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.