At the top end, the risk market has changed rather a lot over the past couple of decades.
I’m not talking about nifty innovations like catastrophe bonds and pension fund capital or about the technological wizardry which, we’re told, will change everything (or not, as the case may be). Rather, I’m on about something rather more basic: reinsurance.
Until recently—alarmingly so—German industrial companies paid an annual visit to their Koko Committee (which probably stood for “Kommerzielle Koordination,”a term borrowed from the communist German Democratic Republic, where it was somewhat more sinister). The Koko was the physical embodiment of West Germany’s insurance cartel, whose cross-shareholding tentacles stretched to the heart of the country’s stupendously successful industrial core.
Annually, each important commercial insured would meet with a panel of people representing the country’s leading insurers to learn about their renewal. They would be accompanied by a man sitting quietly in the background, silently representing the relevant reinsurance giant and inevitably pulling the insurers’ invisible strings (since their capital was his capital). At this potentially harrowing gathering—I can’t help imagining a mob sit-down in a darkened room—the hapless insurance buyer would be told about the cost and structure of his company’s insurance program for the year ahead.
Insurers and reinsurers were able to get away with this until well into the 1990s because they controlled a scarce commodity: capital. But, today, owning half the stock market and a great chunk of real estate on the Königinstraße is no longer a big, exclusive stick to wield. To make a large and long story palatably short, the value of money simply ain’t what it used to be.
That has one pretty serious impact for everyone in all of the world’s insurance business. As international carriers prepare for the annual Jan. 1 reinsurance treaty renewals in the wake of their (virtual) pilgrimage to Monaco for the Monte Carlo Rendez-Vous de Septembre, reinsurers are no longer in the driver’s seat.
Everyone has capital now. With a credible business plan and a qualified underwriter, you can raise some almost as easily as raising your hand to ask for it. That has shifted the balance of power in the risk transfer business from those who hold a mountain of assets to those who have what’s really valuable, in short supply (relative to appetites, at least), and much more difficult to get hold of: an attractive, profitable, and well balanced portfolio of risk.
Pension funds want some good risk because of its uncorrelated nature. Private wealth funds want some because the potential returns are much greater than bonds or banks will deliver. Private equity wants some because they could fatten up quickly for a speedy exit, given a fair wind. Stock market investors want some because the dividends—historically, at least—are miles ahead of the pack.
We can observe the new importance of access to risk portfolios in several recent market trends. I’ve written before in this space about an unusual characteristic of the ongoing turn of the global market cycle. Instead of reinsurers leading the upward charge by withholding their product (capital, essentially), this time around it is being driven by primary insurance companies that could simply no longer tolerate the prevailing painfully low rates.
That has shifted the balance of power in the risk transfer business from those who hold a mountain of assets to those who have what’s really valuable, in short supply (relative to appetites, at least), and much more difficult to get hold of: an attractive, profitable, and well balanced portfolio of risk.
The reinsurance crowd is now gratefully following their lead. They can’t be too aggressive, though. They need those positive risk portfolios and cannot price themselves out of the running. If they do that, the insurers will simply raise a bit more capital for their own balance sheets.
More evidence can be found in the retrocession markets. Once the preserve only of extremely specialist reinsurers with balance sheets larger than small countries, the last five or so years of the decade saw more than half of the retro marketplace—which sells reinsurance to reinsurers to cover their peak exposures—taken over by insurance-linked securities. Pension funds gained access to risk portfolios to service their huge swaths of capital through catastrophe bonds and special instruments known as collateralized reinsurance contracts. It’s true that many of them were burned by the recent and unfortunate series of hurricanes, wildfires, hailstorms, and other calamities (including the literally deadly COVID-19) and have since pulled back. However, I for one am certain that, like Arnie at the police-station counter, they’ll come crashing back. In the interim, retro is in uncomfortably short supply.
All of this means something for brokers. Similarly, it doesn’t mean quite a few things.
It doesn’t mean that brokers will be entirely in charge. Although they hold the original risks, only a few can assemble them into portfolios. Efforts to do so through the big players’ giant market facilities, for which insurers were required to pay hard cash to gain access, have been disappointingly unsuccessful. That’s partly because they created simple pools of risk—not necessarily attractive, profitable, and well balanced portfolios of risk, which is what the holders of the world’s abundant capital increasingly insist upon.
Secondly, it doesn’t mean that insurance prices will fall any time soon. The simple fact is that insurance has been underpriced for years. No one wants to put their capital behind a portfolio of attractive, well balanced, but unprofitable risks, and lately the market has created a very large number of those unpolished gems. That has to change to gain access to the world’s swirling capital. That’s why insurers—and now, finally, reinsurers—have hiked their rates.
It does mean that insurers will compete for high-quality risk, which can only be good for retail brokers. They will do so increasingly (for now, at least) based on enhanced services, improved support, and better-engineered products. Expect the flow of sophisticated online placement systems, speedy response times, and broad availability to keep coming your way.
It also means more consolidation in the brokerage space, since larger brokers are able to assemble portfolios of high-quality risk and therefore make themselves more attractive to insurers and their reinsurers. It’s skill and expertise that’s the valuable commodity now, and brokers have it in spades.
It should also mean an end to the extremes of the insurance pricing cycle. They’re smart, the people who control those huge tranches of capital and have at least one eye on insurance risk. They don’t suffer from the weird condition which seems always to ail underwriters: the willingness to write business even at a loss, often for sustained periods, rather than risk losing market share.
New capital will simply walk away from such antics, and it won’t come back until the return on capital they can realistically expect to receive is commensurate with the risk they take onto their books. The cycle won’t go away, but it should become much more muted. That too will be good for brokers (who might miss the soft markets but certainly won’t lament the loss of the occasional diamond-hard ones).
Finally, it means that brokers large and small (but especially large) have greater decision-making power. The rules of the game will no longer be set by obscure cadres of insurers and their reinsurers who simply lay out their offer and say take it or leave it. We’ve seen that happening for some time already. Things have changed at the top, and the effect is bound to continue.
