One of the things we learned was that Excess & Surplus lines business is growing in importance to Lloyd's as the corporation continues to increase its share of it. Lloyd's is the now largest amount US E&S writer with about 30% of the business coming to Lloyd's through 900 US based "well established" coverholders.
As Sean McGovern, Lloyd's General Counsel and Director of Risk Management was going through his presentation about Lloyd's and the E&S market most of the audience duly took notes and no doubt were impressed with the gains made by Lloyd's over recent years.
It wasn't until Eric Andersen, CEO of Aon Benfield spoke that the light bulb went on. Andersen has been with the reinsurance side of Aon for only the past 6 months. Prior to that he had been on the retail side of Aon which ranks among the largest retail brokerages globally.
Andersen noted that on the retail side there is a distinct lack of product. He said that companies find it almost impossible to buy coverage for auto product liability, pharmaceutical product liability, financial institution professional liability, drilling risk for energy companies and liability risk for shale oil rail tank cars.
As Andersen noted, since they can't find coverage, should a business be required to pay even one claim in any of these areas it could mean "turning the lights out" and the bankruptcy of the business. He said that the products aren't available to sell what is desperately needed by these potential clients. And one of the reasons the products aren't available is that there is a lack of underwriting capacity and underwriting will to create them.
When Andersen came to the reinsurance sector six months ago he immediately contrasted the enormous sums of capital entering the market and the creativity of the reinsurance products spawned by a need to put as much of that capital to work as possible. It was a flood compared to the drought in retail.
By now of course even a disinterested observer would note that the reinsurance capacity barrel may be getting close to full. The reinsurance sector is small compared to the retail capacity needs and it's clear that the reinsurance sector alone isn't big enough to take in all the alternative capital that's come in and will come in.
So, per Andersen, we have an over-capitalized reinsurance market with a roster of high tech tools and creative products for clients on the reinsurance side. On the retail side you have no alternative capital, a desperate lack of products and a willing client base of people who will try anything to shift liability, often at a level that could threaten their futures as ongoing concerns, off their balance sheets.
Here was the light bulb being switched on. Andersen then said "that the people who can connect the two, the alternative capital and the retail buyer, will change the industry". He said that because of the unavailability of certain types of liability product the insurance industry is simply becoming less relevant to the retail buyer.
Andersen noted that even though alternative capital came to reinsurance first that it inevitably will jump to the retail client. He said that the clients will support a structured alternative capital liability product because they are afraid of being closed down in the event of a claim. He said "retail has never heard of Nephila, they are agnostic to the capital --they just want product."
Andersen said that it's a huge opportunity and one that Aon intends to take advantage of by going to the ultimate client, determine their needs, structure a product and find the capital to support it.
Andersen is a compelling speaker and the room was impressed with his presentation. Several thoughts though were expressed by subsequent panelists which seemed indirectly aimed at his conclusion.
There was no dispute that clients such as liquefied natural gas facilities, shale oil rail carriers or pharma liability currently face a lack of relevant insurance product choices for the risks that really keep them awake at night.
While it could be possible to identify alternative capital which might be willing to underwrite such risks at a fair premium price the question was raised as to how specific or individualized would the CAT bond or ILS instrument have to be? Could one really expect to be able to effectively raise capital for a liability event particular to one client in one area against one peril? Isn't that a slippery slope? Where does that end --do we end up marketing individual CAT bonds to cover specifically named private citizens?
Fair points indeed. After all the costs associated with creating a CAT bond or a collateralized ILS are not to be ignored. The end result of speculation like Andersen's could be that those reinsurance side cars, that have been set up to write CAT risks through a rated carrier's underwriting staff, might end up as a near infinite number of instruments aimed at supporting products for a near unlimited number of industries and perils.
We would observe several points though. When we started CATEX 20 years ago we encountered Clem Dwyer then EVP at Guy Carpenter in NY. Clem was one of the first to spot the convergence of alternative capital and reinsurance and one of his oft stated points was the imbalance between the level of potentially insurable interests in the world and the amount of global insurance and reinsurance capacity available to insure those interests. The amount of capacity available to insure those potential risks are a metaphorical thimbleful.
