Duperreault Addresses State Of Reinsurance

Good afternoon, everyone. It’s a real pleasure to be here.

When Chris and I were discussing what I’d talk about this afternoon, he mentioned that I’d be cast in the role of an impresario of capital. He also asked me to think about whether the reinsurance sector faces an existential threat.

I have to admit the two concepts took me by surprise.

I’m an insurance guy. Except for a stint in the US Army, I’ve been in the insurance business my whole working life. I don’t think of myself as the impresario of anything.

And even though I studied some philosophy at university, I had to look up the exact meaning of “existential” before I could consider what kind of threat reinsurance might be under.

I’m not going to comment on what it might mean to be an impresario in the insurance industry. But now that I’ve reminded myself what “existential” means, I have to say no. I don’t think the threat facing reinsurance is existential. I don’t think the industry’s very existence is under siege.

Yes, the industry is at a critical inflection point. But we’ve been at points of inflection before, and it’s usually the place where real opportunity lies.

This is a great time to be a reinsurer. I’ll tell you why. Let’s start with the basics. I’m going to paint a picture of the reinsurance industry using some broad-brush strokes.

First, let me ask you this: what is reinsurance, fundamentally?

You know the answer as well as I do – it’s capital. The value that reinsurers offer cedants is better, cheaper capital.

And why do cedants lay off risk? It allows them to optimize their own capital.

A reinsurer helps cedants arbitrage their capital. That’s the basic value equation.

Now add services to the value equation, like teaching a cedant something about his portfolio that he doesn’t know, or being a trusted partner in assessing his risk or consulting about loss prevention.
[By the way, I’m using “he” as an all-encompassing pronoun here.]

Value-add is an important and strategic differentiator in the reinsurance market.

But capital is fundamental to the reinsurer/cedant relationship.

In order for reinsurers to be relevant, their capital has to be as least as effective as the capital that cedants can get from other sources.

You could ask if this has always been the case. The answer is yes, but there hasn’t been the broad array of capital markets that’s developed over the last decade or so, amidst the excess capacity we’ve been struggling with for the last few years.

As insurers get bigger and bigger – and they have been getting bigger and bigger – they can handle more risk. They don’t need to lay it off the way they did when they were smaller. The biggest issue for the reinsurer becomes whether the cedant will continue to cede their risk.

Insert into that dynamic a brash upstart – alternative capital.

Now, bookend that upstart with risks we don’t fully understand, and markets that are still emerging.

It’s a cliché to tell you that we’re facing a dramatically changing industry in a dramatically changing world.
Just watching health care systems in the developed world struggle to contain the Ebola epidemic is proof of the tenuous grasp we have on 21st century risks.

Generally, our industry has been slow to respond to the challenges and opportunities these new risks represent. Part of that delayed response can be attributed to the conservative nature of the industry.

Part of it can be attributed to the vast legacy systems established through mergers and acquisitions. Being nimble and innovative can be difficult when your organization is carrying decades of administrative weight.

For those carriers who want to take big, bold steps, this is where things can get interesting.

We’ve done a very good job as an industry in developing a business model that supports traditional risks. For the most part, we have risk assessment, modeling, underwriting guidelines and claims handling down pat.

But here’s where the real threat lies. And it’s not existential. It’s quite pragmatic:

Our industry looks at the past to predict the future.

We use trends and patterns to develop the framework for our pricing, terms and conditions.

But there is no “past is prologue” in the world of cyber threats, climate change, global pandemics and terrorism.

This is a new world of risk. Again, a cliché – but true. We have new roles to play.

Capital is the fulcrum upon which new risk and new roles pivot.

Alternative capital is one force to be reckoned with. Its entry has been disruptive, forcing reinsurers to be more innovative. There’s a common refrain from ratings agencies and from brokers: Aon said it in a report earlier this year. They warned reinsurers to “innovate or perish.”

This is where traditional capital can call on its inherent strengths.

High quality underwriting and an enhanced asset strategy still make a traditional reinsurer an attractive partner to cedants.

And reinsurers who respond to changing market dynamics know how to stay relevant with their capital: in some lines of business, they can provide solutions that alternative capital can’t, like multi-year coverage and reinstatements.

But there’s something else to consider.
Tell me how many pure, stand-alone reinsurers there are today.

Not many.

After Hurricane Andrew, seven new cat reinsurers were formed in Bermuda.

I bought two of them when I was at ACE and people thought I was crazy. Everyone asked if an insurance company could really own a reinsurer. At one of them – Tempest – the thought of putting the ACE brand on their company was considered heresy.

Now, no one bats an eye that there’s a company called ACE Tempest Re. And the company that only writes reinsurance is a rarity.

The reinsurance operations of Hamilton Insurance Group, Hamilton Re, established a partnership earlier this year with Iron-Starr that gives CEO Kathleen Reardon and her team access to some attractive lines of primary business.

The fact is, there is no purity to the reinsurance industry. It’s not some monolithic structure – never has been. The move from a pure reinsurance play to a diversified book is part of a natural evolution. It’s smart, prudent management of your balance sheet and your portfolio.

The debate about concentration versus diversification is one that I had decades ago. I believed then, and I believe now, that you have a greater chance at long-term success if you build a diversified company.

And within a diversified company, capital is allocated to insurance, and it’s allocated to reinsurance. You move it back and forth as you navigate market fluctuations and catastrophic events.

After 9/11, I raised a significant amount of capital proportionate to our book value, and dedicated most of it to our reinsurance book.

As a cedant, your essential question is: do I use my own capital, or borrow someone else’s? You gather risk directly or derivatively. Then you decide to keep it or pass it on to maximize your return.

Maybe we’ll get to a point where there’s more of a liquid trading of risk. Maybe insurers will go directly to capital markets. That’s a new proposition that’s being tested by some of the larger insurers, including ACE.

The fact is, with alternative capital, less ceding of risk, and consolidation, the reinsurance market will be constantly forced to adapt and innovate.

But that’s life.

The cedant is under the same type of pressure as the reinsurer, mitigated slightly if they have internal options before looking externally to lay off risk.

The broker is pressured from both sides. There’s that dichotomy again.

The confluence of less purchasing will naturally force more M&A activity in our business. There will be – there already are – less pure cedants and less pure reinsurers.

In the end, we’ll all be doing the same thing: we’ll cede risk, we’ll assume risk, we’ll directly access capital markets.

This dynamic doesn’t represent an existential threat to the reinsurance market, although it may signal the demise of some carriers. This is the natural evolution to a blending, a great convergence in our industry.

And I think it’s terrific. After a career as an insurer, a reinsurer and a broker, I’m agnostic about risk.

Ultimately, if I’ve got a shareholder who wants to maximize their return on investment, I’m agnostic about the type of risk I’ll to take on.

Because, at the end of the day, we’re all risk takers. We price a risk and match it up with the best capital possible.

How well we match risk and capital will be driven by how well insurer, reinsurer and broker adapt to the winds of change.

The brush strokes we use to paint the future of our industry should be big and bold.

Based on what I’ve seen over four decades in the business – maybe that’s what makes me an impresario – I have no doubt they will be.

Thank you.

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