Reinsurance sector fit to navigate troubled waters ahead: Kessler

As part of our Risk Perspectives series of interviews with leaders of the world’s biggest insurance and reinsurance groups, Commercial Risk Europe editor Adrian Ladbury speaks to Denis Kessler, CEO of SCOR. He is asked about the state of the reinsurance market, what it needs to do to retain relevance, and how it can help tackle massive challenges such as climate change and the protection gap. Mr Kessler says the market faces some tough decisions as it rises to the threats posed by a rapidly evolving global economy and environment. But he believes that fundamentals are healthy for reinsurers and insurers, so long as they clearly identify what the challenges are and act decisively.

Adrian Ladbury [AL]: In what lines and territories do you see the biggest opportunities and challenges for the traditional reinsurance market in coming years? Will demand for reinsurance in emerging regions such as Asia and Africa compensate for lack of demand in mature regions such as the US and Europe?

Denis Kessler [DK]: The US, which represents almost half of the global reinsurance market, is the single largest driver of increased cessions into the global reinsurance market. Growth there has been driven by large cessions, by both major US carriers and smaller carriers that need risk capacity, particularly in catastrophe zones.

Demand in emerging markets is also structurally increasing as it benefits from economic growth, even though there is always a lag between economic growth and the increase in (re)insurance penetration in those markets.

I believe in the protection gap hypothesis, according to which a very large part of the world’s population is underinsured, and this is true in both developed and emerging countries. This is the real challenge to meet! The way to reduce the gap could be through new and innovative products and partnerships between the private and public sectors.

I believe that risk awareness and risk aversion are growing globally. I am convinced that risk aversion is well and truly the most widely shared thing in the world. I expect that the demand for insurance – and reinsurance – will therefore continue to increase in different markets, both quantitatively and qualitatively.

[AL]: Do you think the process of consolidation that we have seen in recent times among insurers will accelerate again in 2018 as margins tighten and reserves run dry? What impact does this have upon the reinsurance market and demand for reinsurance? Will we continue to see demand for run-off reinsurance solutions as insurers continue to reshape their books in reaction to Solvency II and other rules?

[DK]: Reaching critical size is a key concern for insurers and reinsurers alike – on the one hand to achieve economies of scale and economies of scope, and on the other to expand their footprint onto the full risk-to-capital value chain, thereby accessing all the pockets of value in the insurance ecosystem.

From that perspective, consolidation and mergers and acquisitions (M&A) have been, and still remain, a driving force in the (re)insurance industry. The worldwide life reinsurance industry is already significantly concentrated. There is scope for concentration in the P&C reinsurance space. In the meantime, insurers and large corporations value a diversified panel of risk carriers.

More specifically, some of the many considerations facing insurers in 2018 will include the ultimate shape of Brexit and the effects of the US tax reform, continued regulatory changes like the EU-US Covered Agreement, the development of the C-Ross solvency regime in China and the upcoming IFRS 17 accounting standard, as well as the impact of a weakening dollar. These factors may all weigh on M&A activity this year.

[AL]: What impact will rising interest rates have upon the supply of ‘alternative’ capacity such as ILS? Will we finally see a reduction in appetite for insurance risk within the capital markets or is it really here to stay?

[DK]: Following the series of destructive events in 2017, which represent the largest hit to the ILS market ever, many market participants wondered whether the appetite of capital markets investors for this asset class would, at least partly, dry up. Available information indicates that this does not seem to be the case. Let’s wait until we have more reliable data. There are no indicators yet of a reduction in ILS capital.

Nevertheless, as an economist, I believe that the normalisation of economic and monetary conditions will affect the supply of ILS capital. It’s clear that the expansionary monetary policies that have been implemented since the financial crisis, and which have artificially maintained yields at record-low levels, have distorted capital allocations and contributed to strong investor interest in ILS.

Without a doubt, there is a cause-and-effect relationship between quantitative easing since 2008 and the more than fourfold increase in alternative capital during the same time period! All things being equal, higher interest rates are likely to reduce the attractiveness of the ILS asset class compared to other, less risky asset classes.

That being said, I believe that ILS capital is an established player in the (re)insurance ecosystem. By the way, SCOR issues ILS to cover its risks. We invest in ILS and we help our clients to issue ILS.

It should be emphasised that ILS have so far primarily concerned short-tail lines in developed markets. These lines are event-driven with readily available off-the-shelf models, such as property catastrophe. So, ILS are currently complementary to traditional reinsurance, and have actually been integrated by reinsurers that opportunistically use this alternative capital to expand their capacity and balance their credit exposure. Don’t forget that reinsurers themselves issue about a quarter of all ILS on the market!

[AL]: Do you think London really has a chance to become the European hub for ILS solutions or will Brexit scupper this potential? What impact will Brexit have on the London market in your view?

[DK]: ILS vehicles in Europe are primarily registered either in Dublin or Guernsey. However, a number of London-managed transactions are also registered in Bermuda, indicating that an EU domicile is not a key criterion for current market participants. What is more important is the regulatory framework, including the timeframes for approvals and the tax rules applied to the ILS vehicles.

