put in place barriers to cross-border reinsurance

(e.g. mandatory cessions from local insurers to local reinsurers as in the cases of Brazil and Indonesia).

Reinsurance trade barriers can lead to lower insurance availability and higher prices. This reduces insurance penetration, which in turn has detrimental consequences for economies if a natural or man-made catastrophe occurs. Economies with lower insurance penetration recover more slowly, in terms of GDP growth, than those with higher insurance

penetration.2 Access to international reinsurance markets is therefore crucial for an economy to increase its insurance penetration and as such its financial resilience.

Fragmentation on the marchAs of today, more extreme forms of regulatory fragmentation remain limited to emerging markets and developing countries – where most cross-border reinsurers seek growth, but are nonetheless familiar with the obstacles.

A less welcome development is that since the Global Financial Crisis (GFC) we have also observed an uptick in regulatory fragmentation in developed economies. This is worrying since they are not only a larger source of premium income but also historical architects of the liberal international order. Since the GFC, levels of de jure financial openness appear to have not only declined in emerging markets, but also have levelled off in developed markets and severely contracted in Iceland and Greece.3


REGULATION m

“Reinsurance trade barriers can lead to lower insurance availability

and higher prices. This reduces insurance penetration, which in turn

has detrimental consequences for economies if a natural or man-made

catastrophe occurs”

Figure 1: Protectionist measures recently employed in developed economies and relevant to reinsurance

c Administrative hurdles for foreign companiesc Restricting market access for foreign companiesc Preferential treatment of incumbents in capital requirements,

taxation, supervisory practicec Financial repression via suasion, regulatory requirementsc Limited recognition of intra-group requirements that (potentially)

transfer capital out of jurisdictionc Capital controls via limits on dividend payments to parentc Diluting supranational standards c Limit group internal outsourcingc Require local subsidiaries to operate as standalone entitiesc Require foreign subsidiaries to be fully capitalizedc Put government functionaries on boards of banks/insurersc Legal action against subsidiaries of foreign groupsc Forced sale of portfolios, extortionc Nationalization of financial industry

Source: Keller, Philipp, “Threats to the Viability of Insurance Groups and Financial Conglomerates,” Presentation, 6 April 2016, s. 61

CONTINUED ON PAGE 10


m REGULATION

Despite liberalisation in foreign investment regimes and import tariffs, protectionist measures by G20 countries also appear to have accelerated – led by more subtle but nonetheless effective forms of state aid, trade defence measures, and public procurement localisation.4

More specific to our industry, in 2016 the Global Reinsurance Forum identified governments in 28 major insurance markets that had implemented or were committed to implement a variety of regulatory barriers to market access. These included outright restrictions on cross-border reinsurance, limitations on freedom of establishment, requirements for localisation of assets, and/or the use of compulsory cessions. Among them are not only key emerging markets like China, India, and Brazil but also some developed markets.5 As Figure 1 indicates, some protectionist measures are not as overt as a tariff barrier but instead assume the form of red tape, capital controls, political pressure, or prudential policies.

Accelerating protectionist measures Since January, the US has withdrawn from two landmark agreements, the Trans-Pacific Partnership and the Paris Climate Accords. In the past six months, it has initiated or committed to initiate a series of actions under various US trade laws (e.g., anti-dumping, countervailing duty, global safeguards, and import threat to national security), which could present an increase in the percentage of US imports subject to barriers.6

These developments are troubling. It has become more difficult to see a workable balance between international and national efforts, and avoiding fragmentation requires strong leadership. The fact remains that the US continues to boast the largest and deepest capital markets, the US dollar remains the primary international reserve currency and the Federal Reserve and US Treasury remain the most important single actors in the global financial system. The European Union is currently struggling with populist forces in its more peripheral member states, and is attempting to resolve contradictions in its monetary union. The adoption of the Renminbi as an international reserve currency is conditionally dependent on domestic financial sector reforms, which at this point seem politically difficult. So, any major shift will not happen quickly.

However, the past is not necessarily the best indicator of the future – and it is difficult to foresee one-off events. Our approach to singular and materially significant political risks at Swiss Re is to think in scenarios, monitor their trajectories and proactively prepare potential actions.

In the most upside of these scenarios, today’s protectionist rhetoric turns out to have been mere

posturing. A resurgence in support for globalism in G7 countries drives forward the reform of international institutions and accommodates the power of rising emerging markets and brings them into the liberal fold. As a result, strong collaboration among international insurance regulators strengthens a group supervisory mechanism. In an extreme worst-case scenario, G7 countries descend into economic nationalism as a growing segment of the population feels left behind by the liberal market economy. In a retaliatory spiral, today’s more subtle forms of protectionism give way to high tariff barriers, capital controls, and local favouritism that hark back to the Smoot-Hawley Tariff of 1930 – which raised US duties on hundreds of imported

goods to record levels – and its aftermath. Such policies would certainly deny national economies the growth benefits of trade and capital flows. They may also pose unique and historically unparalleled challenges to a globalised and regulated financial sector (many

cross-border insurers thrived in the interwar period because they were still able to access atomised and protected primary insurance markets that depended on them for risk transfer, but it is not clear that this would be the case going forward).7

Where we standSwiss Re supports internationally harmonised rules. It is essential to establish trust among supervisors and to strengthen consistent group supervision. Historic examples show that protectionist measures would reduce reinsurance capacity. In this context, it is crucial that we engage with supranational institutions, governments, and regulators to find solutions to further close protection gaps and make the world more resilient.

1 “The Benefit of Global Diversification: How Reinsurers Create Value and Risk.” Zürich: Swiss Re, October 2016, p. 15.2 “Unmitigated disasters? New evidence on the macroeconomic cost of

natural catastrophes,” BIS Working Papers, December 2012, http://www.bis.org/publ/work394.pdf

3 Ito, Hiro and Menzie Chinn. “Notes on the Chinn Ito Financial Openness Index 2014 Update,” 30 June 2016., based on Chinn, Menzie D. and Hiro Ito. 2006.”What Matters for Financial Development? Capital Controls, Institutions, and Interactions,” Journal of Development Economics, Volume 81, Issue 1, Pages 163-192 (October); Swiss Re calculations based on International Monetary Fund. (2016). Annual Report on Exchange Arrangements and Exchange Restrictions. Washington.

4 Evenett, Simon J. and Johannes Fritz. FDI Recovers? The 20th Global Trade Alert Report. London: CEPR Press, 2016, pp. 16, 34.

5 “Reinsurance Trade Barriers and Market Access Issues Worldwide,” Global Reinsurance Forum, August 2016, http://www.grf.info/publications/barriers-to-trade

6 Bown, C. P. (2017). Steel, Aluminum, Lumber, Solar: Trump's Stealth Trade Protection (No. PB17-21), Peterson Institute for International Economics.

7 James, Harold, Peter Borscheid, David Gugerli, and Tobias Straumann. The Value of Risk: Swiss Re and the History of Reinsurance. Oxford: Oxford University Press, 2013.

“In an extreme worst-case scenario, G7 countries descend into economic nationalism as a growing segment of

the population feels left behind by the liberal market economy”

Artificial Intelligence, machine learning, Big Data and blockchain are the buzzwords of the year. At

a time when the word “disruption” is on everyone’s lips, every company is wondering and analyzing whether new players can really encroach on its market and contest its business model.

Judging by how insurers and reinsurers are on constant alert for these developments, as demonstrated by both their level of funding in the InsurTech space and their extensive communication around the subject, this is a concern at the top of the industry’s agenda.

Are insurers and reinsurers are bound to die if they merely do the same thing for too long? Should we revisit what we take for granted?

To answer these questions, first of all you need to grasp the fundamental difference, from a market economy standpoint, between competition on the one hand and contestability on the other.

Both imply a rivalry between at least two companies over the same business and group of customers. But while competition involves rivalry within a known framework, between well-identified competitors in a given market, contestability depicts a situation in which a new player, an intruder, enters the market using different technologies and tools and/or being subject to different constraints and regulations.

The Uber urban transport services app and the Airbnb accommodation booking site are perfect examples of outsiders that contested well-established businesses. They resulted in an upheaval of the supply and demand balance of two traditional markets, as they started doing the same job as licensed taxis and hotels, but with a new production function and without being subject to the same constraints or regulations. In both cases, what were supposed to be significant barriers to entry were circumvented.

When we talk about competition between incumbents, all the players involved have more or less the same production function: they face similar input prices (wages, IT, etc.); they basically have access to the same

set of information; they produce services and products that are largely similar; their capital costs converge to a narrow range of values; they are subject to the same regulatory and fiscal frameworks; and they have access to the same financial markets in which to invest their assets.

In insurance and reinsurance, competition leads to market clearing rates, and a regression towards the mean in terms of profitability. The difference between winners and losers mostly comes from different asset management policies and/or underwriting policies. Recourse to reinsurance or retrocession to better absorb large events, and more fundamentally the quality of risk management, are also key factors for success or failure.

When we talk about contestability, the situation appears quite different. Production functions as well as input costs, regulation and taxation differ between existing market players and the intruder. This also holds for the level and cost of capital, and so on. In other words, there is no level playing field.

In a nutshell, competitors play the game with the same rules, while intruders – or contesters –play the game with different rules, thereby threatening the traditional business model of incumbent companies. Contestability unbalances the market and redistributes positions.

Sources and consequences of contestability Although patents can be obtained for insurance-related inventions under some laws, legal protection and property rights remain marginal in insurance and reinsurance when compared to most industrial sectors. The bulk of insurance products and operations may be copied as soon as they are produced. All things being equal, this feature makes the threat of contestability higher.

There are two channels for the possible contestability of the insurance industry: technological on the one hand, and financial on the other. The digital revolution will


DISRUPTION m

COMPETITOR OR CONTESTER – THERE’S A DIFFERENCECompetitors play the game with the same rules, while contesters play by different rules. Denis Kessler, chairman and CEO of SCOR, says it is important to understand the difference



m DISRUPTION

lead to an ever increasing differentiation between risk traders and risk carriers

Technological contestability is probably the biggest concern to most insurers and reinsurers today. The digital revolution is accelerating and is widely regarded as the upcoming Industrial Revolution 4.0 for all industries, not least the financial sector, including reinsurance. Could intruders, be they start-ups or tech giants, disrupt the sector and replace age-old incumbent competitors?

Tech companies, mastering data analytics and networks, could supply insurance services at a much lower cost or at a better price, i.e. a price which deals better with anti-selection. This would negatively affect the traditional players operating with a different production function and/or having significantly less access to data, with a depressive effect on rates and/or a potential increase in the anti-selection risk. Some of the traditional players – the less efficient and adaptive ones – could eventually be put out of business. For the others, contestability from tech companies would decrease margins and hence profitability. As a general rule, competition usually leads to erosion, contestability to disruption.

However, whilst the contestability threat from digital transformation is often viewed through the same lens for both insurers and reinsurers, the situation for these two industries is fundamentally different. There is indeed a very important distinction to make between risk traders and risk carriers.

Contestability will primarily affect risk traders, i.e. the brokers and distributors of insurance products and services. The new networks contain a considerable amount of diversified data – which is usually proprietary – and have the tools to process this data very efficiently. In addition, these new networks have very low marginal costs for conducting transactions, as compared to the costs borne by traditional networks (agents, salesforce, small brokers, banks, etc.). Primary insurers will mainly be concerned by contestability in their function of distributing and accessing risk.

Conversely, the risk carrying side is more immune to contestability. The reasons for this are manifold. Firstly, the reinsurance industry comparatively benefits from significant economies of scale and low costs, considerably limiting the possible upside in terms of productivity gains compared to insurance intermediation and distribution.

Secondly, some of the headwinds faced by reinsurers provide protection against intruders, in particular the regulatory overload. Furthermore, in current market conditions and given the level of risk, potential new entrants are likely to consider the profitability of reinsurance relatively low compared to other sectors, notably the tech industry.

Last but not least, the risk carrier business model is very capital-intensive. For solvency reasons it requires a large capital base over the full lifespan of liabilities, which is a significant barrier to entry for start-ups and a major constraint for Tech giants, from both a profitability and capital fungibility standpoint.

Technological developments are primarily disruptive for two-sided B2C markets, where the cost of distribution and intermediation is high. Direct primary insurance is therefore far more contestable than reinsurance in this regard.

One could argue that disruption, by definition, always seems impossible to incumbent competitors before it actually happens. In the case of reinsurance, however, the nature of the business model makes disruption by ongoing technological developments highly unlikely. This is because the reinsurance business model consists of carrying large risks diversified by geography and by lines of business, on the basis of major transactions between a few known parties, and relies on customised expertise and the immobilisation of significant amounts of capital.

Improving reinsurers’ performance From a reinsurance standpoint, these technological changes may be perturbing, but not disruptive. On the contrary, they open the way for a full range of improvements. Technical innovation, which is very often customised in reinsurance, involves adapting cover to the changing needs of clients and improving risk knowledge and modelling, with a view to offering them new solutions to optimise their risk management. In this respect, by investing both individually and collectively in new tools and technologies, reinsurers are bound to benefit from upcoming technological changes.

The reinsurance industry has long been an intensive user of both internal and external data to refine its risk analyses. Digitalisation and the data it makes available therefore provide the reinsurance industry with an opportunity to access new, richer information, which should reinforce the technical expertise of the sector. Digitalisation will enable reinsurers to know their clients and risks better, even if they already have access to a lot of private information from their corporate clients.

Automation, which mainly focuses on routine intellectual tasks, should be viewed as an opportunity to implement faster and timelier processes, thereby freeing up time for strategic analyses, customer engagement and the design of tailor-made solutions.

The real question today is how quickly and how far artificial intelligence will progress. Will robots replace underwriters one day? Underwriters are already assisted by a large number of tools to assess and price risk (cat modelling platforms, data base, statistics, simulation tools), to draft policies and to handle claims. A robot could combine all those functions and effectively learn to take underwriting decisions, accumulating knowledge and experience and improving its performance over time thanks to machine-learning techniques. But if this is going to happen, existing reinsurers will be best placed to lead the change, in liaison with tech providers.

Reinsurance is and will remain a knowledge-driven industry, resting primarily on high-quality human capital. In this context, technology is nothing more than an enabler. Overall, the reinsurance industry

is benefitting and will continue to benefit from the technological revolution rather than being disrupted by it.

Contestability by the financial marketsSo far, the contestability of reinsurance has been far higher on the financial side.

Over the past two decades, the reinsurance industry has been confronted with financial disruption in the form of alternative capital. Inflows from capital markets have fueled the development of a brand-new asset class, in the form of Insurance-Linked Securities (ILS). We can view them as intruders in the traditional reinsurance space for three main reasons. First, like Uber and Airbnb with regard to urban transport and hotel industries, ILS have the potential to radically change the supply and demand balance of the reinsurance market, effectively allowing each and every institutional investor to become a reinsurance capital provider.

Second, ILS are not subject to the same regulatory requirements and supervisory oversight as traditional players. Last, and by no means least, even though the liquidity of the ILS market remains limited compared to other mainstream vanilla asset classes, ILS are tradable securities, which can be bought and sold on a secondary market.

