EXTRAORDINARY RE CEO GUEST OPINION ARTICLE AT THE FINANCIAL REVOLUTIONIST

The severity of the recent data breaches at Equifax — in which personally identifiable information on over 143 million US consumers was stolen by unknown hackers — and the US Securities and Exchange Commission — whose Edgar database processes over 1.7 million corporate filings per year — underscores the enormous issue of cyber risk.

Over time, free-market economies have evolved ways to manage a variety of risks through the use of insurance. But the complex, ever-changing, and expanding nature of cyber risk has exceeded the insurance industry’s ability to serve those who seek protection. No standard insurance coverages or contract wording have yet evolved, and the historical data available to insurers that’s required to create actuarial pricing models are paltry. Even if such data existed, it would have limited predictive value due to the dynamic nature of the risk, as hackers constantly develop new methods to evade security and more and more of our intellectual and physical assets become interconnected through the Internet.

Despite these limitations,

Cyber risk insurance has become the fastest growing product in the property-casualty insurance industry. Annual global insurance premiums in the category are estimated to be $3 billion and projected to grow to $10 billion over the next several years, and perhaps to $20 billion over the next decade.

The nature and scope of cyber risk is rapidly changing. Like a cancer or a new kind of virus, the cyber threat metastasizes and evolves to exploit weaknesses and opportunities. The growth in demand and rapid change of cyber risk strains the capacity of insurers to carry the new risk. Since demand seems likely to exceed supply for the foreseeable future, a new approach is needed. That new approach will likely be grounded in the creativity of insurance innovators to develop vehicles through which the risk burden —  and profit potential — can be spread beyond the insurance industry to tap into deeper pools of capital. The capital markets are great for this kind of creativity, as evidenced by the creation and development of asset-backed securities markets over the past 40 years, which brought liquidity to markets for mortgages, credit cards and auto loans.

The insurance industry, where reinsurers historically have served as the ‘lenders of last resort,’ has also seen the emergence of capital market solutions to manage accumulations of risk. These have taken the form of so-called ‘alternative capital’ products that have enabled hedge and pension funds to assume property reinsurance risk through catastrophe bonds and similar vehicles. In recent years, these products have served to dramatically decrease the cost of capital in the catastrophe reinsurance market while creating a high-yielding investment opportunity whose returns are uncorrelated with equities or interest rates.

At our firm,

Extraordinary Re, we have built a trading platform for insurance risk, initially targeting ‘extraordinary’ risk classes such as cyber. By embedding our trading platform inside a reinsurance company, we sit between the insurance and capital market worlds, enabling insurers to transfer accumulations of risk to institutional investors in the form of tradable reinsurance. This innovation allows investors to assume risk in a liquid market with the ability to control the amount and types of risk and the timeframe over which that risk is carried. That permits the allocation of capital in a more flexible manner than is possible in the insurance industry, which takes a ‘buy and hold’ approach to underwriting risk.  

The creation of this risk-transfer market produces a new source of data that will provide new benchmarks for pricing and valuation, leading to new product development efforts among the insurance companies originating the risk. Such an information feedback loop is particularly valuable for dynamic types of risk such as cyber, where investors’ trading responses to real-time changes in the risk environment (including changes identified using new data sources and analytics) are likely to have far more predictive value than any historical data set.

Former Secretary of Homeland Security Tom Ridge commented earlier this year that cyber risk is now a major permanent condition facing our digital world. The damage from the Equifax and SEC breaches further evidences that risk, and dramatizes the societal need to do something about it.

While there is no way to eliminate cyber risk, there are ways to reduce, mitigate and transfer it through cyber insurance. But only the global capital markets can provide the resources of liquidity and expertise to value and manage such complex risk. If the track record of 300 years of capitalism has taught us anything, it’s that a liquid trading market is the best mechanism for allocating capital and pricing risk in a dynamic and changing environment.

William Dove is the CEO at Extraordinary Re, a company that is working to unlock existing liabilities on insurance company balance sheets by creating a marketplace to trade those liabilities.

Expanded Role for Alternative Capital

by Will Dove

Summary:

It produces a new source of data that will provide new benchmarks for pricing and valuation, leading to new product development efforts.

