Over the weekend of May 4th and 5th Berkshire Hathaway held its annual shareholder meeting in Omaha. As usual, some 35,000 people attended what has become a "must follow" event for anyone following the economy.
Omaha is a nice town if you've never been. The people are friendly and open. Believe it or not all that hype about Berkshire's CEO, 82 year old Warren Buffett, being a regular Omaha guy is probably true. He does live in the same Omaha house he bought 55 years ago. To be fair he also owns a house in Laguna Beach, California and we do know that Omaha can be cold in the winter.
While waiting for Buffett and Berkshire's 89 year old Vice Chairman Charlie Munger to speak the crowd of 35,000 were entertained by a video presentation. Media reported that "shareholders watched Buffett and Munger star in parody clips of the TV show "Breaking Bad" and behind-the-scenes mock negotiations with Arnold Schwarzenegger on who will play the villain in "Terminator 5." Another reminded the audience that Buffett once sang a duet with rocker Jon Bon Jovi."
Bon Jovi and Buffett Jessie and Walt in "Breaking Bad"
It doesn't get any better than that does it? How can you not appreciate someone who is the richest man in the world who doesn't mind making others laugh at his own expense? It's a pretty compelling and attractive picture and there's little wonder Buffett is so admired.
The (re)insurance industry no doubt watched the annual rites in Omaha with keen interest while still digesting news of the Berkshire-Aon arrangement announced last month. That little deal you may remember saw Berkshire agreeing to provide 7.5% of capacity to an Aon Risk Solutions $2.5 billion quota share that is placed in the Lloyd's market. Berkshire has agreed to provide the capacity and is letting the Lloyd's market processes vet the underwriting and premium pricing.
Meanwhile others in the industry claim they can't figure out what Berkshire's insurance chief Ajit Jain is doing. The CEO of Validus Holdings Group Ed Noonan said that Berkshire "was taking advantage of the Lloyd's process" and that it was "unseemly". At the InsiderScope conference in New York Validus Re's CEO Kean Driscoll said that he "can't quite figure out what Ajit is doing."
Driscoll's remarks came at the InsiderScope meeting in the context of many attendees wondering why Berkshire was willing to surrender its underwriting expertise and embark on what really could be termed a binder deal with Aon. Next, we read the comments from Lloyd's Chairman John Nelson who in a New York speech warned that Lloyd's managing agents need to protect the expertise that makes Lloyd's unique and are not compromised by new "blind underwriting" deals.
InsiderScope NY Driscoll
We can't help but think of the Pink Panther scene when Peter Sellers asks a sidewalk busker if he had seen two criminals who had just run past him. The man, is playing an accordion and is wearing a sign "Aveugle". When the man asks "What two men?" and Clouseau says "Idiot! What are you? Blind?" the man helpfully answers "Yes!".
There may be something else here too. Just as Clouseau needn't have asked the unfortunate man whether he was blind or not it could be that some of the answers to what is going on are hiding in plain sight.
Let's review some other stories we saw this month.
First, a study by Munich Re predicts that the global P&C market will grow by 50% in the next seven years. Growth, which Munich expects will be especially strong in emerging markets, is expected to top out at $2.38 trillion by 2020.
The study notes that growth in the reinsurance market will be slower than in the primary P&C market but that "there is a strong correlation between the forecast growth in reinsurance and expectations for the primary insurance markets." Obviously, instead of "trickle-down economics this is trickle-up. As more and more primary business comes in traditionally primary carriers will seek to buy reinsurance for it but the primary market will see the huge growth.
It's interesting to note that at the InsiderScope conference many speakers had already observed that the reinsurance market wasn't growing and the $30 billion in new capital that had flooded into the market last year was having a hard time being put to use.
Aon, it seems, already knew that the primary P&C market was getting ready for significant growth. Both Greg Case and Bryon Ehrhart have dropped a few hints that even Inspector Clouseau would have seen.
From attendee notes taken at the New York conference we see that Ehrhart was definitive in that Aon is working on healthcare insurance, workers compensation and auto insurance -or high frequency low loss business - and wants to match ILS products to these lines of business. Ehrhart thinks that eventually about 1/3 of the current $505 billion in traditional reinsurance capacity will transition to reinsurer managed ILS capacity meaning that there is still a lot of ILS capital to come and that, in time, reinsurance underwriters will manage it.
In an analysts conference call a week earlier Greg Case made it clear that Aon was continuing work on healthcare insurance, workers comp and auto insurance "exchanges". If Aon thinks that ultimately much of the ILS market will be managed by reinsurers, and Munich Re believes there will soon be a dramatic need for coverage of primary P&C risks, why not look at the growing primary P&C market to accommodate the flood of new ILS capital?