Alternative capital market solutions have enjoyed strong momentum, particularly in the last 10 years. Between 2008 and 2016, the amount of alternative capital has multiplied by four, and its share in global reinsurance capital has increased from around 6% to around 14%.1

Are ILS really disruptors?Earlier this year2, the Financial Times ran a headline on ILS that read Investors move in on reinsurers’ turf, adding: “Instruments that push risk on to the capital markets are disrupting an age-old game”. However, the truth is that ILS have been more of a complement to traditional reinsurance than a substitute for it. The mere fact that reinsurers themselves issue around 25% of ILS proves that they consider these instruments in their own risk management toolkit and have integrated these new solutions.

The latter have not ousted traditional players, which have instead used them opportunistically to expand their capacity and balance their credit exposure. The way alternative capital and reinsurance complement one another has therefore, so far, outweighed contestability.

The key question today is whether we should expect increased risk transfer to the capital markets and

whether the range of risks covered by ILS will expand further. While ILS have traditionally covered well-modeled, peak nat cat risks, new risks have come to the market recently, including non-peak nat cat risks such as meteorite strikes or volcanic eruptions, and even man-made operational risks such as cyber breaches and rogue trader losses.

Even if this kind of risk cover forms the exception to the rule rather than the norm, it is entirely possible that ILS will gradually cover an extended spectrum of insurance and reinsurance risks, particularly with the

foreseeable developments on the risk modelling side.

Driven by the repressive monetary policies of the last decade, today’s abnormal economic conditions also blur this analysis. This is because investor interest in ILS, apart from the fact that they provide uncorrelated returns from the financial markets, is partly driven (or at least influenced) by the very low yield environment. Therefore the sustainability of

the cat bond solution cannot really be tested before interest rates pick up

or a major event wipes out investors’ capital.

Nevertheless it should be noted that, unlike traditional reinsurers, which have a long time horizon and can carry long-tail lines, ILS have so

far specialised in short-tail lines that are event-driven, such as property cat, because investors want their money back after a limited period of time (three to five years).

The reinsurance industry has not been uberized by ILS – yet! Some experts, with limited knowledge of the industry and its dynamics, have been quick to bury age-old reinsurance with the development of ILS solutions. This is clearly going too far, but it has to be said that ILS do have more potential to contest and commoditise our industry than digitalization.

Constant innovation is necessary Contestability is always a possibility – it may be remote, but it is real. The day a genuine movement of contestability happens, it will be too late for competitors to react and a lot of value will be wiped out by the intruder. Therefore the right behaviour is to permanently adapt to changing technologies that are potentially disruptive, and to invest in those. Reinsurers have done this very well with ILS, which they have been structuring, issuing but also investing in. Similarly, the significant funding from both insurers and reinsurers in tech developments is the right strategic attitude. It seems clear that new technology is now the Trojan horse of contestability.

1 Source: AON Benfield2 Financial Times, 13 March 2017

“In the case of reinsurance, however, the nature of the business model makes

disruption by ongoing technological developments highly unlikely”


DISRUPTION m


m INNOVATION

Ahead of last year’s CEO Risk Forum, I used a surfing analogy in an article to highlight the need

for insurers to ride the wave of technological innovation currently gathering momentum in the industry.

Pondering that theme for this follow-up, it set me thinking about the underlying source of the wave’s power and about how and where it is breaching or could breach established industry practices.

After talking with our company experts, one core aspect of the relative force of the wave kept re-emerging – the value of information and insight.

Essentially, what they were saying is that the technologies that they expect to drive the greatest change are those that enable companies to compress the value chain and claim the economics associated with the displaced link. For example, those that allow policies to be quoted, issued and bound to reduce frictional costs. Or those that offer new sources of information that materially improve risk selection and risk pricing.

The power withinTo a large degree, this makes the power of technological innovation, “technology agnostic”. Our own studies in areas like telematics support this conclusion, with most consumers being focused on the benefits to them and ambivalent about the hardware and software used. Power is derived from what companies are able to do with the

technology, not the technology itself necessarily, as we have already seen occurring in some other industries.

And you can see where my colleagues are coming from. If we look at a few examples from a functional insurance point of view, analytics and algorithms have already transformed pricing and distribution in large swathes of the P&C personal lines market. Some companies have successfully transferred the skills learned to their sales and marketing – in areas like reward programs – and to managing the customer relationship. A select few are now moving into applications such as entirely tailored individual pricing and underwriting presentation using intelligent negotiation techniques.

As an extension of the increased levels of customer insight being developed, some organizations’ thoughts are now turning to restyling the fundamental customer relationship. Following the example of airlines that offer travel insurance when you book a ticket and, to some extent, the way that managing general agents have successfully targeted niche areas in insurance, avenues being explored include the potential to offer micro-insurance products that match personal lifestyles and changing buying habits alongside traditional covers. It could lead in time perhaps to tech-enabled personal insurance apps.

Such moves are symptomatic of the general trend towards digitalization of business models and

THE POWER BEHIND THE TECHNOLOGY WAVE How technology could disrupt a company’s place in the existing insurance value chain appears increasingly linked to the ability to generate analytics that help engage customers and capital providers, according to John J. Haley, CEO of Willis Towers Watson

transformation of the customer experience, both through the style and channels of communication and practical measures such as claims triage and handling.

Big data battlesDevelopments of this sort are also informing approaches to big data. One thing that insurers have found out pretty quickly is that if you simply throw a machine at a lot of data, more often than not you get the blindingly obvious result – just quicker. Companies that are making bigger strides in this area have typically moved to an approach whereby subject matter experts are integral to forming a hypothesis about a business improvement issue which can then be investigated by interrogating larger and more diverse data sources. The intelligent use of the technology and data is what really matters.

We see this happening, for example, in the workers’ compensation insurance space. Twenty years ago companies could do little more than allow for a certain level of workers’ compensation costs. Now, analytics enables companies and brokers to not only use data to be more sophisticated in analyzing the circumstances from which costs have arisen, but can enable them to use that information dynamically to manage smarter and potentially aim to change the behaviors that lead to claims.

In commercial markets more broadly, progress is slower but many companies are nonetheless taking steps to position themselves to interpret risk more widely for clients and act as their champion in the insurance markets. This is becoming apparent in the SME market, for example, where the nature of the broker relationship is starting to lean as much towards risk understanding and appetite as traditional risk placement. In this kind of model, there could be real potential value to be added from providing data husbandry and benchmarking services.

In a similar vein, analytics looks set to become an increasingly important tool in the war for distribution among mid-market companies, by placing insurance more centrally in the value chain. This underpins some companies’ desire to move away from the traditional annual renewal cycle to a more “evergreen” approach.

Capital connectionsBut disintermediation linked to analytics hasn’t been confined to distribution. Capital is increasingly coming in

for the same treatment, with the objective in most cases of moving capital closer to risk.

Competitive advantage seems increasingly likely to migrate to those companies that can best leverage the holy trinity of client proximity, access to lowest average cost of capital, and all forms of information from which to more precisely price, assume and manage a portfolio of risk. And just as technology and analytics have acted

as a catalyst for shortening the traditional insurance distribution chain, they have begun and continue to provide the means for wider investor confidence to participate in insurance risk as an asset class.

Just why capital efficiency has become so important is apparent when you compare recent

growth in industry premiums versus surpluses. Between 2004 and 2014, premiums in the US

P&C sector grew by $90bn, compared with a $300bn growth in capital

surpluses over the same period. A consequence of surpluses outstripping premium growth

by a factor of nearly four is that capital leverage decreased from 1.1 in 2004 to 0.7 in 2014.

Role of InsurTechs and human capitalInevitably, when talking about innovation in insurance from either the distribution or capital angle, the role of InsurTech companies surfaces. Much

is made of their powers to whip up a more violent and disruptive technology wave.

Certainly, many of these companies offer or propose interesting ways to generate and use analytics to create economic value from insurance. But the fact is that the vast majority of InsurTech start-ups do not want to go to war with industry incumbents, and very few are driving disruption for disruption’s sake. Their overwhelming focus tends to be on leveraging technology to create value within the insurance value chain – not collapsing it.

As such, they do have an important role to play. The recent growing trend towards insurers forging alliances with, or making investments in, early stage businesses shows a growing and heartening sense of cooperation between MatureTech and InsurTech.

What the trend also reinforces is that for all of the current technology wave’s inherent potential to eliminate barriers to entry, to weaponise data and to create information from which to more precisely gauge risk, and connect capital, analytics and brain power are its sustaining forces.

John Haley is a member of the Steering Committee of the Insurance Development Forum.


INNOVATION m

“Competitive advantage seems increasingly likely to migrate to those companies that can best leverage the holy trinity of client proximity, access to lowest average cost of capital, and all forms of information from which

to more precisely price, assume and manage a portfolio of risk”


m DIGITALIZATION

Change is in the air. All around, leaders across the risk and insurance industry from market-

leading incumbents to new start-ups are challenging assumptions. What is insurable and how can we break through to new opportunities? How can we crush the latencies in our process and move faster and closer to our clients? How do we innovate and what does it take to master new competencies? Where do we really add value, what do we need to do to distil the right secret sauce? Who should we partner with, and who wants to partner with us?

Most are making investments to automate and outsource functions, reduce costs and increase efficiencies across the enterprise – and many are making investments to streamline, scale or disrupt distribution, with customer intimacy and access a key strategic high-ground throughout the vertical market. These important priorities are burgeoning trends well underway.

Costs and efficiencies matter, and so does distribution. However, tackling these as a series of discrete challenges risks distracting from a more fundamental priority, and to truly drive transformation we need to crack the DNA of the problem.

What is the core function of the insurance and reinsurance enterprise? After all, risk is risk, and capital is capital. The industry exists to intermediate risk with capital in a giant supply chain with both backwards and

forward-chaining feedback loops. At the heart of the proposition is the orchestration of

risk. Risk is the underlying driver of demand in a rapidly changing world. Risk is the costs, features, and benefits of products designed to meet customer needs. Risk is the intra-and-inter business workflow, from customer to capital (and in reverse). Risk is the key enterprise resource to be dynamically managed to balance the resiliency and optimization of returns.

To gain dramatic improvements in efficiencies and customer impact, what is necessary is to digitalize the re/insurance enterprise. Nothing short of digitalization is needed to create the operational liquidity needed to compete, adapt and to remain relevant. Digitalization is not just automating, it is a cognitive challenge. It is the ability to convert information – information that is increasingly liquid (vast, real-time, and pervasive) – into actionable digital objects, adaptable digital processes, and agile digital decisions that are able to discern and respond as the underlying patterns of risk and customer demand first shift and then jump from established rails.

From actionable risk objects to adaptable risk processes to agile risk decisioning, it is clear that digital insurance enterprise is digital risk enterprise. Digitalizing risk is a daunting task, and is arguably the most challenging. Given its nature - abstract, pervasive and ultimately so fundamental - it is not surprising that transformation initiatives usually start with more peripheral activities.

Digital risk enterprise’s cognition lights-up in three dimensions: how it underwrites its business, how it manages and deploys its capital, and finally how it innovates to engage and create new value for its customers. Ultimately, what is meaningful for the industry is how it adapts on faster and faster cycles at

THE DIGITAL ENTERPRISE IS THE RISK ENTERPRISERadical digitalization will enable re/insurers to create the operational liquidity they need to adapt and to remain relevant, according to Hemant Shah, co-founder and CEO, Risk Management Solutions

the intersection of all three.Digital underwriting merits an entire article to itself.

It is not just a process, it is a value chain, from how information is orchestrated to create differentiated insight to how it is operationalized in the business. One important question pertains to the role of the underwriter in this transformation. It almost goes without saying that many current underwriting activities will inevitably become redundant given the rise of data-driven decisioning, models and machine learning, and automation and algorithms.

And yet I am somewhat of a contrarian on one aspect of this transformation. For some classes of business, the debate suggests a false choice between the models/machines and underwriting judgement and intuition. For these lines, the extent of digitalization will not be measured by straight-through analytic execution but by the degree to which digital systems augment the reasoning of human experts. For these use-cases, the metaphor should not be the automation of the underwriter, but that of a computer-mediated dialog between expert and information, an analytic discourse that yields superior insight that neither a model nor a human could achieve on their own. These use cases require different digitalization strategies, and can draw upon pioneering computer science work from other fields, such as Homeland Security – but I digress.

Capital management already relies heavily on models and computational methods to crunch big data. These processes are ripe for improvement, with existing systems struggling to keep pace with the volume of data and simulation, and the increasing demands on interpreting the results. Why did the number change over last period? What-if we changed our programs or plans?

Yet it is more than this. Digitalization of capital management requires comprehension and consistency across all classes of exposure, with real-time risk analytics that integrate pervasive awareness of accumulations across all lines at all levels of granularity. And, with dynamic linkages between capital management and underwriting, and with key stakeholders (both people and machines) increasingly able to anticipate rather than react.

Which brings me to product innovation. Most fundamentally, the risk enterprise is an innovation enterprise and digitalization must address the biggest challenge facing the industry: its very relevance. Most of the world’s risk is under or un-insured. And not

only in emerging markets, but right here at home. The nature of risk is shifting as technological, societal, and climatological forces accelerate change and increasingly disrupt established patterns of customers’ preferences, behaviors and needs. We need new ways of working

that bring us much closer to the end-customer, to understand their needs, harness and analyze

disparate information to create new and more relevant offerings in a far more agile manner, and then deliver impact and adapt on faster and faster cycles. Tackling these challenges cannot be

undertaken on an incremental basis. Digitalization of risk is not the automation

of a list of functions or activities but an inter-dependent investment in the core competency

of the enterprise at the intersection of how risk is underwritten, how capital is managed, and how

customers are engaged. This requires foundational investments in foundational capabilities.

It is an architecture for the business. Not just data-lakes, algorithms under every desk, and armies of data scientists, but an operating system able to ingest and action data. It requires extensible standards, new vectors of

collaboration and inter-operability, and truly scalable solutions. Not dataset by dataset, peril by peril, model by model, LOB by LOB, or use-case by use-case, each hard-wired into its own process. That would be a blueprint for a Tower of Babel that will collapse under its own weight rather than the holistic design required to catalyze the transformation.

To become a risk enterprise:c Place digitalization of risk at the heart of your

transformationc Prioritize the convergence of underwriting, capital

management and product innovation c Design the foundation in horizontal layers, not in

vertical silosc Partner with those able to work at the intersection of

data and modeling science, analytics technology, along with deep knowledge of the risk and insurance domain

c Recognize that digitalization is as much about people and culture as data and technology

Hemant Shah is Co-Founder and CEO at RMS, a data science and risk analytics firm developing solutions to help the re/insurance industry evaluate and manage risk world-wide.


DIGITALIZATION m

“Risk is the underlying driver of demand in a rapidly changing world.

Risk is the costs, features, and benefits of products designed to meet

customer needs. Risk is the intra-and-inter business workflow, from

customer to capital (and in reverse)”


m SUSTAINABILITY

In June this year President Trump announced that the US would withdraw from the Paris climate change

agreement. In spite of this dramatic U-turn from the world’s largest economy, I believe it’s more important than ever that we remain committed to tackling climate change by building up our resilience, reducing greenhouse gas emissions and transitioning to a low carbon economy.

Global warming is the single biggest threat facing our planet and it impacts every one of us. Each of the past three decades has been warmer than the previous one, and the vast majority of scientific evidence points to this being caused by mankind’s reliance on carbon-based fossil fuels. Lloyd’s knows all too well the damage this can cause.

The frequency and cost of natural disasters continues to rise, with direct losses in the past decade estimated at $1.4trn globally.

