Big Changes coming to Insurance?
A long time ago people of means joined with other wealthy investors and would promise to pay a ship owner for the loss of a crew, ship and cargo in the event his vessel failed to return from a voyage.This promise was supported by the pledge of all of the worldly assets of each investor to provide the ship owner with the security he required before he paid over a premium fee.
The original "names" at Lloyd's started out this way. Some names were passive investors, relying on professional underwriters and syndicate managers to ensure that premiums were adequate and that the risk insured against was manageable. Steady annual profits remitted to many names kept the system running effectively for generations.
Then things changed. Risks had been assumed that led to high unforeseen claims. Not only did "long tail" liability risks never seem to stop piling up but actual reported claim volume didn't reduce over time. Asbestos went from being a miracle fiber to a curse.
Worse, claims from events like the deadly Piper Alpha oil platform fire showed that uncertainty existed even as to which syndicates and names were participating on risks. Some names even learned that they had participated unwittingly on the same risk twice in a deadly claims spiral that caused fortunes to be erased.
New types of "names" were allowed into the marketplace. So called "corporate names" came to replace many of the individual investors. The full extent of the possible claim losses that could be faced meant that only the very wealthy or those who possessed very good underwriting knowledge remained as non-corporate names.
Nice little history lesson? Keep it in mind when looking at today's changes in the reinsurance market. During a trip to Bermuda earlier this month we were reminded again that the reinsurance industry is increasingly attractive to new capital originating from many different sources.
Even though premiums have not seen the sharp increases that many expected after the losses of 2011 new money is flowing into underwriting vehicles through Insurance Linked Securities (ILS), sidecars, SPI's and SPV's. When rates of return on capital invested in traditional market debt instruments such as T-bills and corporate bonds are as low as they are today, capital looks for higher yielding alternatives.
It now appears a winning combination has been found. Some reinsurers are providing their underwriting expertise to pools of new capital by segregating that new capital from other business placed by the reinsurer. The reinsurer is acting as underwriter, "transformer" (allowing the capital the ability to underwrite on its paper) and fund manager, as the exposed risk of loss needs to be fully collateralized.
Aside from the fully collateralized requirement, that didn't exists 400 years ago at Lloyd's, it would seem that in some ways the industry has come full circle. But there is one other big difference. Participants in today's pools comprise a wide spectrum of investors including pension funds, college endowment funds, hedge funds (people with fiduciary responsibility) as well as wealthy investors.
Investors have rightfully perceived that the risk of loss associated with a hurricane or earthquake is not correlated to the risk of loss in the traditional capital markets. Investing in ILS or reinsurance is a way to hedge one's investment against so called "normal" losses in traditional investment markets. In short, investors without underwriting knowledge or expertise are now entering the reinsurance market to a greater extent than ever before, largely attracted by uncorrelated risk and high returns.