2015 RendezVous: Smiles or Scowls?
Nikolaus Von Bomhard was not a happy man this time last year. The CEO of German reinsurance giant Munich Re — in line with its general policy — is rarely outspoken. However, ahead of the September 2014 Monte Carlo gathering of the reinsurance industry’s key personnel, he spoke of being “disappointed, exasperated and even rather appalled by what is happening in the market.”
It’s unlikely that the past 12 months have offered much to lift his spirits. Guy Carpenter reports that global property catastrophe rates were down by 11 percent on average at Jan. 1 2015, the same rate of reduction as the year before. “Reductions were sustained across all lines of business with few exceptions,” the group commented. “We continue to see rate reductions and easing terms and conditions at the various key renewal anniversaries during 2015.”
Attendees at the 59th annual RendezVous in the tiny European principality of Monaco next month will therefore be confronting familiar problems; indeed, the mood could best be described as “the same, only more so.”
Low inflation, minimal interest rates and meager investment returns have regularly featured on the RendezVous agenda since the 2008 global financial crisis broke. More recently, Europe has seen low inflation turn to deflation, while some corporates have followed the lead of its more confident governments and been emboldened to offer negative rates on bond offerings. This year also began with the European Central Bank (ECB) belatedly adopting the experiment applied by both the Federal Reserve and the Bank of England, to kick-start an economic revival by launching a quantitative easing (QE) program.
As for Munich Re, more recent pronouncements have employed milder language — although when the group issued its annual results in May, board member Torsten Jeworrek admitted that market conditions looked fairly certain to remain soft.
“The question for us is not how far the rates can decline,” said Jeworrek. “The question is how to manage the cycle and where to find new business opportunities. We are proceeding on the assumption that the market environment will not change significantly in the upcoming renewal rounds in 2015, unless extraordinary loss events occur, or there are any major changes in the market.”
New Channels for Excess Capital?
With what Aon Benfield describes as “too much capital and less opportunity to deploy it” prevailing, 2015 has seen an upturn in merger and acquisition activity with more defensive and strategic deals than in any year since 2007. Swiss Re’s chief economist, Kurt Karl, said recently that activity pointed to a squeezing out of the middle-tier specialist insurers and reinsurers. “Some firms do not have the scale or the breadth of services to differentiate their offering from more commoditized reinsurance capacity,” he noted.
The unsolicited takeover attempt launched by Italian investment firm Exor for PartnerRe is still grabbing headlines. This has threatened to overturn the reinsurer’s planned “merger of equals” with rival Axis Capital Holdings that was announced at the start of this year.
The resulting turbulence was recently commented on by XL Catlin’s CEO Mike McGavick, who cheerfully admitted: “We’re awfully happy to be able to take advantage of the confusion that mergers create for others.” Admittedly XL can display a degree of schadenfreude; the group’s $4 billion takeover of Lloyd’s of London underwriter Catlin went through relatively smoothly — announced in January, it had wrapped up by April.
“While both XL and Catlin were major reinsurers pre-combination, we are now the eighth largest P&C reinsurer in the world and have a larger suite of products and a broader geographic reach together,” said Greg Hendrick, CEO of XL Catlin’s reinsurance operations.
“This will be the main thrust of our meetings at Monte Carlo; we can entertain any P&C risk that a client faces anywhere in the world and we will be very focused on the overall relationship across products and geographies.”
It will take rather more major M&A deals to change Aon Benfield’s assessment. However, Bryon Ehrhart, CEO of Aon Benfield Americas and a regular speaker at the RendezVous, said that while the pronouncement remains valid, he sees grounds for optimism. “The growth in reinsurance capital continues to outpace the growth in demand for reinsurance,” he said.
“However, material new demand has emerged for U.S. mortgage credit risk and certain life reinsurance transactions. While the industry clearly has the capital to deploy in these areas, the industry’s skills are still developing and currently limit the ability of the industry to match the opportunity.”
Ehrhart also believes that the industry’s leading players have made “material progress” toward incorporating lower-cost underwriting capital into their value proposition. “Reinsurers have seen that they have and can sustain their significant competitive advantages when they optimize their underwriting capital structures.”
So what else will feature on the Monte Carlo agenda next month? Negative interest rates are likely to be a key topic, said Jean-Jacques Henchoz, CEO reinsurance for Europe, the Middle East and Africa (EMEA) at Swiss Re. “After large parts of European sovereign yield curves dipped into negative territory during spring this year, investors have certainly become aware that zero may not necessarily be the lower bound for bond yields.”