Under the Paris Agreement of 2015, the world’s countries agreed to reduce carbon emissions dramatically in the coming decades. While there are certainly signs that this has encouraged some countries to reaffirm their commitments, my concern is that the US administration’s attempt to turn back the tide on climate action could encourage other nations to scale back too. Any delay at all is bad news.

We can’t ignore the warning signs: recent heatwaves and deadly forest fires in Portugal, soaring temperatures in England, and the idea that we could be reaching a climate tipping point, where the Gulf Stream starts to weaken affecting the climate in North America and Europe.

New research in Nature also suggests that climate change is increasing the hail threat potential in North

America, and a recent report in Science finds that poor US counties stand to suffer economic damage of up to 20% of their income if global warming continues unabated.

In the context of these self-evident truths about the impact of climate change, the question is whether the re/insurance industry is playing its part and doing enough to help tackle these problems. I think we can do more.

The adoption of the Sendai Framework for Disaster Risk Reduction, the Agenda for Sustainable Development and the COP21 Paris Agreement all promote the need for a comprehensive approach to managing extreme events and climate risk.

As an industry on the front line of tackling climate related disasters, the re/insurance sector has a particularly important role to play in all this. Let’s be clear, if a major climate related catastrophe happened today our sector would absolutely remain solvent, pay claims and be there to help people back to their feet. But, in addition to this, the industry has a duty to influence behavior and drive further action on climate change. This is even more important following the recent US decision.

There are two main levers that we can use to do this: by making underwriting decisions, thereby encouraging our clients and customers to build resilience to extreme events and climate risk; and also through facilitating a transition to a low carbon economy through our investments in sustainable and low carbon stocks.

Let’s look at the underwriting side of the equation first. At Lloyd’s we already know that the effects of climate change on the global sea level is having an impact on the severity of natural disasters. In 2014 Lloyd’s released research showing how the roughly 20cm in the sea level since the 1950s at the southern tip of Manhattan Island increased Superstorm Sandy’s surge losses by 30% (up to $8bn) in New York alone. The question is – what can be done about this?

Earlier this year Lloyd’s alongside the Center for the

MAINTAINING MOMENTUM ON CLIMATE CHANGE BEYOND PARISThe insurance industry has a huge role to play in securing the future of the planet, says Lloyd’s CEO Inga Beale

Imag

e: U

NFC

CC

Blue Economy, the University of California, Santa Cruz and The Nature Conservancy, released a new paper which explained the unique role that natural coastal habitats can have on protecting communities more effectively against coastal storms than traditional defences, like seawalls. The research showed that many coastal habitats, including mangroves, coral reefs, and salt marshes, play a significant role in risk reduction world-wide and save billions annually in avoided flood damages.

Not only should insurers consider this coastal resilience when pricing flood risk, but they could also do more to protect and build up these defences. Couldn’t we, for example, together with governments, find a way for insurance to help finance the preservation of natural habitats? One suggestion I have heard is to insure the natural infrastructure itself so that if it is damaged after a major event we could rebuild or restore it – such insurance could be marketed to city officials as a sub-sovereign contract.

If a city becomes more resilient because a coastal wetland stands between it and a tidal wave or a storm surge, then underwriters should take this into account when pricing that risk. Taking this a step further, couldn’t some of those savings be used to conserve that habitat as a way of protecting against floods in the future? This makes financial sense because investments to conserve natural habitats are cheaper than building seawalls. In 2015, we released the Lloyd’s City Risk Index, which shows exactly how governments, businesses and communities could do more to mitigate risk and improve resilience.

After a disaster strikes, some insurance payments could be funneled into wetland conservation, with the aim of further reducing insurance premiums and building coastal resilience against disasters in the future. Unfortunately, around the world, we spend 30 times more building coastal ‘gray’ infrastructure than we do on building and restoring natural infrastructure.

When it comes to climate change couldn’t we, as an industry, spend as much time and effort encouraging risk reduction and resilience to future threats as we already do on recovery after a disaster has struck?

The good news is that the re/insurance industry is already making a big difference. Initiatives like the Caribbean Catastrophe Risk Insurance Facility, the first multi-country risk pool in the world and the African Risk Capacity, the continent’s first natural disaster insurance pool, demonstrate new ways of thinking of how insurance frameworks can tackle climate related catastrophes.

Furthermore, in 2016, the Insurance Development Forum (IDF) was launched to help address the problem of underinsurance in less developed countries, which

hampers reconstruction and recovery after a disaster strikes. A unique public private partnership between the World Bank, the United Nations and 13 leading insurance firms, it aims to give access to modern risk management practices for vulnerable countries and cities with a goal to extend the benefits of insurance to an additional 400m people by 2020.

As part of this, a group of businesses at Lloyd’s have launched a Disaster Risk Facility which pools $400m

capacity along with the expertise to develop reinsurance solutions for natural catastrophe

risks in emerging economies.The re/insurance industry has another

important role to play on the climate issue, which is on the investment side of the business, by reducing greenhouse gas

emissions and helping the transition to a low carbon economy. In essence this means investing

more money to support low-carbon technologies that will reduce the

pollution that is warming the planet.

One way to do this is by investing in green bonds – instruments whose proceeds are predominantly allocated to financing projects such as renewable energy, pollution prevention and conservation.

The green bond market was originally viewed as niche. But in less than a decade green bonds are proliferating. According to the World Economic Forum, in the first half of 2017, around $55bn of labelled green notes were issued, an increase of 38% year-on-year from the $40bn issued in the first six months of 2016. The Climate Bond Initiative estimates that the total amount of green bonds issued in 2017 could reach $150bn. Compare this with 2016, when green bond issuances touched $82bn.

Meanwhile, more insurers are making public commitments to invest in green bonds. As well as providing stable financial returns clean energy investments have a positive impact on society and provide an effective way for the re/insurance industry to hedge against its exposure to climate risks. At Lloyd’s we have roughly £151m of our fixed income assets invested in green or social impact bonds and we are committed to growing this number as fast as we can.

The Lloyd’s market has always been known as a pioneering place and an enabler of human progress. Today, fossil fuels remain an integral part of our economy and they require insurance. We believe careful underwriting helps make these industries safer.

But we must continue to look forward. I have no doubt that there will be a transition to renewable energy and a low carbon economy. The re/insurance industry must be ready to facilitate this transition and to underwrite the new economy. Let us act boldly together.


SUSTAINABILITY m

“In the context of these self-evident truths about the impact of climate

change, the question is whether the re/insurance industry is playing its part and doing enough to help tackle these

problems. I think we can do more”


m MICRO-INSURANCE

With the exception of the past four years, Africa’s economies have enjoyed exceptional growth

since the turn of the century. The outlook is favourable even though the projected growth falls short of past trends.

However, the economic expansion has not yet translated into equal insurance growth and penetration is still low. This is particularly true for agricultural insurance, which is essential in improving the resilience of Africa’s farmers – who still represent 60% of the continent’s work force – against weather related events.

Technological change and index-based insurance products open up new avenues to provide protection. Reinsurers, with their expertise and experience across the continent and beyond, can help to spread these products - as a recent initiative of Africa Re with its founding investor, the World Bank, demonstrates.

Africa had an average real annual growth rate of 5.4% from 2000 up until 2010. Due to falling commodity prices, weaker global demand and the impact of political instability growth slowed to an average real growth of 3.3% for the years up to 2015, according to the McKinsey Global Institute (MGI).

Although growth fell to 2.2% in 2016, it is expected to recover in 2017 and 2018 to an estimated 3.4% and 4.3% respectively, according to the African Economic Outlook. The decline was most pronounced in the oil exporting countries and in the Arab Spring countries. With the exception of these markets, the bulk of the African countries maintained stable growth of around 4.5% since 2010.

According to the World Economic Forum, three trends continue to fuel Africa’s growth. First, a young and growing population and workforce will add impetus. By 2034 Africa is expected to have the world’s largest workforce of 1.1 billion people.

Secondly, the continent will continue to urbanise. Its middle class, currently standing at approximately 350 million people, will expand and its consumption will outpace GDP growth.

Thirdly, technological change will further accelerate growth, reduce costs and enhance productivity. East Africa is already the world leader in mobile payments. By 2020 Africa’s smartphones penetration will be at least at 50%, up from 2% in 2010. In addition to these mega-trends, spending on infrastructure, which already

doubled over the past decade to 3.5% of GDP, will continue to outpace GDP growth.

Insurance growth lagging behindThese strong underlying factors impact the growth of insurance. Due to the depreciation of local currencies against the US dollar, in 2016 premium volume stood at only US$60bn, down from US$64bn in 2015, according to recent figures from Swiss Re. In local currency, the year-to-year comparison is positive for key markets, however. (Although South Africa’s premium volume, by far Africa’s largest insurance market, declined.)

The continent’s insurance penetration remained at 2.8%, considerably below the world’s average of 6.3% and highlighting Africa’s potential to catch up, in particular, as international investments in the continent are driving the demand for insurance. In addition, awareness to insure against natural disasters is rising. And finally, insurers are benefiting from positive changes to regulation and the compliance systems.

Of particular importance for Africa’s economies and societies is the continent’s agricultural sector. Most of the growth that Africa experienced in recent years had been driven by higher production of mineral and hydrocarbon resources. The rural areas did not benefit equally, as the World Bank states. Today, agriculture still dominates Africa’s economies, accounting for 16% of the continent’s GDP and employing roughly 60% of the economically active population, and 70% of the continent’s poorest communities.

Agricultural growth and enhanced productivity greatly contribute to reduce poverty while supporting structural transformation and urban transition. As the cost of food declines, it remains accessible for an urban population, secures employment and induces the development of an agro-industry.

In addition, food security reduces the continent’s vulnerability to famine and epidemics and will also help to lessen migration and political conflict. While incomes increase, people are able to move out of agriculture into sectors of higher productivity and value-add.

Agricultural insurance essentialAgricultural insurance is a key precondition to facilitating this process as it contributes to enhancing the resilience of farmers against the impact of natural catastrophes – namely drought and flooding. Africa’s farmers – 80% of them smallholder farmers or family-run – are heavily exposed to weather-related events as 95% of the arable land is rainfed.

Agricultural insurance helps to gain access to financing and thus to agricultural inputs, like fertilisers and higher

DRIVING UP AFRICA’S INSURANCE PENETRATION Corneille Karekezi, group managing director and CEO of Africa Re, explains how new technology and indexed based products are stimulating insurance take-up in Africa

yielding seeds, which ultimately increase productivity. As the International Monetary Fund (IMF) found, structural factors limit many African countries’ capacity and capability to respond quickly to natural disasters and strengthen their resilience over time.

Despite its relevance, the penetration of agricultural insurance is still low, however. Many markets know no agricultural insurance or have just commenced with an initial pilot scheme. According to the World Bank, Africa’s agricultural premium volume accounts for roughly US$200m, which is less than 1% of the global agricultural premiums of US$25bn, and disproportionately lower than Africa’s overall share of 1.5% of the world’s total premiums.

Coverage includes crop insurance, which accounts for the bulk of premiums written, as well as livestock, bloodstock, forestry, aquaculture and greenhouses. Broadly speaking, two types of cover exist for crop insurance. The first is traditional, indemnity based insurance coverage.

Secondly, in the more recent past, index-based insurance has gained increasing popularity. It is either area yield-based i.e. based on a yield index, whereby the insurer pays out if the actual yield falls below a pre-agreed guaranteed yield, regardless of the realised yield of the insured farm.

Alternatively, insurers base the index not on the yield, but on the weather, i.e. if the weather index defined, such as rainfall, surpasses or falls short of a predefined threshold, the pay-out is triggered.

Innovative solutionsIndex-based insurance solutions frequently serve as a basis for micro-insurance solutions, which are an important element in increasing agriculture’s insurance penetration in Africa as well as improving productivity in the sector, predominately by limiting the volatility of farmers’ income.

Surprisingly though, micro-insurance in the agricultural sector is still in its infancy. According to the Munich Re Foundation and the Microinsurance Centre, in 2014 Africa’s micro-insurance premiums amounted to roughly US$750m, with life and credit products being the most popular. Approximately 62 million Africans enjoyed some sort of micro-insurance protection, but just one million people were covered in agriculture.

In an environment where historical data is unavailable and a multitude of smallholder farmers with low sums-insured seek cover, index-based insurance products are very efficient. Pay-outs are based on an index, which

do not require costly loss assessment and which can be released immediately after an event. However, for micro-insurance to succeed, it still requires the collaboration of governments, policymakers and private sector investors to provide the regulatory framework and the initial funding to stimulate investments.

Furthermore, agri-finance or micro-finance institutions as well as technology firms, such as mobile companies,

may increase scale, distribution and improve efficiency in the collection of premiums and the pay-out of claims. Reinsurers provide capacity, improve the risk management and reduce the burden for insurers through financial solutions and risk transfer. They provide the overall expertise across markets needed to develop innovative and suitable solutions targeted at farmers.

Reinsurance facilitates expansionAs a consequence, more and more insurers

have been entering the market recently. Several large-scale programmes like the Agriculture and Climate Risk Enterprise (ACRE), Africa’s largest agricultural insurance scheme, insures more than 400,000 smallholder farmers in East and Central Africa; the African Risk Capacity (ARC), a catastrophe

insurance pool launched backed by the African Union, has helped to build scale and improve awareness.

In addition, more and more micro-insurance schemes have proven their profitably, and demonstrated that they facilitate access to new streams of income, such as formerly remote risks and client segments.

In February 2017 the World Bank’s Global Index Insurance Facility (GIIF) and Africa Re launched a joint risk-sharing facility. The IFC, which had been a shareholder of Africa Re until recently, provided through the Global Index Insurance Facility (GIIF), a significant subsidy to be managed by Africa Re in three pilot countries, Nigeria, Kenya and Rwanda.

By way of an experience account, agricultural insurers in these countries are reimbursed if their annual loss ratio exceeds 75% of their net retained premium. As a result, it is expected that premium rates for insured smallholder farmers will decrease and become more affordable, while encouraging more insurers and regional reinsurers to increase their capacity and expand their agricultural insurance book.

If successful, the pilot project will be expanded to all sub-Saharan countries: overall, Africa Re and GIIF aim to widely broaden the outreach and penetration of agricultural insurance across the African continent within the next ten years.


MICRO-INSURANCE m

“However, for micro-insurance to succeed, it still requires the collaboration

of governments, policymakers and private sector investors to provide the

regulatory framework and the initial funding to stimulate investments”


m ILS EVOLUTION

Alternative capital continues to expand its share of global reinsurance capital, albeit at a slowing

pace and significantly falling short of projections made only a few years ago. In 2016, according to Aon Benfield, catastrophe bonds, sidecars, ILWs and collateralised reinsurance accounted for $81bn or 14% of the industry’s total capital, up from 13% in the previous year. The trend towards collateralised reinsurance as the fastest growing segment of the ILS space continues and US catastrophe risk remains its backbone.

Insurance risk is still attractive to capital markets investors given the dearth of other attractive opportunities and the benefit of low correlation with other asset classes. Even though expected returns have declined, dampening investor appetite, we believe that ILS in property catastrophe business is here to stay.

Insurance risk as a strong investment portfolio diversifier will retain its appeal even under scenarios of normalising risk free rates, a series of massive insured catastrophe losses and changes to the US tax regime. The ultimate maximum market share of catastrophe ILS will be determined by the prudential considerations of re/inurance buyers who, of course, will not allow a single source of capital to become dominant.

