New Casualty Capital: Dr. Jekyll or Mr. Hyde?

Dr. Jekyll - Mr. Hyde

Capital pouring in from the property catastrophe space means casualty reinsurance cedants find themselves awash with capacity at a competitive period in the market cycle. This is good news, as long as you can tell who’s here for the long haul.

There has been quite a bit of discussion over the effect that insurance-linked securities (ILS) and the euphemistically labeled “alternative capital” have had on the property catastrophe reinsurance market.

The New Kids on the Block

Less has been said about what is happening in the casualty market, where several traditional reinsurance carriers, seeing both premium volume and margins compressed on property catastrophe accounts, have begun to re-deploy their capital more towards casualty.

This new capacity has resulted in a much wider choice of reinsurers for cedants, with increased supply also creating more competition in terms of coverage, structure, and pricing.

This, coupled with a sustained period of benign loss activity and favourable reported results is in turn leading to a competitive and softening market: Willis Re’s 1st View January 2014 renewals report (see table below) noted that the vast majority of casualty lines were down, some as much as 20  on lines of business with no loss emergence.

Casualty Graph

New Horizons

As well as seeing new entrants in the form of traditional bricks and mortar reinsurers, the casualty space is also playing host to its first sidecar-style operation, in the form of Watford Re.

According to an SEC filing from January 3rd 2014, this sidecar-style operation, which is set to be funded principally with third party capital, has been set up with Arch Re to be a multi-line Bermuda reinsurance company, with Highbridge Principal Strategies acting as the investment manager.

Two aspects of this model make this potentially transformational. First, it confirms that new capital, in search of non-correlating returns, is willing and able to enter the casualty space and participate at the risk level, just as it has in the property catastrophe market.

Second, it expressly offers clients a product that has a lower cost of capital, or an improved investment yield, or both, integrated into its pricing model. This at least conceptually represents a possible game changer in long tail lines.

Increased Choice & Potential for New Ideas

Clients are, therefore, experiencing not only increased choice from amongst established reinsurers but also the potential for a new casualty reinsurer model that, at least in theory, could command a tangible competitive advantage relative to the more conventional reinsurer model.

In principle we welcome this development and will continue to support initiatives that offer clients broader choice, increased flexibility and greater inherent competitiveness.

While we welcome this in principle, in practice this increased choice leads to many questions for cedants.

  • Where they already have established relationships, should those relationships be downgraded or even broken, given the promises of new markets?
  • How do they work out the relative value of an established and proven relationship versus new relationships?
  • How should cedants navigate this new capital in relation to issues such as counterparty and tail risk?
  • To what extent might this new capital diminish once interest rates start to rise or conditions in the property catastrophe arena become more attractive?
  • What could the market look like post a major casualty event given the imperative of a sustainable post event market place and will all the new capacity be so willing to continue?

Furthermore it raises interesting questions about what reinsurance products are available that can shorten the tail for casualty events and reduce continuity, tail and counterparty concerns.

Evolving Casualty Exposures

Such questions are particularly relevant in the casualty arena where the underlying perils are continuously evolving driven by societal, judicial, behavioural and legislative forces and newer perils constantly evolving, such as cyber and regulatory risk and where the time horizon extends over decades in contrast with natural perils where events are generally limited in both time and place.

As a collective, new capital entering the casualty space could be exciting, dynamic, cost effective and valuable at an increasingly competitive point in the market cycle, and as such cannot and should not be ignored.

At the same time all new entrants with whatever operating model should be scrutinised in the context of continuity given the significant time lag aspect of casualty business.

Questions around market selection cannot be readily answered in a vacuum and only serve to enhance the value to clients of expert advice in an increasingly complex and inter-connected market.

Increasing Value-Added Advocacy

On casualty business, clients need thoughtful and informed support in understanding and measuring their casualty risk in order to manage it to within an appropriate risk tolerance framework.

These current changes in market dynamics warrant providing heightened guidance for clients, critical to help them achieve the optimal balance between proven and sustainable reinsurance supply without forfeiting the opportunity to mitigate risk at potentially much lower cost.

About Andrew Newman

Andrew Newman is President and Global Head of Casualty at  Willis Re.…
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