"...usually, over time, consolidation results in opportunities for more-nimble participants to capitalise on the missteps of a big organisation."
In the first part of his interview, Dirk Lohmann, discusses retail investors, the impact of M&A and the reinsurance cycle. Users who have registered (for free) can read the second part of the interview here about opportunities beyond property catastrophe risk.
What does all this M&A activity mean for the shape of the insurance and reinsurance market?
We’ve seen different waves of M&A over the decades – and, in that context, this is not something new. It’s happened before and usually, over time, consolidation results in opportunities for more-nimble participants to capitalise on the missteps of a big organisation. Opportunities also emerge when certain segments of the market have been underserved because they don’t seem to fit. That sort of thing has been a recurring phenomenon.
The real key question is: what form do those new players take? Are they new insurance companies, new syndicates at Lloyd’s, new reinsurers in Bermuda, providers of alternative capital in a different form? The opportunities and the possibilities are quite numerous.
I’m not a big believer in saying that alternative capital providers can now move into the primary insurance market. They can provide capital and let somebody else do the underwriting, but doing it themselves? That’s not going to work really well. We saw in the 1990s when a number of reinsurers got into the insurance business through the so-called ‘programme business’ that they all lost their shirts.
Reinsurance is a wholesale business and insurance is a retail business – those are not the same skill sets. I know that right now the rating agencies seem to think you’re better positioned if you have a reinsurance and an insurance business – for example, when they put Partner Re on a negative outlook because they suggested that it would be better if Exor was a more diversifying partner. I’m not sure I entirely agree.
What are your thoughts on the way in which many reinsurers are adapting their business models?
You’ve had some companies like Hannover Re, Catlin and RenRe that have used capital markets as a core part of their capital strategy for a very long time now. And they’ve been very successful. You now have a number of people who are asking themselves, ‘What do I do when my franchise has become eroded? Is it still something that is valuable in its own right or do I need to start looking at changing my business model?’
I don’t think everybody can change business models and become managers of third-party capital. There isn’t enough business for all of those guys, and a lot of the businesses being created by reinsurers are going to end up being sub-scale. A lot of it is because there’s more of a perceived need to be seen to be doing something than because there’s any real need.
Tell me a bit about your tie-up with Schroders and how this has affected the type of investor you’re able to attract?
Schroders manages our funds and the distribution for us and we have two channels: one is institutional – pension funds etc. – and then we also have an intermediary channel, which is high net worth.
The intermediary channel is focused really only on the more liquid end of the spectrum, which involves the bonds-only type products. We have given a lot of presentations to individual high-net-worth investors so that they understand this asset class, but their knowledge is largely driven by the level of advice the intermediary is giving. But what we do see is a bit more churn in the intermediary channel, so they also react a little more quickly to the declining yields.
The returns of ILS bond funds in the first half of the year were flat and that led to some withdrawals – whereas the institutional investors are very loyal and there’s actually been increased allocations. We haven’t seen a big event yet. It will be interesting to see how the investors respond when there’s a large mark-to-market correction.
The strange thing about retail investors is they all move in a herd and they all go at the wrong time. They do that in equity exchange-traded funds and they’ll probably do that with ILS.
From a retail-investor perspective, there’s a limit to how much you can go down the value chain, because they are still rather complex products. There’s a lot of standardisation, but each bond has its own unique characteristics, for instance. There’s a space for some retail-type investors, but it is a complex product and it’s going to take time to understand what they are investing in.
So has the reinsurance industry and the reinsurance cycle fundamentally changed?
The cycle is always going to be a feature of the market. The degrees at which the cycle shifts can be dampened, but not completely eliminated. It will be only if there is a significantly large loss, which both the industry and the capital markets did not expect, that you’re going to have a very sharp correction; that does happen.
So I don’t think the cycle is dead, because really – at the end of the day – our business is about taking risk, and risk is driven by psychology. If people get shocked and surprised, their ability to take risk is reduced. One thing that’s perhaps working against the industry is the much more complex regulatory environment they operate in – and a surprise is something regulators do not like either.
Regulators are extremely risk averse in their own right; they keep piling on more capital requirements. So if we have a surprise – some out-of-the-ordinary event that shocks the market – I wouldn’t be surprised if the regulators suddenly start to react, and company boards too ... everybody really. That’s what creates a market correction – it’s essentially an emotional thing, and I think that will happen again. Human nature hasn’t changed very much.
In part two of the interview, Mr Lohmann discusses opportunities outside of cat reinsurance. Users who have registered (for free) can click here.
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Posted: Monday, November 23rd, 2015