Looking ahead, one of the most interesting questions is whether the ILS market in itself will achieve a more adequate degree of diversification by line of business and geography. As of

today, almost 90% of outstanding global alternative capital backs catastrophe risk, mainly in the US. For an ILS diversification scenario to play out, the concept would have to make significant inroads into non-catastrophe classes of business, paving the way for “Convergence 2.0”.

Lack of precision stymies casualty ILSMore than two decades after the inaugural ILS transaction was successfully completed Convergence 2.0 remains elusive. The reasons are obvious: investors are keen to have clarity about the results of their insurance bets as soon as possible and with a maximum degree of

certainty. In most cases, catastrophe ILS

investors know after one year whether they have made or lost money. Casualty risks, for example, cannot offer these benefits. A traditional reinsurer can be called pay out on a casualty treaty 10 or more years after it was struck. The longer duration of casualty risks, particularly when compared

to property catastrophe exposures is the main obstacle to a wider

adoption of ILS in this particular field. Also, casualty risks do not

offer the precision – much coveted by investors – with

which quantitative models forecast outcomes. Catastrophe modelling was a major driver

that helped kick-start the ILS market, affording investors

some sort of third-party validation of risk.

In casualty insurance,

rating and

CONVERGENCE 2.0 – IS REINSURANCE GOING FULL CIRCLE?Gunther Saacke, CEO of Qatar Re, questions whether the ILS market can ever achieve more diversification by line of business and geography

pricing practices are still largely retroactive because the longer duration of underlying exposures makes it challenging to establish a predictive view of risk. Investors, therefore, do not enjoy the benefit of independent third party vendor models that enhance risk assessment and pricing transparency. As a result, investors are reluctant to commit collateral for the second year of a transaction, for example, while still uncertain about the final results from the first year. No capital market investor wants to have his capital tied up for as long as the underwriting tail might last.

Furthermore, casualty risk tends to be correlated with the economic cycle. For example, fraudulent motor claims generally rise during economic downturns. This correlation defeats the main rationale of ILS. Another hurdle is the high cost of limit collateralization over longer terms as investors seek compensation for interest and inflation risks – an exposure they wanted to escape in the first place by investing in ILS. Finally, there are uncertainties surrounding the risk capital and ERM credit granted by regulators and rating agencies.

Road of opportunityGiven all these structural impediments it is not surprising that motor third party liability ILS, for example, leads a miserable existence with a global market share of just 1%. By contrast, premium-wise, this line of business is the world’s largest, with a share of more one third.

However, the outlook is not entirely bleak.

Innovative transactional features in combination with advanced analytics can go a long way in promoting non-catastrophe ILS. Most important, transactions need to offer investors a clear exit point. Here, the key challenge is liquidity as clarity of the underlying exposure to losses is more difficult to establish than with shorter tailed lines. Possible approaches include exit features whereby the risk could be transferred back to the sponsor and passed to another specialist or a pre-defined commutation procedure which allows investors to exit and liquidate their positions after one year, or at the end of the deal’s duration at the latest.

In addition to innovative transaction features that provide investors with liquidity, advanced analytics and Big Data could boost non-catastrophe ILS, and casualty transactions in particular, by addressing one of the most relevant obstacles: the lack of predictive models. Overcoming this weakness would pave the way for a much broader adoption of non-catastrophe ILS on the back of parametric covers, as has been the case in property catastrophe insurance.

Investors are set to seize such opportunities as soon as

uncertainty is reduced to acceptable levels. Catastrophe funds have excess capital and are unable to deploy it, adding to the pressure on managers to branch out into other lines of business.

Shortlived ILS nirvanaEven if the diversified multi-line ILS scenario crystallized it could prove short-lived by any standards of nirvana. Any transaction that meets investors’ desire for liquidity will require a significant deal of underwriting and basis risk management. The economics of non-catastrophe ILS could, therefore, develop in a way that

prompts investors to ‘rediscover’ traditional reinsurance as the most attractive risk return vehicle in the multi-line low-volatility space.

Buying and selling the shares and bonds of listed reinsurers offers the liquidity investors want as well as a potentially less

costly and complex way of portfolio underwriting and basis risk mitigation. Investors would be back to square one and, via Convergence 2.0, reinsurance would go full circle, returning to its traditional roots.

This proposition is not about advocating going backwards. The current softness of global reinsurance markets, which increasingly appears to be structural rather than cyclical, will put a premium on reinsurers that jettison long-standing behavioural patterns as market trackers.

In addition, the unrelenting digitisation of the economy is likely to necessitate a modern reinsurance business model which encompasses both retail and wholesale capabilities, direct and broker channels as well as a highly technical and analytical approach.

In the age of disintermediation and disruption it will be crucially important for reinsurers and their investors to gain direct and cost-efficient access to the ultimate source of risk. Bringing capital closer to risk was the vision of ILS from the very beginning – and so another circle nears completion.


ILS EVOLUTION m

“The current softness of global reinsurance markets, which increasingly

appears to be structural rather than cyclical, will put a premium on reinsurers that jettison long-standing behavioural

patterns as market trackers”

Source: www.Artemis.bm

Figure: Alternative risk capital outstanding by risk or peril, 2016


m FUTURE PROOFING

The reinsurance industry is changing rapidly – with the transfer of risk into the capital markets growing

and evolving significantly in the past 20 years. During this period the Insurance Linked Securities (ILS) market has increased dramatically, both in terms of size and also sophistication. Over the past five to 10 years, it is safe to say that the main disruptive force to impact the reinsurance market has been third party capital. That capital now represents about $75bn of the industry’s total capacity as estimated by AM Best for 2016, and it has had a clear effect on the market.

In short, ILS has lowered the effective return on capital and thus changed the traditional reinsurance landscape in a long-term and sustainable way.

Now, this former niche market has undergone a major transition from a little-known segment of the reinsurance market to a real competitive product protecting against natural and man-made disasters. The global capital markets have become more comfortable with ILS as an asset class and as a key part of their investment portfolios.

The ILS industry was conceived back in the early 1990s to revolutionise the reinsurance market after Hurricane Andrew exposed a serious gap in insurance coverage, and drained the reinsurance industry’s claims coffers. After some teething problems in the setup of these complex catastrophe bonds – and following several rounds of testing

by large natural catastrophes - these products now offer attractive returns in comparison to other financial products and are relatively shielded from the volatility of the mainstream economic markets because the underlying risk drivers are very different.

And it’s not just catastrophe bonds. In the past several years a strong catastrophe bond market has evolved into a collateralised reinsurance market, which has now become the dominant source of ILS capacity giving investors broader access to risk. This growing acceptance has grown the alternative capital and ILS market to a pivotal point in its history. As new forms of capital flow into the reinsurance market, the industry’s fundamentals

have been challenged and forced to adapt. Combine that with the ever strengthening influence of

technology and digitalisation and you have an industry undergoing a structural revolution.

Convergence evolutionIn the next decade, convergence of traditional

reinsurance with capital markets as we know it today will be long gone. As capital naturally

follows returns and as investors gain a better understanding of

insurable risks this trend will not decrease. On the contrary, it will continue to increase. Today, according to rating agencies and brokers, one-fifth of global property catastrophe reinsurance capacity is already so-called convergence capital. Further

HOW TO STAY ONE JUMP AHEADStephan Ruoff, CEO of Tokio Millennium Re, says that alternative capital is forcing reinsurers to look for ways to remain relevant

“We have to be willing as an industry to change and innovate. Making the hurdles for entry higher to outsiders through our own innovation is vital if

we are to survive”

down the road this mix of capital will become the new normal. Over time, there will be simply pools of capital looking for a good match with pools of risk.

Providing third party capital access to risk pools they normally would not consider can be a key differentiator for reinsurers in how they work with the capital markets. There is a shift from being pure risk carriers to also facilitating the match between risk and adequate capital – this is where reinsurance companies need to decide where they want to position themselves on the spectrum of the value chain.

This is a positive trend, as many societies are still underinsured when it comes to well-known risks (e.g. natural catastrophes) and in particular emerging risks (e.g. cyber risk). Traditional reinsurance capital in combination with capital markets provides a deep pool of capital to start to address and reduce remaining protection gaps. However, the matchmaking between capital and risk needs to become much more efficient and evolve as to its form. This is where the reinsurance sector can add the most value.

Capital markets participation has already started to become a source of funding to help narrow the protection gap that exists in parts of the developing world or for populations that are vulnerable, developing, under-insured or particularly prone to natural disasters. To delve deeper into this scenario, investing into extending the coverage to populations that couldn’t afford such protection can be accomplished by developing parametric solutions. Reinsurers can also invest in extending risk protection to very large risks, to new risks, or risks previously considered uninsurable. One way in which TMR has focused its investment

and energy on global resilience issues is its research and development on climate change to drive our understanding of the risks and help our customers better understand their exposures.

Staying relevantThe evolution of the alternative capital sector has clearly forced reinsurers to find new and innovative ways to remain competitive with capital efficiency as the main driver. Traditional reinsurers are exploring new forms to package risk to make it digestible for ILS investors. This approach is paying off as we have seen an increased interest in accessing new insurance risk, speciality lines, run-off portfolios, and a new wave of capital markets backed Lloyds facilities in recent years.

To cope with this changing and competitive risk landscape and to remain both agile and relevant, companies must adopt a holistic approach to look at and invest in their systems, processes, organisational set-up and cost structure. A modern operating platform must be scaleable to adapt to the reinsurance cycle and to any new political, regulatory, tax or rating agency imposed change.

Besides risk-capital matchmaking and operational efficiency, there is another secular trend reinsurers will have to embrace: technology. InsurTech has certainly become the big theme, with several initiatives and innovations creating a particular buzz since 2016 (e.g. predictive analytics, blockchain, artificial intelligence). This change driver is very important as technological innovation has the potential to completely reshape how business is transacted in the future. However, we need to take into account that for re/insurance markets regulation and consumer protection may slow the speed of change.

While other sectors have already embraced the sharing economy models, the re/insurance industry has yet to start thinking beyond the factors of innovation, efficiency, and technology. Building strong strategic partnerships and marrying our strong analytical infrastructure and deep customer relationships with technology companies’ vision and knowledge could be more powerful given how fast the world is changing.

Our industry must adapt to stay relevant to society. We must ensure that we are always providing a valuable and comprehensive product to the real risks faced by society. Any inefficient sector quickly becomes a target, this is true also for the reinsurance industry. We have become more vulnerable to disruption from the outside. Although there are clear signs that our industry intends to meet the challenge and is already delivering new and innovative products to the market. This development has to intensify.

Society stands to benefit greatly from the convergence of capital markets and traditional re/insurance if the result is a stronger value chain that more efficiently moves risk to capital and deepens our collective understanding of the risks we face.


FUTURE PROOFING m


m HEDGE FUND REINSURERS

The term ‘hedge fund reinsurer’ emerged several years ago, and is now widely used. Sometimes it is

used to describe our company, Third Point Reinsurance Ltd. But being labelled a hedge fund reinsurer does not single out such carriers as very much different from any other reinsurer. Nor does it do much to explain a reinsurer’s business model or even its investment strategy.

Like most of the reinsurance company start-ups that came before us since the 1990s, Third Point Re is based in Bermuda, was initially funded by private equity, and completed an IPO a couple of years after being formed. In common with many reinsurers of various types, our investable assets are managed by an investment manager. Many other reinsurers employ hedge-fund like investment strategies.

That said, it is not entirely clear just what a hedge fund is. The dummies.com website says: ‘A hedge fund uses a range of investment techniques and invests in a wide array of assets to generate a higher return for a given level of risk than what’s expected of normal investments. In many cases, hedge funds are managed to generate a consistent level of return, regardless of what the market does.’

Based on this definition, most or even all insurers and reinsurers are hedge fund reinsurers, or aspire to the status. Several enormously successful re/insurers have ‘used a wide array of investment techniques’ to ‘generate a higher return for a given level of risk’ over many years. Berkshire Hathaway, Fairfax, and Markel come to mind. If a ‘hedge fund reinsurer’ is one that generates most of its profits from investment income, then almost all fall into the category: over the past 10, 15 and 20 years, according to SNL, more than 100% of the US property and casualty industry’s pre-tax income was derived from investment income.

Nothing is new about the hedge fund reinsurer model beyond the term used to describe it. The average re/insurance company is fully dependent on investment results for its profitability, and a handful have greatly outperformed their peers over many years on the back of their investment management prowess.

Not all hedge fund reinsurers are built alikeThe eight or so reinsurance companies described as hedge fund reinsurers – those with investment strategies that are entirely or predominantly hedge-fund focused – have significantly different business models and operating approaches. Many of them are compelling. The variation in approach includes independent company versus traditional reinsurance company sidecar, public versus private, single hedge fund manager versus multiple managers, and dynamic risk capital allocation versus fully hedge-fund invested.

The model I know best is our own. Third Point Re is independent and New York Stock Exchange-traded. We invest all our investable assets through an exclusive investment management contract with one hedge fund manager, Third Point LLC. We have no plans to add other investment managers, and we do not intend to deploy risk capital dynamically between our investment strategy and our underwriting business based on relative market conditions. We will remain fully invested through Third Point LLC.

Our invested assets are held in a separate account. Third Point LLC manages the way these assets are invested on a mirrored basis with Third Point’s flagship hedge fund. We do not invest in a commingled hedge fund limited partnership (LP), because by owning the underlying assets we have more control over how and when they are liquidated, so we can readily pledge these assets to collateralise our reinsurance contracts, as is typically required of offshore reinsurers. We write most lines and types of P&C reinsurance except for property cat excess of loss and other similar event covers. Property cat is a highly volatile, albeit higher-margin line, which from a risk and liquidity shock standpoint does not mix well with our investment strategy.

Sidecar modelGreenlight Re, like Third Point Re, is an independent, broker market reinsurer. Most other hedge fund reinsurers are effectively sidecars of established reinsurers. These carriers exclusively or predominantly underwrite the ceded reinsurance business of their sponsors at market terms or rely on their sponsor’s staff to underwrite broker produced business on their behalf by using pricing models with higher investment-return assumptions. None of the sidecar hedge fund reinsurers are publicly traded companies. Most have probably suggested to their private investors that the likely

HEDGE FUND REINSURERS OPERATE UNDER A VARIETY OF BUSINESS MODELSThird Point Re president and CEO Rob Bredahl discusses the varying business models of hedge fund reinsurers

future liquidity event is an initial public offering, but all remain relatively young companies, and continue to plot their private investors’ exit routes.

Exclusive vs. multiple managersMost hedge fund reinsurers use only one hedge fund investment manager. Among these companies, some use very large, publicly traded, multi-strategy investment managers, and choose among the many strategies within these complexes, such that in effect they are using multiple hedge fund managers. At least two hedge fund reinsurers use multiple independent hedge fund investment managers. On the one hand, diversifying in such a manner may result in less volatile earnings. On the other, it decreases the chances of significant out-performance on the investment side of the ledger.

Dynamic risk capital allocationAt least one hedge fund reinsurer plans to allocate its investable cash to hedge fund strategies in whole or part based on management’s view of the relative current attractiveness of reinsurance and investment markets. When reinsurance market conditions improve, they plan to write more, higher-risk reinsurance business, and reduce the risk in their investment portfolio. Other hedge fund reinsurers invest only a portion of their money through a hedge fund manager due to regulatory constraints imposed on their US based or Lloyds subsidiaries, or because their hedge fund managers limit their assets under management.

