The new generation of casualty reinsurers backed by asset managers potentially offer a broader proposition than previous hedge fund initiatives. But they must be able to demonstrate long-term commitment to win over buyers.
When seeking entry to a club certain rules must often be observed. Some clubs demand that members wear a collared shirt and tie, others forbid denim.
While such rules are the minimum table stakes for entry, they don’t, however, guarantee access or membership. So it is in the reinsurance industry. Simply turning up in the proverbial jacket and tie doesn’t guarantee that the community is going to welcome you into the club.
In the context of casualty reinsurance, the community has generally been discerning about welcoming new entrants, given the potential complexity and long-term nature of claims they may face.
Asset-Backed Casualty Reinsurers
Standing in the queue for the casualty reinsurance club is a new model of asset-backed casualty reinsurer. Such outfits could potentially command several advantages over traditional “bricks and mortar” reinsurers.
For example, their cost of capital is likely to be significantly lower than for a traditional reinsurer because they value the sector as a diversifier. Their asset manager sponsors are also likely to employ more aggressive investment strategies than those of a traditional reinsurer.
Integrating those returns into the pricing model on longer duration casualty business means higher potential returns, and the ability to be more competitive than traditional players – or both.
A Potentially Broader Proposition
So how does this new model differ from other similar outfits? Historically, hedge fund-backed reinsurers have generally sought structured, semi-structured and other low volatility business. Their business models focused on modest levels of risk on the underwriting side to preserve the ability to perform on the asset side. The benefits of these investment returns might potentially be shared with clients, but this assumption was not generally priced in up front.
It now appears that some asset-backed casualty reinsurers are aiming to enter the market with a broad risk appetite, consistent with established, fully fledged conventional reinsurers, conceptually offering both a distinctive and valuable proposition to buyers of casualty reinsurance.
This new model potentially represents a sea change, distinguished from traditional markets by its ability to integrate a superior yield into up-front pricing, while a broader risk appetite provides differentiation from most current hedge fund-backed operations.
In principle this is welcome, providing wider choice and more sophisticated (not intended as a euphemism for lower-priced) products. This is, however, the nightclub equivalent of a snazzy outfit: eye-catching, but not necessarily an entry pass.
Taking a Balanced View
This is particularly the case in the casualty market, where excess capacity means that cedants can already pick and choose their counterparties for risk transfer. So what criteria will cedants be looking for from a new carrier?
Credible financial metrics are indispensible. Buyers demand minimum financial criteria using a range of internal and external key performance indicators to gauge size, resilience and credit-worthiness (inter alia) in order to satisfy concerns about counterparty risk. There is no point dwelling on that topic, other than to state that if those quantitative criteria aren’t satisfied the proverbial engine won’t even start.
Assuming that they are satisfied quantitatively, the qualitative and more intangible criteria surface. Regardless of whether the new reinsurer’s model happens to be asset-backed or traditional, anyone looking to move into casualty reinsurance should consider how their proposition satiates concerns over longevity and resilience.
Casualty losses and events can be spread over multiple years and territories. A firm’s willingness to pay can and should be just as important when selecting a reinsurer as the company’s ability to pay alone.
For new entrants, clients will no doubt want to know whether a reinsurer is merely involved or truly committed to casualty business, or the reinsurance industry more widely. A former boss of mine explained the difference to me many years ago. He suggested studying a plate of eggs and bacon, acknowledging that in its construction the hen was involved while the pig was committed.
Furthermore these criteria are cumulative. This means it is not simply a case of demonstrating some of either the ability to pay or willingness to pay, or a long-term commitment or the ability to provide assurances over resilience: casualty reinsurers of any ilk must demonstrate all of these qualities, all of the time.
Something to Keep an Eye on
We will continue to measure performance and share it with our clients in order to gauge reinsurers’ organisational ethos on paying claims and evaluating how their responsiveness post-event matches up with their advertising.
The selection process will continue to be complex and dynamic, not dissimilar to a 3D game of chess. Some reinsurers have cultivated an excellent track record of paying claims and others don’t, so how new reinsurers seek to identify themselves, while challenging for a de novo organisation, needs to be addressed—especially where organisational change such as an IPO may be imminent.
Presenting the case for differentiation based on qualitative as well as quantitative criteria will be especially important for those new reinsurers facing hurdles to accessing the market, assuming they struggle to get better than an initial A- rating.
Faced with more choice, clients are seeking more advice and counsel to evaluate and balance the benefits of established reinsurer relationships, where past performance is evident, against the appeal of new markets with a compelling proposition, coupled with an ability and an appetite to expand.
Clients have their own key performance indicators and counterparty metrics, but we would urge any reinsurance capacity looking to gain traction in the casualty space to consider focusing on the intangible as well as the tangible metrics if it wants clients to provide accelerated entrance into the casualty reinsurance club.
This article was originally published in Trading Risk.