“I think the debate now is less about Solvency II content, but about how companies are going to live with it.” — Eric Paire, head of global strategic advisory, Guy Carpenter’s EMEA region
He believes that deflation fears may diminish: While the ECB’s bond buying program under QE had a major negative impact on bond yields over the first half of 2015, it is unclear whether it will remain the dominant driving force. “There are other forces which may push bond yields higher,” said Henchoz. “The U.S. Fed is likely to start hiking interest rates later this year. In addition, it is expected that inflation rates will increase in the second half as oil prices stabilize.
“Overall, the outlook for interest rates remains highly uncertain at this point in time. What is clear, however, is that insurers’ investment returns will not improve significantly anytime soon. This is because even if bond yields increase, existing higher-yielding bonds in insurers’ portfolios will need to be reinvested into lower-yielding bonds. So insurers’ investment returns will recover only slowly and with a time lag.”
Long-established players are also coming to terms with the fact that many of the market’s newer entrants have joined for the long-term. “We believe that alternative capital is here to stay and will be a part of the capital base supporting the reinsurance market,” said Hendrick.
“The only open question in our mind is what size and portion of the overall market will this capital source attain in the coming years. We are positioning XL Catlin to be able to utilize all forms of capital, our own and third party, to ensure that we match each risk profile with the appropriate capital.”
Ehrhart suggested two other topics likely to feature in many discussions. “Cyber [risk coverage] will recur as a topic that is driving demand growth,” he said. “The discussion of alternative capital will move from the debate over whether or not it is a good or bad thing to how best it can be incorporated into a reinsurer’s value proposition to its customers and shareholders.”
Solvency II issues
Just over the horizon is the European Union’s Solvency II legislative program, which introduces a new and harmonized EU-wide insurance regulatory regime in all 28 member states. As it takes effect from Jan. 1 2016, it might be expected to feature highly on this year’s RendezVous agenda. Conversely, having been in the pipeline for several years, is the debate over Solvency II — and the industry’s objections to the directive — now largely over?
“Not at all,” said Eric Paire, head of global strategic advisory for Guy Carpenter’s EMEA region. “I think the debate now is less about Solvency II content, but about how companies are going to live with it, and this includes topics such as internal model validation, volatility of capital requirements, and reconciling increased required capital with low prices and interest rates.
“Furthermore, with doubts about the readiness of some companies and indeed regulators, Solvency II is a long way from disappearing from the agenda.”
Henchoz agreed. “The focus is currently very much on implementation, on understanding how business operates under the new EU solvency regime as well as preparing for application,” he said.
“Many companies are still busy getting their systems ready by 2016, in particular on reporting, and the change towards an economic and risk-based regime has some wider implications which demand a different approach to strategy and products.”
RendezVous 2015 also poses the question of where delegates who usually check in at Monte Carlo’s five-star central Hotel de Paris will find a bed. The iconic venue began a major renovation program last October that won’t be completed until September 2018; until then many will have to settle for an address that is less prestigious — or located further out of town.
P&C Outlook for 2015
Rate increases that will slow or outright decline for the property and casualty insurance industry is just one of the major trends as we enter 2015.
Keefe, Bruyette & Woods analysts expect insurers’ operating earnings to improve modestly in 2015, mostly from the “earn-in” of 2014 rate increases versus still-benign loss cost inflation, partly offset by fading reserve releases and normal catastrophe losses.
KBW’s Managing Director Meyer Shields said workers’ comp and some other casualty lines, general liability and commercial auto liability will see rate increases, albeit at a slower pace, while property lines will continue to decline.
“There are a lot of insurance carriers and so it remains a very competitive marketplace,” — Meyer Shields, managing director, KBW
“There are a lot of insurance carriers and so it remains a very competitive marketplace,” Shields said. “Companies believe they can earn an adequate return and still price competitively, which should drag down prices” but he noted that pricing was “on a line-specific basis.”
KBW also expects loss cost inflation to pick up somewhat, “but not materially so,” as insurance loss cost trends has been very suppressed lately, he said. Moreover, given the decline in interest rates, there will be a continuation of lower investment income and overall returns will also come under pressure.
Potential Pricing Challenges
In a report released in December, KBW analysts wrote that two scenarios could disrupt the trend of decelerating or declining prices.
“First, a resurgence of claim cost inflation could quickly erode prior and current accident-year profitability, which would produce a year or so of weak earnings, but would also probably jump-start rate increases,” the analysts wrote.
“On the other hand, persistently low investment yields could drive the providers of third-party capital to expand their participation into other reinsurance lines beyond property catastrophe and similar short-tailed lines.
“We don’t think an expansion is imminent, both because it would tie up capital for longer, and because expected returns for most lines are much lower than was the case for property catastrophe almost two years ago,” they wrote.
“But we believe that the traditional industry players are rational and disciplined enough to avoid obviously destructive pricing, so it would probably take external forces to really disrupt pricing.”