Impact of investment strategies Hedge fund reinsurers balance the amount of risk they assume on the liability side of their balance sheets with the amount of investment risk they take. Most write some property catastrophe reinsurance and other event-driven covers. However, they carefully limit this form of risk because of its inherently volatile profitability and its substantial liquidity risk. Large loss events could require significant redemptions from the hedge fund management strategy, and not all hedge fund investment strategies can support sudden large withdrawals without significant loss of financial value. Those hedge fund reinsurers that write a larger percentage of event-driven covers will have lower combined ratios in years without large events but they carry significantly more underwriting risk and therefore the potential for larger underwriting losses.

Certain investment strategies impact operating efficiency. For example, some are not suited to the procurement of collateral, which is typically required

of offshore reinsurers to support reinsurance contract obligations. Strategies that allow for investing through a separate account where the hedge fund reinsurer directly owns the investments and is the direct counterparty to derivative contracts and prime broker arrangements is most helpful when it comes to procuring collateral.

Those hedge fund reinsurers that own an investment in a hedge fund limited partnership must pay more to collateralise their reinsurance contracts. Limited partnership investments are more expensive to finance than the underlying assets in the limited partnership, but some hedge fund reinsurers invest in limited partnerships because the underlying investment

strategies do not lend themselves to bifurcating assets into a separate account. These strategies include some forms of high turnover approaches and those that use significant financial leverage, such as leveraged loan investment strategies.

Third Point Re proudly embraces the hedge fund reinsurer label. Our approach has remained

consistent since our inception. We have confidence in our investment manager and in our reinsurance professionals. We market a unique mix of capabilities through a strong, experienced team. While it is tempting to think we have a lock on virtue, the obvious question is: which model is best? All hedge fund reinsurers were formed and are managed by thoughtful, capable people, so time will determine the best approach or approaches.


“Nothing is new about the hedge fund reinsurer model beyond the

term used to describe it. The average re/insurance company is fully

dependent on investment results for its profitability, and a handful have greatly outperformed their peers

over many years on the back of their investment management prowess”


m LONDON MARKET

London’s position relative to the regional markets of the world is undergoing a dramatic and potentially

devastating shift. Insurance hubs in Singapore, Miami, and Dubai, which serve the markets we describe as emerging, are maturing to become fully-fledged global centres of risk-transfer excellence, just as Bermuda has done.

Recently, for example, we have seen German marine business bypass London – its traditional home – and go straight to Singapore. The frequency of such placements is increasing. London must recognise and acknowledge this challenge. It must begin to give customers what they actually want, not what London wants to give them, because inaction may lead inevitably to irrelevance outside London’s own home markets.

London Matters 2017 is the eponymous statistical sequel to the 2014 report that called London to action in areas ranging from efficiency to diversity. It was also the basis for former Lloyd’s chairman John Nelson’s “Vision 2025” push into the emerging markets of Asia, Latin America, and the Middle East. The report is sobering. London risk carriers’ share of global premiums in what are effectively its home markets – the UK and Ireland, the US and Canada – has held steady or even grown. However, London’s market share in fast-growing emerging markets – the Vision 2025 targets – has shrunk. Most dramatically, in Asian markets, which expanded overall by 9% between 2013 and 2015, London’s share of total premium spending declined by

1.2%. This negative performance pattern is repeated, albeit less severely, in Australasia, Latin America, and Africa.

Closer isn’t betterTwo factors are at play. The first is the failure of the “moving closer” strategy. So far, the London outposts set up in emerging markets have not much tempted local buyers. Recreating London’s centuries-old business model (which involves plonking a few underwriters at desks in hub cities) does not ensure that local horses wish to drink.

Our ancient business model has no relevance to a 30-year-old Malaysian tech entrepreneur. The way London does business reflects neither him nor his needs, opportunities, and challenges. London’s people in Singapore are unlikely to speak his language, let alone look or dress similarly. Once, London was his only choice. Now local insurers and other internationals sited locally are just as able, and more in tune.

Asian marine risks now very rarely show up in London. Local carriers possess more than enough intellectual property and capacity to write the risks arising there, and London has done little in its outposts to tempt them away. The stark truth is we have not bothered to learn about their business environments, tastes, risks, or needs. Ask one hundred brokers in Lime Street to name ten Chinese cities bigger than London, and aside from the obvious five or so, you are unlikely to get ten

MAYBE LONDON DOESN’T MATTERSteve Hearn, chief executive of Ed and former chairman of the London Market Group, argues that London could be edged towards irrelevance in emerging markets as regional hubs become global centres of excellence

city names in total from the 100. Chongqing (with a metropolitan population of 30 million), Hangzhou (21 million), Wuhan (20 million), and Chengdu (18 million) probably won’t be mentioned. We are rarely invited to play and it’s simply because we are old, experienced, and newly proximate. We must genuinely know the customers to hold our own in emerging markets.

The monopoly is overThe second factor is that London is no longer the only market for large, difficult, international risks. Miami’s Brickell Avenue, the Dubai International Financial Centre, and Singapore’s Marina Bay are competitive, experienced trading environments populated by the most sophisticated global players. Like London EC3 and Hamilton, they are well capitalised, well rated, well regulated, and well served by various suppliers, from legal experts to specialist IT companies.

Regional hubs no longer exist to cater only to regional risks, just as Bermuda no longer exists solely to underwrite US excess casualty. We all know that over time, to our great cost, Bermuda dramatically encroached on London’s catastrophe reinsurance business. We watched it ebb away.

Miami, Dubai, and Singapore have become global markets in their own right. Their existence as credible competitors to London means that the old market, with the coffee-house at its centre, no longer has any entitlement to genuine international business (like German marine) which could be placed anywhere with the appropriate infrastructure. London is no longer the only player in the game.

Ironically, in an own-goal during what may prove to be the final minutes of the match, London’s drawn-out effort to create local hubs gave a leg-up to local and competing collocated international competitors to acquire everything they need – including the intellectual and risk capacity – to retire London as their market of choice. Technology hastens the shift.

Regional hubs now have what London has. They have capacity and expertise. Ironically, London’s lack of expertise (about local environments, cultures, and business models, for example) has propelled the shrinking-market-share phenomenon in Asia and Latin America. There, expertise is not what we offer, it is our barrier to entry. We lack local acumen. Since hubs no longer lack what we have, Darwinism prevails. Those

better adapted to local environments will succeed. London must adapt, or face extinction.

Customers make the choices, and ultimately will be the winners. Naturally customers are better served when multiple comparable markets compete, since competition is bound to lead to improved products, better service, and lower prices. So in considering what London brings to the game, we must think how we can improve the customer’s experience. They would

rather trade with someone who speaks their language, understands their culture, who has foundations in in

their own business community, and faces the same set of perils.

Upping our gameLondon market players must notice and adapt to the field of play, and consider very carefully what

they bring to the game. They must offer something which these new competitors cannot provide, and

do so in the way they want it done, as locals. If all London brings is capital, we

will be out of the game. If it is intellectual property, we

need genuinely to understand what that means. In some product classes such as political risk, the intellectual property demands are so great, and the barriers to entry therefore so high, that London continues to dominate the space, for now.

But for most of the rest, for the bread and butter fire risks and all the marine cargo, for example, larger global insurers and reinsurers certainly understand what local customers want. They know that the European answer is almost never the Asian answer, and the African answer is not the Asian answer. One size does not fit all. Global solutions rarely satisfy in a regionalised world.

London will retain its Scandinavian, Canadian, Australian, and American market share, for the near future at least. But as multiple global underwriting centres emerge and compete for global business, some of it will shift to them, and London will become one player among several. The solution is for London to provide a better customer experience. That means not only relentless innovation in the products and services that London provides, but also delivering them in a way that makes local customers comfortable.

It means knowing the name of the city they hail from, the business environment in which they operate, and the genuine local challenges they face. It means, perhaps, that London must go native. If we don’t, London really won’t matter.


LONDON MARKET m

“Ironically, in an own-goal during what may prove to be the final minutes of the match,

London’s drawn-out effort to create local hubs gave a leg-up to local and competing

collocated international competitors to acquire everything they need – including

the intellectual and risk capacity – to retire London as their market of choice”


m INTELLECTUAL CAPITAL

Underwriting has always been described as both an art and a science. Since ships were “insured” in

Edward Lloyd’s coffee house in the 1600s, underwriting has continually evolved year-on-year, particularly in the last decade in the face of modernisation and globalisation. Now I see more transformation afoot within the underwriting world - and it spells change for the traditional role of a reinsurance underwriter.

I’ve been at Hiscox for 14 years and when I started, underwriting at the box was key. Many hours were spent there, sitting deep in thought, while open for business. But this way of working - to simply sit over at the box

waiting for risks to come to you - is out-dated now Current market conditions demand that underwriters

transition from passive risk takers to proactive problem solvers and solution creators. As the average number of insurers that clients and brokers consider for business rapidly declines (driven by commoditisation and consolidation), waiting to be picked is no longer an option. Underwriters need to be able to master many trades in a way that certainly wasn’t the case when I was based at Lloyd’s.

Historically underwriters have been trained to be reactive – responding to the risks as they are presented. As a result, many underwriters today lack the sales and marketing skills to go out, compete and win new, quality business. It is no longer enough to rely on the expertise of other business functions – for example, catastrophe modelling teams, or a chief financial officer to assist in the numbers. Now, underwriters not only need a good

THE ROLE OF THE REINSURANCE UNDERWRITER – A GENTLE EVOLUTIONMike Krefta, CEO of Hiscox Re and Insurance-Linked Securities (ILS), says the next wave of underwriters must become masters of many trades if they are to remain relevant

understanding of banking (given the volume of third-party capital entering the market), they also need to be asset managers, business analysts, catastrophe modellers, sales focused and marketers…and still underwrite.

Analytics and automation are also now a fundamental part of the job. Big data, statistical and catastrophe modelling are all the course. Being able to understand risk in this way liberates underwriters, allowing them to spend more time on high-value activities, such as complex risk assessment and decision-making.

Underwriters of the futureI may be biased, but I believe underwriting is the heart of the reinsurance business. The exciting thing right now is that the market has an opportunity to define its future, a future where underwriters are the leaders of tomorrow and are repositioned as higher-profile, strategic influencers and decision makers. It sounds simple, but it’s quite a step change.

And it is easier said than done. Underwriters are not always the leaders they can be, for all the reasons I’ve already outlined - and a few more. At the same time, we hear constantly about the rise of artificial intelligence (AI) and other technologies that have the potential to disrupt traditional underwriting models. Such change isn’t necessarily as bad as it is often portrayed. If AI means that underwriters are freed up to deal with the most complex risks, while simpler risks are handed by new technologies, then that is good news all round – for reinsurers and insurers; for brokers and for clients.

But as the role of the underwriter changes, so too must the attitudes of management. The reinsurance companies that make the most of this evolution will succeed. They shouldn’t neglect or overlook the organisational change management and human dimensions of such transformation, but instead encourage it.

Managing the talent gapReinsurers should also prepare for the underwriting talent gap that is rapidly opening up before us. Many experienced underwriters and executives are heading towards retirement in the next five to 10 years and will leave behind them a gaping hole of experience. This is part of the reason why we hear so much emphasis placed on attracting millennials to the market. It is called future-proofing.

Cultivating the right talent goes beyond attracting

millennials and is as important as a workman using the right set of tools. Those entering the industry today have different expectations from the jobs market: from different working conditions and rewards, to recognition and social purpose.

It also requires a change in leadership style. In World War I, leadership was defined as “command and conquer”. Soldiers were told what to do, when to do it

and how to do it. But by World War II “distributed leadership” was de rigueur. That means being told what you need to achieve, and going off and working it out for yourself. A very similar change is happening right now in reinsurance.

I personally can wax lyrical about the benefits of taking a risk with your career, trying out different

jobs and working in different territories. I’ve worked across six different parts of Hiscox, doing everything

from catastrophe modelling and accounting, to management and underwriting, and most

recently I’ve moved to Bermuda as Hiscox Re and ILS CEO. These experiences have taught me vital lessons – to be flexible, to embrace change, and to keep learning. But I couldn’t have done it if the opportunity and support hadn’t been there from those around me.

And it’s not just in our industry. Take an elite athlete, such as a boxer or a

tennis star as an example. Many are where they are not only because of their own talent, but also because of the team behind them. More often than not, they credit their success to their coach, their mentor or their teammates. Why would someone working in any demanding job not welcome the chance to be better versions of themselves?

The future of underwriting Transformation of the traditional underwriting role is overdue if businesses are to succeed in a modern, fast-changing and highly competitive global reinsurance market. It is clear that tomorrow’s top reinsurance underwriters will have considerably different and higher-value roles – a revolution that will change the way the market underwrites and, more exciting still, drastically change what it means to be an underwriter.

This is an exciting prospect for individuals as well as for our industry. There is a tangible opportunity for underwriters to increase their value in the organisation and develop their leadership position in order to not only drive the future of the company, but also shape the future of the industry.

Success relies on the industry understanding and embracing this evolution and managing a seamless transition. The underwriters of the future will thank us, and the industry will be all the better for it.


INTELLECTUAL CAPITAL m

“Underwriters not only need a good understanding of banking (given the volume of third-party capital entering

the market), they also need to be asset managers, business analysts,

catastrophe modellers, sales focused and marketers…and still underwrite”


m REINVENTION

We hear a lot lately about a phenomenon that has been called “the protection gap”. It is the

difference between real values at risk and insured values. The gap is usually cited in reference to market opportunities such as uninsured risks in emerging markets, or the opportunity to upsell existing clients with yet more insurance products for exposures that they perhaps haven’t thought about.

In this sense, the protection gap is real, but we should all be focussed on another protection gap: the one between what we, as brokers and insurers, are offering and providing to our clients, and what they really want and need.

Brought down to basics, it is very simple. Clients want and need affordable, responsive insurance which covers the risks they face in today’s changing world. Our sector has done very well to consolidate, to cut costs, reach around the globe, and develop new technologies. But somehow we have done all that without always listening properly to our customers. When we do listen, we sometimes don’t hear. We try to solve our clients’ challenges with the same products we have been selling for years, decades even, updated with only minor tweaks to address the incredible, revolutionary changes happening all around us. To twist a metaphor, we are sometimes guilty of attempting to fit square insurance solutions into round risk challenges.

In the past, buyers had few choices about where to buy their insurance solutions - that has begun to change. A new breed of insurer/distributors collectively known as “InsurTech disruptors” is mobilising new technologies to create insurance products and delivery systems which they believe bridge the gap by moving closer to what clients really want and need, and delivering it in ways that reflect the way our world is changing.

They are typically backed by large sums of speculative capital from investors who also see a gap

to be narrowed. So far the InsurTechs have focussed primarily on private client risks, but it won’t be long before the disruptors target commercial insurance too – in particular straightforward risks with big-data resources such as cargo and motor fleet.

Many traditional brokers are doing very little, or even nothing, differently in response to what customers want and need in our changed world of instant connections and new risks. Instead of this inertia, we must reinvent. We need to follow the InsurTechs by adopting fresh approaches to meeting clients’ needs, building from the ground up if necessary.

Transactional broking alone is an unsustainable model in large swathes of our traditional business patch. Reshaping our old products, rather than embracing true innovation, will not carry us into a dizzying future. Fortunately, though, we have some breathing space before our lunch is eaten by others. We have the chance now to offer our customers what internet-based InsurTech operations for consumers cannot: sector specialists that can provide genuinely responsive products and sound risk consulting.