The UK government addressed these issues within the framework that came into force in December 2017 – in particular, the tax regime is very similar to that offered in the current offshore regimes. The PRA then subsequently approved the first UK-domiciled vehicle in just nine working days, addressing concerns over authorisation time and demonstrating its support to establish this activity in the UK.

What London does bring to the ILS world is a well-regarded onshore environment, which will allow new participants to consider ILS vehicles that their local regulatory and/or tax environment might have precluded them from using in an offshore jurisdiction.

The impact of Brexit on ILS will depend on whether Solvency II equivalence or some other form of mutual recognition is agreed between the EU and the UK. Without recognition, EU cedants might be less willing to use vehicles registered in the UK.

The London market is a global center for specialty (re)insurance and has a historical pool of expertise. But as the CEO of a group that proudly operates in the UK, I firmly believe that open markets create optimal business conditions, and therefore that Brexit – as an ongoing development in the re-fragmentation of the world – is harmful to economic growth and market efficiency.

It is no surprise that most London market participants are seeking to establish a minimal footprint within the EU and that a number of carriers have already relocated or set up offices in continental Europe or Dublin. It is a loss – and a pity – for the UK in general and the City of London, in particular.

SCOR will maintain its direct operations in the UK, but because of Brexit we are obliged to create a P&C direct insurance company in France to serve our continental primary clients. So as not to increase barriers and operating costs in terms of writing cross-border business between the EU and the UK, it is essential that there is no divergence going forward between the solvency and prudential regimes in the EU and the UK.

[AL]: What impact will the new US tax rules on insurance and reinsurance transfers out of the country have upon the ability of the international market to provide capacity for US risks? How could and should international insurers and reinsurers respond to deliver continuity of coverage and capacity for customers with US risks?

[DK]: The creation of the new US BEAT (Base Erosion and Anti-Abuse Tax) is a negative development as it creates a market access barrier for international reinsurance groups, which boost local capacity by using their capital outside of the US through internal reinsurance/retrocession.

Open markets create optimal business conditions, so such a measure is harmful to market efficiency, particularly for reinsurance which is intrinsically a global, cross-border business. It leads to increased costs for operating and writing business in the US, which is ultimately detrimental to policyholders.

Luckily, there is an opposite force at work: the US/EU covered agreement. The covered agreement should make it easier for international (re)insurers to operate in the US, for example by progressively removing burdensome and costly collateral requirements.

[AL]: More importantly, what would you like to see the international insurance and reinsurance community do to more effectively support the fight against climate change and poverty/wealth inequality? These are fundamental challenges and opportunities for the insurance and reinsurance market in the future. What would you do to rise to these challenges if you were CEO of the global insurance and reinsurance industry?

[DK]: Climate change constitutes a major long-term threat, because it is by nature a global and potentially systemic risk. In addition to increasingly destructive weather events and natural catastrophes, climate change-related risks may include water risks, food insecurity, threats to biodiversity, global health, forced migrations, social tensions, political crises and so on.

Tackling and addressing the effects of climate change is therefore a global and shared commitment. The insurance and reinsurance industry definitely has a key role to play in the fight against climate change, for two main reasons: Its unique expertise in terms of risk analysis, risk modelling and structuring customised risk transfer solutions; and its fundamental function of pooling tail risks on a global basis to optimise diversification benefits.

First, we must develop expertise and scientific knowledge on climate and natural events, and better share this expertise among all parties involved: governments, private companies, insurers and reinsurers.

Second, we need to fight the so-called ‘protection gap’, because there are still too many people who remain underinsured. Each time there is a big catastrophe, the level of underinsurance is striking. It’s a global issue, for both emerging and developed countries.

Look at Texas for example, an extremely rich part of the world. After Hurricane Harvey we discovered that, in some countries, up to 85% of homeowners were not insured against flood risk. Addressing the protection gap is key to increasing economic and societal resilience to natural catastrophes, and is therefore a priority for the 21st century. It requires the combined efforts of governments and the private insurance and reinsurance industry, with strong public-private partnerships.

SCOR is a strong supporter of scientific research, through its dedicated corporate foundation. A signatory of the UN Global Compact and of the UNEP-FI PSI from the outset, SCOR acknowledges the high relevance of the Sustainable Development Goals, set in 2015 by the UN Agenda 2030, to its business.

SCOR also supports international sectoral climate-related initiatives, such as the French Business Climate Pledge signed in the wake of the Paris Climate Agreement and the Geneva Association’s Climate Risk Statement on Climate Resilience and Adaptation. SCOR is also active in the Chief Risk Officer Forum, which monitors emerging risks and climatic events; in the Sanctions in Insurance Roundtable; and in the Sustainable Development Commission of the French Insurance Federation.

In addition, I co-chair the Extreme Events & Climate Risk working group of The Geneva Association and am a member of the Insurance Development Forum Steering Committee, both of which aim to foster modeling and increase (re)insurance penetration.

The next Risk Perspective interview is with Stephen Catlin, who rose from teaboy at Lloyd’s to eventually sell his insurance business to XL for $4.1bn.