The P&C industry’s underwriting performance continues to lag behind 2013, but remains favorable, according to A.M. Best’s Nine Month Financial Review of the U.S. P&C industry published Dec. 16.
The pure loss ratio increased by 2 points to 58.2 for the nine months through Sept. 30, 2014, primarily as a result of higher catastrophe losses and reduced benefit from favorable development of prior accident years’ loss reserves.
Favorable Commercial Lines Outlook
While net premiums written (NPW) grew, the pace of that growth has slowed. However, increased NPW has benefitted the underwriting expense ratio, as those expenses climbed at a slower pace than NPW, according to the rating organization.
The commercial lines segment posted another set of favorable results for the nine months ended Sept. 30, although some underwriting performance deteriorated somewhat year over year, according to A.M Best’s report.
Through the first nine months of 2014, the segment’s combined ratio was 97.6, compared with 95.6 posted the same period in 2013. Net income totaled $19.2 billion, down $9 billion from a year earlier.
A.M. Best’s analysts are seeing a continuation of the trends exhibited earlier in 2014, said Jennifer Marshall, an assistant vice president in the property casualty ratings department.
“We also now have a negative outlook on the reinsurance sector, but we have seen some solid results, so we expect the industry will post an underwriting profit for 2014.” — Jennifer Marshall, assistant vice president, property casualty ratings, A.M. Best
“Moderation in catastrophic losses continues, as it was yet another year without a major hurricane hitting the U.S. East Coast, which typically is a substantial driver of losses for third quarters,” Marshall said.
A.M. Best’s analysts are also seeing a slowing in premium increases, she said. They also believe the industry in general is well-capitalized, though they have concerns in the commercial line segment, specifically related to questions about reserves in recent years for companies that write a significant amount of long-tail business.
“We also now have a negative outlook on the reinsurance sector, but we have seen some solid results, so we expect the industry will post an underwriting profit for 2014,” Marshall said. Overall, “the industry seems to be performing in line with what we expected for this year.”
Morgan Stanley researchers believe that alternative capital such as catastrophe bonds is driving “secular changes” in the global (re)insurance ecosystem, according to a report released in December.
“We estimate that alternative capital currently accounts for 15 to 20 percent of global reinsurance capacity,” the analysts wrote. “We see it as a secular shift that disrupts balance sheet-based reinsurance models with a goal of directly matching risks with the most efficient capital.”
However, the trend also offers opportunities for primary insurers to re-enter markets and lines of business, to lower operating costs through lower-priced reinsurance, and to open up new revenue streams by managing third party capital.
“Those that adapt can not only survive but thrive, in our view,” the analysts wrote. “Longer term, we believe thriving reinsurers that adapt to this secular change should (1) maintain strategic relevance (size and breadth), (2) manage third party capital, (3) become closer to the end customers, or (4) focus more on investments (asset-manager-backed reinsurers).”
7 Questions to Answer before Choosing a Captive Insurance Domicile
Risk managers: Do your due diligence!
It seems as if every state in America, as well as many offshore locations, believes that they can pass captive legislation and declare, “We are open for business!”
In fact, nearly 40 states and dozens of offshore locations have enabling captive insurance legislation to do just that.
With so many choices how do you decide who is experienced enough to support the myriad of fiscal and regulatory requirements needed to ensure the long term success of your captive insurance company?
“There are certainly a lot of choices,” said Mike Meehan, a consultant with Milliman, an actuarial firm based out of Boston, Massachusetts, “but not all domiciles are created equal.”
Among the crowd, there are several long-standing domiciles that offer the legislative, regulatory and infrastructure support that makes captive ownership not only a successful risk management tool but also an efficient entity to manage and operate.
Selecting a domicile depends on many factors, but answering these seven questions will help focus your selection process on the domiciles that best fit your needs.
1. Is the domicile stable, proven and committed to the industry for the long term?
The more economic impact that the captive industry has on the domicile, the more likely it is that captives will receive ongoing regulatory and legislative support. The insurance industry moves very quickly and a domicile needs to be constantly adapting to stay up to date. How long has the domicile been operating and have they been consistent in their activity over the long term?
The number of active captive licenses, amount of gross premium written in a domicile and the tax revenue and fees collected can indicate how important the industry is to the jurisdiction’s bottom line. The strength of the infrastructure and the number of jobs created by the captive industry are also very relevant to a domicile’s commitment.
“It needs to be a win – win situation between the captives and the jurisdiction because if not, the domicile is often not committed for the long term,” said Dan Kusalia, Partner with Crowe Hortwath LLP focused on insurance company tax.
Vermont, for example, has been licensing captives since 1981 and had 589 active captives at the end of 2015, making it the largest domestic domicile and third largest in the world. Its captive insurance companies wrote over $25 billion in gross written premiums. The Vermont State Legislature actively supports an industry that creates significant tax revenue, jobs and tourist activity.