We have something to learn from our successes in the cyber insurance market. Cyber risk is slippery, nebulous, and constantly evolving. The market’s latest cyber

products are comprehensive and flexible. When data protection became a concern in the US, the

sector developed third-party cyber liability covers. When manufacturers said they

were worried that hackers could hijack industrial control systems and wreak

physical damage to their plant and equipment, we developed physical damage cover triggered by a cyber event. We added genuine risk management tools to our insurance: cyber-security audits and advice, as well as post-incident support, and even funds for reputation management if a public breach smashes into a client’s good name.

The industry’s early efforts were perhaps not stellar, but now we

are getting it right by providing cover that may assuage our clients’ real concerns about cyber risk. At

Gallagher we have done so by

THE WAY WE (MUST) DO BUSINESS NOWThe insurance industry must head off the InsurTech disruptors by reinventing itself, according to Grahame Chilton, CEO of Arthur J. Gallagher International and founding partner of Capsicum Re

listening to clients, travelling way out of our comfort zone, and rethinking what a cyber insurance product should do and how it should be made accessible to as many clients and sectors as possible. The market has developed a suite of useful products which are proving their genuine worth. We have built ours from scratch, rather than simply tweaking old products and adding new clauses.

As an industry, there are multiple lessons to learn from this success in cyber. We can and should look at all the products we sell, and reinvent them so they truly match customers’ needs. We should consult our clients to determine how we can make risk less of a concern in their day-to-day business operations. We should do more than simply encourage insurers to expand cover under existing policies, then negotiate a better price. We should work with our markets and our clients to develop better products that include risk-assessment and management support throughout the life of the policy.

When all we offer is indemnity, we sell only a commodity. When we provide something more, maybe to reduce workplace accidents, or to change behaviours to help our clients avoid public liability, we offer a genuine value-added service which is tangible and cannot be provided by the internet alone.

We must, of course, embrace the internet for distribution. We must harness big data to ease the quotation process, and ensure our clients can buy the coverage they want and need at a reasonable and fair price. We must become experts in emerging risks, and consult with our clients to uncover the known unknowns which they face, but may not be facing down. The true role of a broker is to be a risk advisor and advocate, one that delivers the advice, support, and services that clients need.

Consolidation and the development of mega-brokers has sometimes seen the focus on meeting clients’ real needs usurped by the imperative of meeting internal benchmarks. But clients don’t give a damn about their broker’s internal targets or their operating structure or their organic growth rate. They simply want to sleep at night, knowing their risks are transferred to a secure third party, or managed away, and that claims, should they arise, will be met with alacrity. It is vital that we upset the status quo, overturn industry norms, and offer a new, entrepreneurial, outward-looking approach that gives clients what they want and need.

We must look at who we are, what we do, how we do it, and how it helps insurance buyers. We can begin by looking at how our businesses are structured, and how our cultures work. If the producing brokers or the underwriters are the stars of the show, we may need to

rethink. Where in the hierarchy is the risk engineering team? The wordings experts? The technology innovators? The claims innovators? They will carry us forward, giving the producers and the underwriters something valuable to work with. We need to ask, constantly, why a client would choose our firm over the competition. Far too many companies rely on the old relationship answer. Familiarity is valuable, without doubt, but relationships will crumble like an oatcake in the face of the disruptors.

The same is true of brokers’ relationships with markets. They are, of course, extremely important, but customers don’t really care who is underwriting their cover when it is simply commodity risk transfer. As long as they have the rating and the track record, and the confidence that claims will be paid without quibble in an efficient and timely manner, any insurer will do. For the customers, it is the product that counts, and the product includes

the advisory services and technical support that goes with it.

What products do they truly need? It is our job to find out, and then, in a market awash with capacity, summon the entrepreneurial flair to find the markets that will work with us to meet those clients’ desires, as we

did with cyber. Under current market conditions, we should be able to offer almost anything.

Working with our markets as risk consultants should be a top priority. For them, we are often simply thought of as distribution. But we have the keys to the mansion, the client relationships. Brokers are in a position to discover what clients really need, and to work with markets to construct the ways and means of delivering it. At Gallagher we recently developed a £500 product to protect the smallest of businesses against crises like kidnap, cyber, terrorism, confiscation - the lot. It includes consulting, counselling back-up, ransom cover, pre-loaded cash-cards, and many other contingencies which may be invaluable to clients caught up in an out-of-the-ordinary event. We worked closely with insurers to develop the product. They are now selling cover to hundreds of new clients who they haven’t met before, and importantly our clients are enjoying a little more peace of mind.

You could call it disruptive. Perhaps it is just innovative. It is certainly new, and meets the needs of businesses that were unable previously to find anything close to this kind of insurance package at an affordable price. For our clients, it closes a very real protection gap. But it required a new approach. It demanded that we hear what customers want and need, and work with markets to deliver it. Developing these kinds of radical solutions to client challenges is vital in our effort to beat the disruptors, retain our place in the changing world, and grow our businesses within it.


REINVENTION m

“Working with our markets as risk consultants should be a top priority.

For them, we are often simply thought of as distribution. But we have the

keys to the mansion, the client relationships”


m TERRORISM

On June 29, the UK Government declared the attack on London Bridge, which left eight people

dead and 48 injured, to be a terrorist event. At the time of writing, it was the third UK event in 2017 certified as terrorism for the purposes of the 1993 Reinsurance (Act of Terrorism) Act. Each of the three attacks, at the Manchester Arena, Westminster, and London Bridge, caused significant loss of life and economic damage. However, the latter two highlight a series of serious gaps in terrorism insurance coverage.

Business interruption losses suffered by shops, traders and tourist attractions within post-event police cordons were not covered by most insurance policies. Even those small traders who had had the foresight to purchase terrorism insurance may not be covered for business interruption at Borough Market. The reason is because very little property damage occurred, so policies are unlikely to be triggered. Traders who bought cover therefore, probably found that it does not perform as they might have expected.

Property insurance policy conditions invariably state that property damage is required in order for the insured to receive an indemnity in the event of a terrorist attack. However, such wordings suggest that the insurance industry is in danger of selling products that are no longer fit for purpose. The terrorism cover that was intended to sit back-to-back with property policies now presents a gap which, if not closed, will damage the reputation of our industry.

Several key issues must be addressed in order to ensure the adequate provision of terrorism insurance in the UK. First, is the cover available? Terrorism has changed. Causing damage to property is no longer the terrorists’ sole focus. At Borough Market, as well as the horrific loss of life, a terrorist attack closed businesses without causing significant damage to property. That scenario has now played out time and again in the UK, and across continental Europe. National terrorism reinsurance schemes designed to allow businesses to quickly get back on their feet, have been found lacking.

The solution in the UK is straightforward. The requirement for a property-damage trigger in the 1993

Reinsurance (Acts of Terrorism) Act must be removed so that non-damage business interruption can be insured. The political will to do this exists, and once the legislation is amended, members of the Pool Re scheme will be able to make new, better cover available to insureds.

Problem solved? Hardly. The main issue for traders in Borough Market, as for

SMEs impacted by terrorism across Europe, is not that they had purchased terror cover which excluded non-damage business interruption. Instead, most simply had not purchased terrorism insurance cover at all. They either chose not to buy it, or were not offered it.

This presents a long-term issue for the insurance industry, and underlines a penetration gap which is less easily solved.

Many people view terrorism as a peril restricted to large cities. However, the methods employed by today’s terrorists are principally

aimed at causing death. That means clusters of high-value property are no longer necessarily at greater risk of attack. This is not widely understood outside of the insurance industry, so the uptake of terrorism insurance remains overwhelmingly concentrated in city centres even though crowded places are not necessarily located there.

A terrorism event outside of a major conurbation presents a moral hazard for insurers. Unless insurance penetration is increased, businesses which did not purchase, or were not offered cover, will probably seek compensation from the government following an attack. Such a call seems unlikely to be refused by any government. Any business that had purchased terrorism insurance will question that decision if and when it sees neighbours receive compensation without having paid a premium. This again will damage insurers’ reputations.

Given what the insurance industry knows about the risk posed by terrorism, why do we not systematically offer cover to all businesses? Why were commercial property policyholders not made sufficiently aware that they are uninsured? And why might the taxpayer be asked to foot the bill, when schemes such as Pool Re and others around the world have been established specifically to

BRIDGING THE GAPS IN TERROR COVER

“The evolution of terrorist methodology is likely to continue unabated. Gaps in

coverage highlighted by the attacks in London, Manchester, and across

continental Europe have made obvious the need to adapt coverage”

The changing modus operandi of terrorists means that the industry must urgently rethink how terrorism cover works, says Julian Enoizi, CEO of Pool Re

ensure that liability for terrorism incidents does not immediately fall on the public purse?

These are legitimate questions. They should be asked and addressed now, rather than in the aftermath of yet another event. Several possible solutions could be imposed by insurers and brokers. One is to make the offer of terrorism insurance mandatory in every property insurance renewal. While terrorism insurance should remain a discretionary purchase in the hands of the private market, many businesses are unaware that such cover is excluded from their property policies.

Simply ensuring that every business has been offered cover may move the needle and increase penetration. It would stimulate the market for terrorism insurance beyond large businesses in major cities, and ensure that insurers at least seek to provide cover. The level of claims resulting from the terrorist attacks in France in 2015 and 2016 emptied the coffers of the nation’s Fonds de Garantie. As a result, the French government imposed an additional tax on every property insurance policy so as to rebuild the fund. This can be avoided in the UK if we act now.

The markedly low uptake of terrorism insurance among SMEs is an issue of awareness. The insurance industry can play a role in changing this. Insurers and brokers can work with insureds to highlight the level of exposure that many of them do not realise they face. Attacks across continental Europe have tragically emphasised that terrorism is no longer, if it ever was, restricted to major cities. Percentage penetration among SMEs outside of major urban centres is in single digits. In part, this is a gap in awareness between the perceived threat and the reality of the risk. SMEs that better understand their exposure are invariably more likely to purchase cover, particularly if the cost is reasonable and fair; another issue that must be tackled.

We can work with insureds to help them better protect their businesses against terrorist attacks even if they are not themselves the target but their location, next to a crowded place for example, causes an interdependence issue. Moreover, by implementing proven risk mitigation measures, businesses will be better protected, national resilience will improve, and current buyers will enjoy reduced premiums as a result of better spread of risk.

The same cannot be said for cyber terrorism. In the future, it is inconceivable that terrorists will not look to deploy cyber attacks to further their agenda. Technology has become ubiquitous, creating another area where the public (again with justification) will not understand why, simply because a fanatic has hacked into computer to cause an explosion rather than parking a truck outside a building, their policy does not respond. It is only a matter of time before this gap becomes glaringly apparent. Pool Re has held intensive discussions with the government to avoid this and expects cyber terrorism to be

included in its proposition imminently.The insurance industry has been slow to adapt to the

evolution of terrorists’ methodologies. Policies appear increasingly out of date with today’s terrorist arsenal. While some developments could not have been foreseen – few would have imagined that cars and trucks would be used in a series of attacks to kill and maim – the unlimited liability for these vehicles means that insurers are now facing claims which were not envisaged. If attacks using vehicles become more frequent, how long before motor reinsurers begin to increasingly scrutinise their exposure and look to introduce exclusions or raise premiums?

The evolution of terrorist methodology is likely to continue unabated. Gaps in coverage highlighted by the attacks in London, Manchester, and across continental Europe have made obvious the need to adapt coverage. Non-damage business interruption caused by terrorism has been shown time and again to be one such gap. It can, and should be, closed.

Doing so will provide cause to look beyond what is immediately necessary and demonstrate that we can be forward thinking. Bridging gaps in coverage, penetration, and awareness is immediately necessary if the insurance industry is to provide relevant products today. Such action will remove risks that may otherwise fall on the government’s balance sheet, by placing them in the private market using Pool Re as the conduit to do so.

Cyber terrorism is a clear example of this. Amending the cyber exclusion is an acknowledgement that terrorism is evolving and will continue to evolve. It has become more sinister, more diverse and is now a global threat. Working together to address the gaps that are apparent between: awareness and reality; terrorism insurance products versus the methodology being

employed; and penetration in cities compared to towns,

will improve resilience. It will ensure that the economy remains resilient and that the insurance industry is able to respond to today’s terrorism events.

The need to close the gaps has been thrust upon us. That should be reason enough to be

proactive, to learn from recent events, and to close

those gaps before future attacks occur and

leave us open to criticism.


TERRORISM m


m INVESTOR SENTIMENT

As new capital flows into the insurance space from institutional and individual investors, everyone in

the industry is asking if these trends are the first wave of an irreversible disruption of the value chain. They are disruptive and the disruption is irreversible, but the wave crashing over us now began building more than twenty years ago.

I first heard of capital markets and individual investors outside our industry weighing the advantages of jumping into insurance for the first time in the mid-Nineties. Looking for places to deploy capital and generate positive returns, players in other sectors noticed then that insurance is quite profitable when catastrophes are absent. Free of the financial burdens faced by regulated insurance companies, they hoped to ante up in select short-tail risks, get lucky and avoid losses, reap some rewards and cash out before any catastrophe occurred.

Twenty years later, they account for a substantial amount of our industry’s catastrophic capacity. Weighing risk against reward, they steel themselves against the considerable losses they might suffer if the wind blows and the ground shakes.

Why not? As returns from traditional fixed investments continue to be low, such risk taking is easily rationalised. Their entry into our industry

was the genesis of the class of investments we now know informally as catastrophe bonds. Structured more like credit default swaps, their continuous quarterly payouts give them the look and feel of bonds. In my opinion, this development was just the opening chapter in the story of the wholesale disruption of our industry today.

Risk looks better from the outsideThe market for these catastrophe bonds grew quickly, as did other risk-transfer mechanisms we refer to as insurance-linked securities (ILS). Today, as much as 80% of the retrocessional market is served by

collateralized reinsurance backed by investors seeking to participate in reinsurance risk

directly. Similarly, the flow of this kind of capital into the insurance space has

increased every year. No wonder. Outside investors have

an advantage over legacy carriers. They’re able to keep expenses much lower than we are, so even a lower price will generate an adequate return. In addition, these risks are among the largest aggregations faced by insurers, while for most investors they are a diversifying

investment. Between the benefits of diversification and low expense, the

return required by investors in this business is lower than what the equity

markets require from the

WHAT WILL HAPPEN AFTER DISASTER STRIKES?Mark E. Watson III, CEO of Argo Group, believes that a big event will change everyone’s perception of value and margin

insurance companies in which they invest.That too makes sense. A required return is driven

by the sum of all the risk you’re asking an investor to take. When a shareholder buys stock in an insurance company, the risk of an actual catastrophe is only one of many. That company might make poor decisions about its own investment portfolio that could directly affect net income. It might spend too much money by being inefficient, offering policyholders terms that are not sustainable, or writing a whole book of business that simply disappears.

With all these issues at play, most investors judge the required equity return from an insurance company to be about 10%, at least in the current rate environment. Not this new class of investors; other than the wind blowing and ground shaking, they risk little. As such, they can be satisfied with a return of as little as 4%.