In recent months, we have witnessed a series of significant events producing large — and mostly uninsured — economic losses. The Equifax data breach exposed personally identifiable information from more than 140 million consumers; there were tens of billions of dollars in flood losses from Hurricanes Harvey and Irma; and the damage costs from long-term power outages and business interruption losses stemming from Hurricane Maria’s devastation in Puerto Rico are still being calculated. All those underscore the low level of insurance penetration for perils like flood, cyber and contingent business interruption even in the U.S., one of the most highly insured economies in the world.

Spurred by the growth of new technologies, the advent of new business models reliant on increasingly complex supply chains and the dynamic forces of climate change, emerging risks such as these have become increasingly important to consumers and businesses around the world. At a recent industry gathering, Mike McGavick, CEO of XL Catlin, asked how the insurance industry can remain relevant to its customers when it has seemed unable to develop insurance products to protect against some of the most critical risks facing policyholders in our modern, connected economy.

It is an important question.

While the insurance industry’s development of new products has typically lagged in the changes in technology and risk environment that drive demand for protection, the wave of new products, business processes and companies from insurtech startups can help insurance industry incumbents to accelerate their response to a changing risk environment. There are three categories of insurtech innovation that will be critical to this evolution: data, analytics platforms and tradable risk.

Over time, free-market economies have evolved in ways to manage a variety of risks through the use of insurance. But the fundamental nature of emerging risks has challenged the insurance industry’s ability to develop new insurance products and price those products using historical data that actuaries typically rely upon to parameterize their pricing models. Even if such historical data existed, it would have limited predictive value for emerging and changing risks such as cyber because of the dynamic nature of the risk, as hackers constantly develop new methods to evade security and more and more of our intellectual and physical assets become interconnected through the internet. And the forces of climate change are quickly rendering historical data sets obsolete — even for classes of risk like hurricanes that have been considered to be well-understood.

A number of innovative companies, both insurtech startups and a few more established enterprises, are building new platforms and data collection modalities designed to enhance the amount, granularity and quality of underwriting data for a broad range of traditional and emerging classes of risk. Companies like reThought Insurance (US flood insurance MGA), Audeamus Risk (a platform for managing and underwriting operational risk) and both Cyence and Symantec in the cyber risk area are collecting unprecedented amounts of data, including new data elements that can provide real-time indicators of changes in risk profiles in these areas. Other new technologies including sensors, wearables, telematics and social media networks can capture types and quantities of data far beyond what insurers have used to set premium rates and loss reserves. These new datasets can provide insurance and reinsurance companies with more extensive amounts of data and real-time information, allowing a carrier to track and monitor its policyholders with far more timely and actionable information than has previously been available.

Increased quantity and quality of exposure data is a prerequisite to insuring emerging risks, but making sense of this tsunami of data requires other forms of innovation. Developments in artificial intelligence and machine learning provide new tools that can allow insurers and investors to filter vast data sets to isolate the variables with the most predictive value in signaling relationships between exposure and claim activity.

But improvements in data collection and analytics alone are not sufficient to provide the risk-bearing capacity needed to accommodate emerging risks with the sheer volumes of exposure to loss of flood, cyber and contingent business interruption. A new approach is needed to develop vehicles through which the risk burden — and profit potential — can be spread beyond the insurance industry to tap into deeper pools of capital. The capital markets are great for this kind of creativity, as evidenced by the creation and development of asset-backed securities markets over the past 40 years, which brought liquidity to markets for mortgages, credit cards and auto loans.

Since the 1990s,

The insurance industry, where reinsurers historically have served as the “lenders of last resort,” has seen the emergence of capital market solutions to manage accumulations of risk. These have taken the form of so-called “alternative capital” products that have enabled hedge and pension funds to assume property reinsurance risk through catastrophe bonds and similar vehicles. In recent years, these products have served to dramatically decrease the cost of capital in the catastrophe reinsurance market while creating a high-yielding investment opportunity whose returns are uncorrelated with equities or interest rates.

At Extraordinary Re we have built a trading platform for insurance risk, initially targeting “extraordinary” risk classes such as cyber and flood. By embedding our trading platform inside a reinsurance company, we bridge the insurance and capital market worlds, enabling insurers to transfer accumulations of risk to institutional investors in the form of tradable reinsurance. This innovation allows investors to assume risk in a liquid market with the ability to control the amount and types of risk and the timeframe over which that risk is carried. That permits the allocation of capital in a more flexible manner than is possible in the insurance industry, which takes a “buy and hold” approach to underwriting risk. It will even become possible for different investors to hold shares of a single reinsurance risk at different points in the lifespan of that risk between policy inception and the date when the last claim is settled. A trading market allows risk to be allocated to the most efficient (and lowest cost) capital provider throughout the term of each risk.