2. Are the domicile’s captives made up of your peer group?
The demographics of a domicile’s captive companies also indicate how well-suited the location may be for a business in a particular industry sector. Making sure that the jurisdiction has experience in the type and form of captive you are looking to establish is critical.
“Be among your peer group. Look around and ask, ‘Who else is like me?’” said Meehan. “Does the jurisdiction have experience licensing and regulating the lines of coverage for other businesses in your industry sector?”
3. Are the regulators experienced and consistent?
It takes captive-specific expertise and broad experience to be an effective regulator.
A domicile with a stable and long-term, top-tier regulator is able to create a regulatory environment that is consistent and predictable. Simply put, quality regulation and longevity matter a lot.
“If domicile regulators are inexperienced, turnaround time will be slower with more hurdles. More experience means it is much easier operating your business, especially as your captive grows over time,” said Kusalia.
For example, over the past 35 years, only three leaders have helmed Vermont’s captive regulatory team. Current Deputy Commissioner David Provost is one of the longest tenured chief regulators and is a 25-year veteran in the captive insurance industry. That experienced and consistent leadership enables the domicile to not only attract quality companies, but also to provide expert guidance on the formation process and keep the daily operations running smoothly.
4. Are there world-class support services available to help manage your captive?
The quality of advisors and managers available to assist you will have a large impact on the success of your captive as well as the ease of managing the ongoing operations.
“Most companies don’t have the expertise to operate an insurance company when you form a captive, so you need to help build them a team,” Jeffrey Kenneson, a Senior Vice President with R&Q Quest Management Services Limited.
Vermont boasts arguably the most stable and experienced captive infrastructure in the world. Many of the leading captive management companies have their headquarters for their Global, North America and U.S. operations based in Vermont. Experienced options for captive managers, accountants, auditors, actuaries, bankers, lawyers, and investment professionals are abundant in Vermont.
5. Can the domicile both efficiently license and provide on-going support to your captive as it grows to cover new lines of coverage and risks?
Licensing a new captive is just the beginning. Find out how long it takes for the application to get approved and how long it takes for an approval of a plan change of your captive’s operations.
A company’s risks will inevitably change over time. The captive will need to make plan changes which can include adding new lines of business. The speed with which your domicile’s regulatory branch reviews and approves these plan changes can make a critical difference in your captive’s growth and success.
The size of a captive division’s staff plays a big role in its speed and efficiency. Complex feasibility studies and actuarial analyses required for an application can take a lot of expertise and resources. A larger regulatory team will handle those examinations more efficiently. A 35-person staff like Vermont’s, for example, typically licenses a completed application within 30 days and reviews plan changes in a matter of days.
6. What are the real costs to establishing and managing your captive?
It is important to factor in travel costs, the local costs of service providers, operating fees, and examination fees. Some states that do not impose a premium tax make up for it in high exam fees, which captives must be prepared for. Though Vermont does charge a premium tax, its examination fees are considered some of the least expensive options in the marketplace.
It is also important to consider the ease and professionalism of doing business with a domicile in the ongoing operations of your captive insurance company.
“The cost of doing business in a domicile goes far beyond simply the fixed cost required. If you can’t efficiently operate due to slow turn-around time or added obstacles, chances are you have made the wrong choice,” said Kenneson.
7. What is the domicile’s reputation?
Make sure to ask around and see what industry experts with experience in multiple domiciles have to say about the jurisdiction. Make sure the domicile isn’t known for only licensing certain types of captives that don’t fit your profile. Will it matter to your board of directors if your local newspaper decides to print a story announcing your new insurance subsidiary licensed in some far away location?
Are companies leaving the jurisdiction in high numbers and if so, why? Is the domicile actively licensing redomestications — when an existing captive moves from one domicile to another? This type of movement can often be a positive indicator to trends in a domicile. If companies of a particular size or sector are consistently moving to one state, it may indicate that the domicile has expertise particularly suited to that sector.
Redomestications made up 11 of the 33 new captives in Vermont in 2015. This trend is a positive one as it speaks to the strength of Vermont. It reinforces why Vermont is known throughout the world as the ‘Gold Standard’ of domiciles.
Asking the right questions and choosing a domicile that meets your needs both today and for the long term is vital to your overall success. As a risk manager you do not want surprises or headaches because you did not ask the right questions. Do the due diligence today so that you can ensure your peace of mind by choosing the right domicile to meet your needs.
For more information about the State of Vermont’s Captive Insurance, visit their website: VermontCaptive.com.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with the State of Vermont. The editorial staff of Risk & Insurance had no role in its preparation.