All eyes on the marginsLast year, many of us expected to see cedants buying more reinsurance as pricing continues to decline. That happened, but it hasn’t yet helped reverse the trend to undercharge. There’s still too much capacity in the market and margins are at an all-time low as a result. Where margins are low, all-digital services have an advantage. That has many of us pondering if the all-digital companies we call InsurTech will begin to target specialty insurance and reinsurance, where margins are better.

My prediction is “no” in both cases. Specialty insurance, where scale is smaller but margins often higher than in personal lines, may seem a desirable target for these capital-rich entrants, especially FinTech unicorns with their $1bn-plus valuations. But specialty insurance is tough to underwrite without deep domain expertise in a diverse group of disciplines. As each new risk emerges (think of cyber today), the aggregate data that can be used to judge the degree of risk is slim. Even systems that leverage artificial intelligence and machine learning will have too few numbers to crunch to make an accurate assessment of likely outcome.

Over time, the data will become richer, but, as it does, margins will compress as a result. (Specialty has better margins only when an insurer covers risks on the edges of the market that are more difficult to assess.) Similarly, success in the reinsurance market is complex. While underlying risks are relatively easy to identify, they can be enormous in scale. There are fewer events, any one of which can be severe. So reinsurers have two challenges. First, it’s difficult to get enough data from one event

to predict either the likelihood or severity of the next one. Second, losses from these large events can quickly erode the capital base of any reinsurance company. (Some companies have been wiped out after a series of catastrophic events within a short time.) Neither of these conditions will give comfort to either capital markets looking for easy profits or investors looking at short-term involvements.

Legacy or digital: who will triumph?Our current market’s dismal margins are as much a harbinger of imminent, massive change as they are the result of shortsightedness among those who have refused to change. But new entrants to the insurance industry—be they capital market investors seeking

better profit or digital players looking for a new game to disrupt—will not have an easy time of it on their own.

Our insurance industry is deeply regulated to protect those who trust us to be there when something bad happens. Rigorous public oversight of our activities has in our own lifetimes lifted insurance from an incomprehensible and suspect player in the financial sector to the very backbone of growth in a

progressive and increasingly global economy. Ethical behavior, proved by transparency and accountability, is now expected. And regulation, as messy as it can be in multiple jurisdictions, will continue to be the watchdog of ethics.

Great changes are upon us, and no one looking to break or overlook the rules will last for long. In my opinion, the judicious use of cutting-edge technology combined with insurance expertise and experience represents the clear and, for established insurers, successful path to continued growth. By building digital expertise, often by forging creative partnerships with existing digital players, we will collaborate in ways that bring capital closer to the risk, reduce the complexity of our offerings, and offer even greater value to our customers.

In my experience, the wise thing to do in times of change is pose the right question. In the past few years, the vast majority of industry underwriting profits have come from property risk where the catastrophes that might have occurred haven’t. The question before us all now is, “How will our industry adjust when we lose that tailwind?” Without doubt, we will be digital and our capital will be close to the risk. It’s up to us all to determine how to do that in ways that benefit our customers and, because of it, ensure our own wellbeing.


INVESTOR SENTIMENT m

“Our current market’s dismal margins are as much a harbinger of imminent, massive change as they are the result

of shortsightedness among those who have refused to change. But new

entrants to the insurance industry – be they capital market investors seeking better profit or digital players looking

for a new game to disrupt – will not have an easy time of it on their own”


m EFFICIENCY CHALLENGE

Upheaval is reshaping our industry. The cyclical underwriting model that used to be such a

prevalent part of our industry is becoming outdated and reshaped. Advances in analytics and risk modelling have afforded re/insurers and other capital providers a much deeper understanding of risk, which has stabilised pricing. That, in turn, has allowed investors to become increasingly comfortable with insurance as an asset class. Insurance now provides capital with a home that promises relatively stable returns.

While the path will not always be smooth, it is difficult to see how this situation could change significantly. The abundance of capital is likely to remain and by extension, pricing will remain more consistent and soft (unless you have key adjustments to the model assumptions – witness the effect of Ogden in the UK). If pricing is no longer the main lever that insurers can pull to improve returns, then savings must be found elsewhere. All roads lead to the expense chain.

In many instances, up to 50% of the original insured’s premium is spent on expenses before it reaches the ultimate underwriting capital provider. This is not value. Between the underwriting capital and the original client, every point in the chain takes its cut, from retail broker to traditional insurance market, wholesale broker to traditional wholesale market, reinsurance broker to traditional reinsurance market. In tandem, the larger

traditional insurance brokers continue to hike up commissions, leading to ever increasing acquisition costs for the insurer.

This situation is unsustainable. Technology and data will be the catalyst which removes those who do not add value.

The key pillars of our industry are at loggerheads. Pricing for insurers has become very low, making meaningful returns more and more difficult to come by. Brokers continue to raise commission levels to balance falling premium rates. Over the past decade underwriting has undergone its own period of disruption and change: hedge funds and pension funds are now key players. This end of the market will continue to evolve, but the distribution side is now beginning its own revolution. The value chain is too long and too expensive. The growth of insurtech and MGAs is already beginning to disrupt the established distribution model. They will be key drivers of radical change over the next decade, with disruptive distribution seeking out disruptive underwriting capital – and vice versa.

Businesses will be bypassed if they are too slow to recognise the changes coming to our market, too reliant on outdated processes, or reluctant to embrace the savings, both in time and costs, which new technology can confer. Several characteristics will define those left standing. On the distribution side, access to customers will be crucial. An increasingly customer-centric approach will be essential to success. The balance of power has shifted in favour of the end customer.

Customers view speed, ease, and convenience in their transactions as a minimum requirement. Greater

BREAKING THE VALUE CHAIN

Grahame Millwater, CEO of reinsurance intermediary Beach, says the insurance value chain has become too long and too expensive

transparency is also needed. Mobile technology and social media will become increasingly important customer-access channels. Distributors will need competitive pricing, comprehensive and relevant coverage, and a focus on service. Customers have become savvier, and will not tolerate outdated, ineffective platforms or poor service.

Distributors will also need to convince coverholders that their systems, processes, and claims payments are secure. They will need access to underwriting capital with good security. Successful players will have low expense bases, and will be centred around technology. This will be critical not only to distribution, but also to provision of the data demanded by the capital that is supporting underwriting. Peer to peer insurance and mobile apps which offer flexible short term policies offer a glimpse of the future in this section of our industry.

It is not only the changes within the insurance industry that will drive change, but the rapidly evolving environment around it. Climate change, driverless cars, social responsibility, social media, blockchain technology – the list could go on, but all have the potential to dramatically impact our sector.

For underwriters, several key components will underpin their future prospects. First is expertise. The ability to provide cover in highly specialised classes of business or to underwrite portfolios will be essential. The latter must combine cutting edge analytics with deep underwriting knowledge. Risk carriers will be data rich with a markedly low expense base. Finally, they will need access to capital.

It is likely we will see a real bifurcation between skilled single risk underwriting on large complex risks (such as airlines, oil tankers, major corporate D&O, catastrophe risk) and high volume commodity lines (such as general aviation, yachts, small commercial, cargo). The former will continue to require skilled underwriters with deep technical expertise in their specialty line, the latter will be more and more data driven with actuarial science and risk modelling analysing large portfolios of diversified risk data.

Finally, there are the intermediaries, the area where Beach plies its trade. A low expense base will be a given for our part of the chain too. Sitting between the distribution and the underwriting capital, intermediaries must add value rather than unnecessary additional cost.

Analytics and technical ability will define distributors’ offering. Data, and the ability to analyse that data in order to negotiate on behalf of the client, will become a true differentiator, and will lie at the heart of connecting distribution with capital.

Successful intermediaries will also have access to a wide range of global underwriting capital. The focus will shift from regional insurers to whatever underwriting capital offers the best value and cover for the insured, regardless of whether these funds sit in London, New York, Bermuda, Zurich or another point on the globe. Licensing and rating will still be critical, but new solutions will evolve to solve current complexities.

Clients increasingly want their broker to provide unconflicted advice and expertise, often different, transactional expertise. For years, underwriters have sought to own distribution channels, while brokers

have looked at underwriting. They have established their own MGAs as the means to improve their bottom lines, and to circumvent points in the chain. Results for both sides have at best been

mixed. But, developing existing offerings, deploying new technologies, and beefing up analytics to enhance existing experience

and expertise promises a more secure long-term future for all parties.Our industry is primed for disruption at

every stage of the chain. Steps are already being taken to remove those links that do not add value, whose costs are too high, or whose input is not critical. MGAs have become increasingly sophisticated, and insurance funds are now looking to back them directly. Underwriters

will need to be highly specialist in large and complex single risk transactions or able to analyse and support portfolios of risk such as broker facilities or MGAs – the alternative is that their value will ultimately be questioned.

At the other end of the spectrum, disruption in the distribution sector can come from myriad sources. Technology and social media firms, which already have access to vast libraries of customer data, can easily turn their hand to insurance, and edge out those established players who fail to develop the channels necessary to compete. Intermediaries need to become leaner. Relationships will still be important, but so will data, technology, analytical skills and deep specialist and technical expertise.

The way in which customers view and purchase insurance is changing. So too must every stage of the insurance chain. In the next few years the speed of change will only accelerate. Innovative new ways to transact business will challenge established insurance principles. Our market will have to become more nimble, and better equipped to implement new technologies quickly and adapt to changes in buying patterns. Those businesses that have failed to recognise these necessities may have already consigned themselves to history.


EFFICIENCY CHALLENGE m

“If pricing is no longer the main lever that insurers can pull to improve

returns, then savings must be found elsewhere. All roads lead to the

expense chain”


m BROKERS

If you believe recent headlines, the future of many brokers is under threat. Pundits have predicted that

disruptive innovators are poised to disintermediate traditional brokers. They may well be right in some cases: brokers who fail to be much more useful to their customers indeed face redundancy.

Disintermediation is already reality for a great slice of those brokers who focus on commodity lines and consumer policies. But with a change of focus, the survivors can overcome the challenge of the disruptors to maintain and even strengthen their place in the insurance value chain.

Talk of disintermediation is nothing new. It has been going on for twenty years or more. First it was the direct insurers who were going to eat the brokers’ lunch, then the banks, with their move head-on into bancassurance. Then the hypermarkets were expected to kill the traditional broking model. But brokers are still with us, despite the directs and the banks and the aggregators. The old model has not died. The radical perspective is clearly overcooked.

However, many brokers will have to act decisively to avoid elimination in the current round.

The disintermediation threat posed by the disruptors is often digital. To counter it, brokers should embrace the technological revolution as opportunity. Already within the sector, new technologies are significantly enhancing operational efficiencies and increasing revenue opportunities. To stay relevant, brokers must be agile, and use technological advances to their own advantage.

For insurers, something called FOMO – Fear of Missing Out – can be an important driver of their move towards insurtech novelties. For brokers, I believe, the acronym should be FODO – Fear of being Driven Out. Brokers must be willing to reach out and get a piece of the digital

revolution. They must be proactive.The main areas where the technology disruptors are

nipping at brokers’ heels are big data, analytics, and internet distribution. To deny the threat, or leave it to the insurers, paves the road to irrelevance. To prevent that, brokers should take steps to deliver innovation in analytics. They should adopt technology to capture and harness large volumes of data, and translate the raw numbers into the quantifiable insights that clients and insurers increasingly demand.

As these sophisticated intelligence techniques evolve, insurers will make bigger, more important decisions based on this data. They may use it to help choose the product or solution best suited to a client and their predicted future situation. They may use it to choose emerging economies to enter, or to manage customer experience proactively, and therefore increase customer retention. Brokers need to be at the forefront of influence in these decisions, not trailing behind.

But brokers will have to do more than simply improve their processes and expand their analytical capabilities. That alone will not help enough against the disruptive direct sellers using quote-and-bind platforms. Firms must adopt broader business strategies to stay ahead of the curve, by focussing on expanding their innovation strategies.

No one has yet written an algorithm that offers high quality risk management advice, or suggests alternative ways to structure a programme; or one that negotiates to get the best deal from risk carriers. No one has written a bit of code that can take a client out to lunch to discuss their risk profile. These are the broker’s competitive strengths.

With bigger risks, the consulting side of brokers’ businesses is fast becoming the most important. To survive, brokers must remember that a very important part of the broker’s role has always been to manage the risks insured under the policies arranged and placed, and recognise that technology has created new ways to do this. The difference between an intermediary and

DEATH OF THE SALESMAN?The reports of the brokers’ death have been greatly exaggerated, says José Manuel Dias da Fonseca, CEO, Brokerslink

a consultant is very great indeed, and becomes more important every day. An agent is an intermediary, whether of a single company, or many. To survive, a broker has to be a consultant. Many have already realised this, so the shift towards consultancy is now a trend.

In order to stay relevant, and beat the disruptive innovators, brokers need a high-quality advice and consulting side to their business. They must consider themselves first as clients’ trusted advisors, as consultants, as risk professionals. Those that do not face being disintermediated, or pushed aside by digital services that can complete transactional intermediation incredibly efficiently.

To support that, brokers need to add regularly to their knowledge of risk. Education is key. Every day, new perils become more important and material in our society and economy. But the details of many are not known, even to many brokers, let alone to their clients. To succeed, brokers will have to be experts in environmental impairment, cyber threats, wind turbines, and street-level terrorist attacks. Customers are crying out for advice in these areas. Brokers must work closely with clients to help them gain an understanding of how these new perils may pose a danger to their own organisations.

Varying degrees of knowledge and advisory capacity will lead to a new kind of natural selection among brokers. It will come down to the quality of the services they deliver. The good brokers – not necessarily the big ones – are much more likely to survive than the others. “Good” means they embrace quality in knowledge, technology, and relationships. A good relationship is a close one.

A close relationship has multiple characteristics. The past two decades have seen a wave of M&A within the broking fraternity, and made global power-houses. Many mid-sized and small brokers disappeared. Often not only their companies vanished, but often the individuals, too. Many joined or were swallowed by large firms driven by a corporate vision, not a client vision. Their focus has had to shift from clients’ needs to their employer’s quarterly result.

Some have had to adopt a timesheet model of service, and are pressured to stimulate so-called “organic growth”. Such expansion of the top line is sometimes achieved in ways less than ideal for clients, which can place bigger broking organisations’ relationships in jeopardy. Oftentimes, clients are handed off between

divisions, or around the houses. When that happens, a genuine relationship is very difficult to build and maintain.

There is no secret to what makes a good relationship. It is trust. Brokers, especially smaller brokers, can use trust to become disruptive innovators themselves. Trust is the glue that holds client relationships – and brokers’ businesses – together for the long haul. Trust between a

broker and their client is very difficult to replace. It is still current, and will always remain so.

Equally important is trust within carrier relationships. They too need to become more ‘brain-based’.

Clients act based on the advice brokers offer. They trust in reputation, in the guidance they are given about which risks should be transferred, and which

retained. They trust in a collaborative work model. They trust brokers’ judgements

about programme design structures, risk assessments, and mitigation

strategies. Brokers must be able to show always that their trust is deserved. They can achieve this by consistently delivering to clients the solutions that best fit their risk profile and appetite, based on the broker’s knowledge of old and emerging risks, their leading-edge analysis of the relevant big data, and on the informed

risk management consultancy which knowledge and technology supports.

Achieving all of that will put brokers in pole position with clients. If they do the right job with every client, with the managing director, the chief financial officer, the risk manager, the HR manager and anyone else in the process, they will build, nurture, and maintain the trust that bolsters relationships. Their businesses will grow and prosper.