The creation of this risk-transfer market produces a new source of data that will provide new benchmarks for pricing and valuation, leading to new product development efforts among the insurance companies originating the risk. Such an information feedback loop is particularly valuable for rapidly changing types of risk, where investors’ trading responses to real-time changes in the risk environment (including changes identified using new data sources and analytics) are likely to have far more predictive value than any historical data set.

Only the global capital markets can provide the resources of liquidity and expertise to value and manage emerging risks. If the economic history of capitalism has taught us anything, it’s that a liquid trading market is the best mechanism for allocating capital and pricing risk in a dynamic and changing environment.

About the Author

William Dove is chairman and chief executive officer of Extraordinary Re. He has 28 years of experience in the property/casualty insurance and reinsurance industry as an actuary, an underwriter and a senior executive with leading companies.

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Why in the World Would Anybody Start a Reinsurance Company Now?

Written by Christopher Blum, Advisor to Extraordinary Re.
 

The world doesn’t seem to be a friendly place for startup reinsurers.

There is a staggering amount of capacity in the reinsurance and insurance-linked securities (ILS) markets – $420 billion according to some experts. By all accounts rates have been soft for years, and get softer year over year.

Reinsurers for the most part maintained profits in 2016, but predominantly through lack of large U.S. catastrophe losses, capital management tactics, and by being able to take advantage of favorable development on older business rather than through rate growth or new sources of reinsurance premium.

Potential new sources of reinsurance premium are out there, but the so-called ‘coverage gap’ yawns wide. Earthquake and flood elements of traditional property coverage and parametric risks are difficult to underwrite, at least in part because reinsurance coverage is hard to come by for those catastrophic risks; cyber insurance is a coverage that becomes more necessary to businesses daily, yet reinsurers have so far been unable to offer significant capacity.

ILS markets may close some of the coverage gap, as they take advantage of capital market desire for returns uncorrelated to traditional investment markets, but ILS issuance requires a process that can be time-consuming and inefficient and which results in a security that is relatively rigid in that it doesn’t allow trading and re-trading of risk once placed, with limitations on returns and potentially catastrophic risk to capital.

All of this indicates that a startup planning to break into the market as a plain-vanilla reinsurer has the odds heavily stacked against it. However, there is a huge world of un- or under-reinsured risk out there that could support a next wave of reinsurance solutions. So, any startup reinsurer that wants to make it big needs to answer a couple of related questions: how will the model deepen and broaden what can be reinsured, beyond what traditional reinsurers can do? How can one combine the best features of traditional reinsurance and ILS issuance to evolve the reinsurance business to today’s needs?

Extraordinary Re’s response to these questions is to:

1) use familiar mechanics of reinsurance cession, claims handling, and other operational aspects to the greatest extent possible;

2) create a model that entices all kinds of capital, from insurance experts to hedge funds to financial instrument and commodity traders to institutional traders like pension funds, to invest in and bear reinsurance risk;

3) broaden the ability to take on difficult-to-price risks, by combining insurance and trading expertise and willingness to take risks, to benefit insurers and intermediaries rather than compete with them;

4) provide real-time ability to take-on and lay-off risk, from binding as it develops through resolution of reinsured risk, evolving beyond current ILS models. Our model complements the infrastructure of a standard Bermuda reinsurer with an internal mechanism that slices up reinsured risk and enables capital markets investors to take on or lay off as much or as little risk as they choose, on a day-to-day basis, as it develops.

The reinsurance industry plays a critical role in the global economy by sharing in the accumulations of peak risks from the retail insurance companies who serve individuals and businesses. Traditional reinsurers have filled that role by using historical data to price risk and hold it on their balance sheets. However, growth in global economies and new technologies have created emerging risks (think of cyber risk) that don’t fit the traditional models. Extraordinary Re is one of the companies addressing this challenge, and its new model of allocating risk to investors through a trading platform is ready to permanently change the insurance risk transfer market.