In one move Berkshire and Aon were able to make Berkshire's AA rated reinsurance rating available to primary commercial risks. Admittedly the risks were packaged as binder and fac business but their origin was from Aon's retail side. That's one route to deal with the expected 50% increase in the P&C market over the next seven years and to deploy more of the new capital.
Here's another way. If Ehrhart is right, and some $170 billion in capacity ends up originating from the ILS markets, then the same comfort that escrowed funding and full CAT bond subscriptions that ILS products have provided to the reinsurance market could have the same effect on the primary market.
How would that work? Delegated authority business is one way. As Driscoll observed in New York a lot of business is being packaged into binders that really shouldn't be. Some business that might once have required placement through a primary market, is now bundled into a binder quota share, coming direct into the Lloyd's market on a delegated basis. Brokers and MGA's could well continue to exploit this gap and no doubt will until the markets (or Tom Bolt) react and say "Stop".
But can a reinsurer managing an ILS fund package a product aimed specifically at a primary P&C line of business? One problem could be the pricing of the risks. Reinsurance and primary underwriters are different species of animals but as Ehrhart noted reinsurers can put capital out into many different formats and one of their biggest advantages over the new ILS reinsurers is that their capital is "rated" by a ratings agency. He said that the rated capital tends to be less creative than unrated capital (ILS) but that "they can and will do better".
Bryon's predictions about reinsurers being more creative would be fulfilled if they began to pursue the exploding P&C sector (remember that Berkshire is already way ahead of them with the Aon Risk Services quote share). Ehrhart said that the crux of any of this change will be in the models. He said that the more creative the structures become the more model intrusive the process becomes.
Having reinsurers begin to look at matching ILS funds with primary P&C business would certainly be "creative" and would presumably require a fairly intrusive modeling process to assist in setting a fair premium.
At the InsiderScope conference Kean Driscoll echoed what Lloyd's Tom Bolt said earlier this year when he observed that the new non-traditional capital reinsurers could be viewed as "plug and play" underwriters who simply input the model results to set the premium.
Driscoll noted that Validus maintain a vast database of proposal pricing, contract pricing, claims costs, etc. and marries that experiential data with the model results to set a price. Presumably, like other traditional reinsurers, Validus is lacking deep data on the P&C market though. The new ILS reinsurers have no such historical data in either the reinsurance or P&C markets.
Well....someone is thinking ahead here. Ehrhart mentioned something in passing about it at the InsiderScope conference. Greg Case talked about it in detail during his analysts call. The "it" in this case is Aon's Global Risk Insight Platform database (GRIP) and it has 1.6 million trades and more than $83 billion in bound premium recorded on it. Last year Aon is reported to have spent over $100 million on GRIP and added premium data from its health and benefit business.
Aon licenses GRIP for a fee and according to reports GRIP revenues added approximately $120 million to Aon's revenue in 2012. Case is hoping to generate $160 million in GRIP revenue in 2013 which would represent a 33% increase. Clearly Aon is counting on that increase coming from somewhere.
Interesting isn't it? Common wisdom is what Stephen Friedman said at InsiderScope --"Picking up nickels in the path of a steamroller is bad strategy", suggesting that reinsurers should avoid writing risks they either don't know enough about or can't get their price for.
But, as Kean Driscoll suggested, the capital market view of "dead capital", or that capital waiting on the sideline because no one is running out to pick up those nickels, is that returning it to investors, without being invested, is anathema.
Meanwhile the reinsurance market seems to be slowing in growth while the P&C market is predicted to grow by half in the next 78 months. Why not begin to look at the growth market as a place to deploy capital? If some ILS reinsurers are already being viewed setting rates by "plug and play", as underwriters supposedly base premiums simply on model results without the benefit of their own data, why would they feel any constraints about doing the same with the P&C market? But if Ehrhart is right, and reinsurers end up managing a significant chunk of ILS capacity and do decide to play in the P&C market, there are only a few options available to them.
They can try deals like Aon's Berkshire arrangement but Tom Bolt seems determined to close that door. They could try to reach this market by avoiding Tom Bolt and try to go it alone in some way (losing the benefit of the price-setting process of the Lloyd's market). But they would need to find the right P&C data (and enough of it) to compare their models to and avoid the "plug and play" stigma.
Presumably the smart money will sit out and pass up the nickels to avoid the steamroller. But let's face it --what Berkshire is getting from the Aon deal aren't just nickels and no one would ever call Berkshire anything other than smart.
Either way Aon is well positioned too. They can act as a binding broker, and continue to look for more capacity partners to cover business coming from its vast retail network, or they can offer their GRIP data to capacity providers (traditional and ILS) who want to try to go it alone. After all, with the global P&C market forecast to reach $2.38 trillion in 78 months, having both reinsurance and P&C covered seems to be a smart bet.