For decades brokers have survived the strong competition that everyone said would destroy them. Clearly rumours of their early demise were exaggerated, and they remain so. Brokers who take the steps necessary to make themselves the best choice for clients will continue to survive, and even thrive. Disruptive innovation is real, and disintermediation is a genuine threat. But so long as brokers maintain their trusted role, and change the way they do things when necessary by becoming knowledgeable risk advisors, and if they embrace the technology that will help them help their clients to improve their own businesses, brokers will prosper in the face of the disruptive forces of disintermediation.


BROKERS m

“No one has yet written an algorithm that offers high quality risk management advice, or suggests alternative ways to structure a programme; or one that negotiates to get

the best deal from risk carriers. No one has written a bit of code that can take a client out

to lunch to discuss their risk profile. These are the broker’s competitive strengths”


m MENA

The insurance and reinsurance industry in the Middle East and North Africa (MENA) region has

always been viewed as an area of potential: a unique landscape with the possibility for growth and prosperity. However, despite the region’s attractiveness to both foreign and domestic insurers and reinsurers, unless you understand the drivers and barriers to local growth and prosperity, MENA can be a difficult geography to crack.

As the Middle East markets continue to mature due to new regulatory requirements and market liberalism, the variation in physical, geographic, cultural, political and economic conditions across the states and territories is enormous.

Improving access to and retention of talent must become a top priority in furthering any growth opportunities in the MENA region. To have a long-term impact on the prosperity of the MENA region’s talent ecosystem, the insurance and reinsurance sectors need to ensure that local talent can find the necessary skills to flourish.

The importance of local talent According to the World Bank, in most Gulf Cooperation Council countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) over 60% of the workforce is made up of expatriates.1 However, nationals bring unique skills and local perspectives to an organisation – they are usually highly motivated and have strong relationships and firm ties within their communities.

International General Insurance (IGI) itself is a business founded on family values with a strong belief in not only fostering relationships, but more importantly cultivating partnerships. We set up in 2001, and now write specialist commercial insurance and reinsurance on a worldwide scale – with operations in Bermuda, London, Amman, Dubai, Kuala Lumpur and Casablanca. Registered in the Dubai International Financial Centre, the MENA region is where the company’s roots lie.

The size, sophistication and strength of the region’s insurance and reinsurance markets have increased notably over the past decade, and while in a certain regard it does rely on the international markets for balance sheet support, local knowledge is the most efficient way to build business and more importantly to retain it.

A prime example is in Algeria and Morocco, where in a bid to bolster government involvement and participation with local insurers, compulsory cessions are enforced in these countries. Local players are obliged to place a component of their reinsurance programme with state-backed reinsurers. IGI has a presence in Morocco – a team of six staff, all of which come from the local market and half of which joined from the government-backed reinsurer. The team has a knowledge and expertise of

the local intricacies that we could never obtain ourselves.

However, international players have helped to expand big ticket commercial and industrial risks in the MENA region – prompted by the creation of financial hubs such as the Dubai International Financial Centre (DIFC) and Qatar Financial Centre (QFC). This model has been replicated in other countries, such

MAINTAINING MOMENTUM IN MENAWaleed Jabsheh, Jordan-based president of International General Insurance, stresses the importance of being grounded in local markets – and staying up to date

as Morocco, where the Casablanca Finance City (CFC) has been established. This has prompted many reinsurers and brokers to express an interest in using the CFC to expand their African footprint with several already having done so.

While this close proximity to markets is increasingly being recognised as a fundamental mechanism for insurers and reinsurers to better understand the characteristics of the markets they are operating within, some still fail to fully understand the risks and exposures they are underwriting.

MENA landscapeThe market has seen many new entrants over the years trying to establish and develop a local presence. However, as is the case for most global insurance territories, profitability remains a key concern for insurers as investment income is also impacted by a low interest rate environment and weak equity performance. The MENA region is no different - in increasingly competitive markets with price and margin pressures, insurers are undoubtedly struggling especially with the recent spate of market losses.

This has led to the majority of players abandoning underwriting discipline in favour of top line growth and a desire to expand market share. Unsurprisingly, this has resulted in greater pressure on underwriting margins.

The MENA region is a very large and diverse part of the world, but there sometimes is a common misconception that exposures across the territory are homogenous. This could not be further from the truth - the diversity in physical, social, political, cultural, developmental, catastrophe and moral exposures is immense. Without a true understanding of these characteristics, business will never be underwritten sensibly and very importantly, claims will never be adjusted proficiently.

Despite the fact that premium rates in the market are expected to remain stagnant over the medium term, profits remain there to be made if underwriting discipline and prudent planning are exercised properly. The softening market conditions in the MENA region commenced quite some time before they did in other parts of the world. As that softening began, we started to re-engineer our portfolio in terms of geographic distribution in a bid to improve our approach to risk selection.

The Middle East, along with some markets in Africa, continues to be a very profitable part of the world for us. We continue to strengthen our regional operations with new staff - especially in Dubai where new leadership was brought in in 2016 in addition to the expansion

of business lines being underwritten from that office. Markets like Dubai have become international business and insurance centres and IGI’s presence there allows it to capture risks that these days tend to stay in the regional markets - allowing us to access business that would otherwise not be seen.

We also see plenty of Middle Eastern specialist insurance risks come to us via one of our other operations. Ironically, this is business that we may not necessarily see, even though we are physically in Amman and Dubai.

Local knowledge remains the driving and fundamental factor in the entire business process. It is critical to the underwriting of regional business, one that is very different to the position of an underwriter who is only seeing information as it is presented to him or her in

the context of a different environment.

Earmarked for growthWhilst the MENA market remains a very attractive proposition with growth opportunities, competition is as intense as ever and pricing pressures are expected to stay. Companies will need to improve their

quality of service and offer new and innovative products to maintain their market share.

Profitability remains a key concern for MENA insurers. As investment income has not contributed significantly to shareholder returns, insurers have focused on technical profitability and cost reduction. With poor pricing and increased reserves, technical profits have been under stress for most insurers. While cost-cutting measures may bring short-term relief, sustained results can only be achieved by well-executed operational transformation strategy, backed by robust technology and a customer-centric approach. An increasing focus on data quality, surveying techniques and risk mitigation practices is assisting reinsurers in improving their underwriting approach.

This presents both a challenge and an opportunity. Companies that can be nimble and flexible, with the right sponsorship, mindset and people, can leverage technology that some in a way that larger players, constrained by outdated software and procedures, are unable to.

Insurers willing to invest in innovation and digital technology in the Middle East markets will reap significant benefits. But this will require them to adopt robust actuarial modelling techniques to improve pricing sophistication, apply data analytics to reduce fraud, focus on customers and adopt advanced technology to revamp their operations.


MENA m

“While this close proximity to markets is increasingly being recognised as a fundamental mechanism for insurers

and reinsurers to better understand the characteristics of the markets they are operating within, some still fail to fully

understand the risks and exposures they are underwriting”

1 http://www.changeboard.com/content/4692/leveraging-local-talent/


m CHINA

China’s insurance sector continues to outpace the global insurance industry. According to its

insurance regulator, CIRC, and Credit Suisse, the sector grew by 29.7% in 2016. By contrast, the global insurance industry expanded by only 4.4%. Without the contribution from China, global growth would have been a mere 2.3%. Almost half, or $80bn, of the new premium of $170bn registered in 2016 came from China.

However, China’s current economic outlook is more muted. Down from 7% in 2015, it is expected to grow by about 6.5% and 6.3% for 2017 and 2018, respectively, according to the World Bank. Insurance growth will be affected by a combination of tighter regulation in life and non-life business, slowing car sales, a reduced appeal of savings products and slower agency growth in life insurance. Still, the Chinese government set a target of an insurance penetration rate of 5% for the country by 2020 in its thirteenth Five-Year Plan. In 2016 the industry made significant progress towards that goal by increasing the overall penetration rate to 4.15%, up from 3.6% in 2015.

In life insurance China has become the global growth engine. In 2016, global life insurance premiums

expanded by 2.5%. Emerging markets, very much driven by China, grew by 17% and without China by 5.7%. In emerging Asia markets, China now accounts for 70% of the total life market, according to Swiss Re. Going forward, the Middle Kingdom is expected to expand by about 15-20% annually, comparable to the achieved 18.7% annually over the past 10 years and an exceptional 41.3% in 2016. This growth was driven by strong demand for traditional life products and the government’s desire for consumers to invest in protection products. However, growth is also driven by strong demand for short-term savings products, sold under the life insurance label.

Health insurance, although still only representing 2.3% China’s total premium volume, even outgrew life. In 2015, premium volume stood at $36.7bn, up 52% from premiums of $23.4bn in 2014. In 2015, just five insurance companies specialised in health insurance, while another 100 offered health insurance products. According to the CIRC currently, there are seven insurance companies specialising in health insurance, with 2,300 health products available in a market heavily driven by China’s expanding middle class.

China’s insurance market is expanding, albeit at a slightly slower rate than before – but it’s growing up in different ways, according to Franz Hahn, CEO of Peak Re

CHINA – THE GROWTH MARKET THAT KEEPS ON GROWING

According to Boston Consulting Group, 50% of all private healthcare spending is still paid in cash. Those who cannot afford these cash payments will either receive inadequate treatment, or, in the worst case – none at all. Since 2010 health insurance has grown at about 36% annually, primarily driven by indemnity products that are usually offered as riders to life insurance products. These products commonly pay out a lump sum, if the policyholder is diagnosed with certain stated conditions.

Non-life business in general experienced continued growth in 2016 too. The sector expanded by 18.8% for the past ten years, according to CIRC and Credit Suisse. In 2016, it grew by another 20%, partly due to the demand for health products, rising interest in specialty products, but also due to high auto sales, which benefited from government subsidies and tariff liberalisation.

Growth opportunities persistChina, and insurance in China will continue to grow. Future demand will arise from China’s expanding middle class, its continued urbanisation and the ageing population. According to Credit Suisse, China is the most underinsured country in Asia with the largest protection gap in monetary terms. In life, the bank estimates that a $32trn mortality protection gap exists, which widened by 17.2% annually from 2004 to 2014, highlighting the large demand for

protection-oriented life insurance products. Health insurance, China’s fastest growing line of

business, will expand by more than 35% annually until 2020. The government incentivises its sales by offering tax breaks for individuals who buy private health insurance and by encouraging partnerships between health insurance companies and private hospitals. Furthermore, consumers have also become more insurance literate and prepared to use insurance to fund their own protection.

In property and casualty, China’s so-called One Belt, One Road (B&R) initiative, encompassing six international economic corridors and one maritime Silk Road, will initiate substantial activities in construction, engineering, property and marine, but possibly also leading to liberalisation in trade relations. According to Willis Towers Watson, from now to 2030

additional premiums of $16bn are expected to be generated by projects from the B&R

initiative, with Chinese insurers earmarked to benefit the most.

China’s insurance industry will continue to enjoy profits generated by the innovative products and digital platforms. According to the CIRC and Oliver Wyman, Chinese insurtech related premiums will surge to $174bn by 2020, driven by online sales of traditional products, upgrades

of existing products and the introduction of

entirely new insurance products.


CHINA m



m CHINA

However, China’s InsurTech companies demonstrate the enormous success insurers may harvest, if customers’ appetite is met. Zhong An, the Chinese online insurer, which was only founded in November 20 13 by Ping An, the Alibaba Group and Tencent, has already sold more than 8bn policies to roughly 600 million customers. Its main product, which still accounts for more than 50% of its sales, insures customers against the cost of returned shipments for their online purchases. In June 2017 Zhong An filed for an initial public offering (IPO) at the Hong Kong Stock exchange that might value the firm at $15bn to $30bn.

Regulatory reformConcurrent with this backdrop of strong growth, CIRC has started to reform its regulatory approach. In life, it tightened regulation on short-to-medium term life policies, curbing the aggressive sales practices of some life insurers. Life insurers had bundled conventional life policies with so-called universal life products to guarantee policyholders short-term gains and flexible surrender terms. In May 2017, the CIRC banned these products that had been a key driver in life policy sales since 2013.

Starting in 2013, the CIRC is de-tariffing China’s auto sector, which currently contributes about 75% of premiums to the non-life sector. By 2015 it approved six provinces for the reform pilot. An additional 12 provinces followed in 2016. The new programme allows more flexible rates to better reflect loss experience and auto value.

This liberalisation of the market, coupled with the excessive oversupply in the sector, intensified competition and led to a further decline in rates. According to Marsh, in 2016, rates were lower in motor, marine, aviation, D&O and financial institutions, while liability, environmental and employee benefits were almost stable. Potentially slower automobile sales might add to the industry’s insurance challenges as sales are expected to drop from 18% in 2016 to 7% in 2017, according to Credit Suisse, largely as a result of changes in subsidies and taxes. The industry was also affected by the decline in investment returns, which is a major source of income for the majority of China’s insurers.

As the Chinese insurance market continued its amazing growth momentum, China’s regulator CIRC leapfrogged several stages in regulatory development and introduced the China Risk-Oriented Solvency System (C-ROSS) in January 2016. Similar to Solvency II, the new solvency capital regime is a three-pillar risk and solvency framework, which is more reflective of individual

risk profiles and ERM program quality. The latter is being viewed as vital to the sector’s future healthy development. Particular emphasis is being placed on Pillar 2. An insurer’s ERM quality can even impact its final minimum capital requirement.

Nevertheless, C-ROSS impacts on reinsurance purchasing as it lowers the amount of solvency capital needed to underwrite motor risk, enabling insurers to significantly increase their retentions. As a result, reinsurers hardly benefit from the growth of insurers’ top line. Reinsurance pricing is further affected by the shift from the previous business tax to a VAT system, as

implemented by the Ministry of Finance since May 1 2016. Not only does the new VAT exceed the

former business tax, it is also accrued differently, thus affecting insurers’ results.

Nevertheless, the introduction of C-ROSS encouraged international reinsurers to move onshore in response to the lower capital requirements that the mainland businesses

enjoy in comparison to offshore players. As Lloyd’s forecast, this resulted in a 400%

increase of onshore capacity. In May 2017, the CIRC and

the Hong Kong Office of the Commissioner of Insurance signed an agreement that aims at the mutual recognition of the solvency regimes between Mainland China and Hong Kong. To be implemented within the next four years, the 18 international reinsurers

operating from Hong Kong are set to benefit from this recognition of equivalency. C-ROSS is perceived as more sophisticated than Hong Kong’s rule-based capital adequacy regime. However, Hong Kong is currently in the process of introducing a risk-based capital regime which is likely to be introduced in a few years’ time.

The world’s largest reinsurance market Prior to 2016, there were only a few domestic reinsurers in China. As of this year, CIRC has granted approval to several reinsurance players to set up local operations and another 20 are expected to apply in the coming years. By 2022, as Willis Towers Watson predicts, China might be the world’s largest reinsurance market – driven by the growth of its direct insurance market and the ambitious penetration targets set by the government.

As to be expected in a fast-growing market place, competition is fierce in China. Players will only succeed in this constantly changing and complex market environment, if they develop an intimate know-how of the major business risk drivers and a detailed understanding of the differences between cedants. Careful risk selection and knowing one’s client are thus the key to success in China.

“Chinese insurtech related premiums will surge to $174bn by 2020, driven

by online sales of traditional products, upgrades of existing products and the introduction of entirely new insurance

products”

September 28thCipriani 25 Broadway,

New York

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