Insurable interest can be just about anything these days like infrastructure, patents, IP, lives, homes, boats, buildings, refineries, planes, rolling stock, etc. and, as we saw in an earlier edition from Roger Crombie, even one of the Kardashians' derriere. Any estimate for this number will be huge --really, really huge and despite intensive research we were unable to come up with even an approximate number for it! We thought about going back to the number we believed Clem Dwyer used all those years ago and then somehow adjusting it for 20 years of inflation and adding an estimate of organic growth but we realized that it would be futile. We don't know what the number is.
We do know that there are some $100 trillion in managed assets globally and one would assume that at least part of that pool of money certainly qualifies as an insurable interest. We may assume then that the total value of global insurable interest may be north of $100 trillion? Maybe. Like we said, this will be a really, really huge number.
Here's what else we do know. The combined gross written premium totals of the global commercial insurance and reinsurance industry is only $1.2 trillion (Yes, we know that there are many "accurate" numbers for this total. This is the one we chose.) leaving a presumed gap of many trillions of dollars representing interests that could be insured if products were built to sell to holders of those interests and if underwriting mechanics came up with a fair price. Presumably included in that group of as of yet uninsured interests are the vast pool of retail buyers described by Andersen as desperate for insurance.
No wonder this has attracted Aon's attention. No wonder they brought someone in from the retail side to be the CEO of the reinsurance side. This is the "pot of gold" to beat all others but it will be a long and methodical road to reach it.
As Andersen noted the first step is to understand the client and what their coverage concerns are. Then structure a product that you think will meet their needs and then revert to them to fine tune it. Once they say to you --yes, we would certainly buy something like that if it's at a fair price --Aon would normally take it to the market to find a carrier to underwrite it.
Andersen's point is that rather then hear the declinations from the industry (who, after all, apparently are not writing the business now anyway) Aon would go to the capital markets and structure an instrument that would be prepared to support the product after underwriters establish a price.
Andersen notes that the CAT model tools available for reinsurance was part of what made reinsurance the logical entry point for alternative capital products but believes that a combination of better modeling at the retail level, loss histories (remember GRIP?) and a dire need for cover by the ultimate purchase (the business) have combined to offer a perfect storm of opportunity.
You can take it to the bank that someone will begin to structure alternative capital products for retail and as they do others will follow. Rod Fox of TigerRisk noted that securitized retail capital is already coming into the market. After all if David Bowie can successfully securitize proceeds of his songs for 10 years in exchange for $55 million then really, how hard would it be to securitize premium payments that are set at a fair price in exchange for liability responsibility for a defined period of time. There might need to be a runoff requirement after that defined period but that could be part of the fair premium price.
One of the things Andersen reviewed were what in his mind were the three functions of insurance. First, insurance prices and accepts risk; second, it keeps up with new products for new risks faced by clients; and third, exhibits a willingness to pay claims. Andersen noted that this "willingness" to pay claims means more to a broker than can ever be known.
This point was reinforced later by Jed Rhoads of Markel when he observed that rather than examine a contract for a reason why a claim cannot be paid (which seems to be a common complaint against ILS products) an insurer will frequently pay the claim simply for good business practices and to strengthen the relationship. Given the volume of claims at the retail level compared to reinsurance any capital backer would have to be prepared to pay losses and understand that they are in for the long haul.
Will it happen? Look at it this way. Later in the day both Pat Ryan and John Charman spoke about the increasingly diverse and global needs of clients which leads them to think that the larger a market is the better it can serve a client as a one stop shop. There would have to be a number of unprecedentedly large insurers and reinsurers to fill that $25 trillion hole. It is likely that, if alternative capital has the appetite, it can be put to work in the insurance arena.
We have written in the past in CATEX Reports about the insurance needs of the developing world. It will not be too long until Chinese, Indonesian and Latin American citizens demand the same kind of liability indemnification that the West has had as it industrialized. Between those needs, in the developing markets, and the needs of businesses in the West that are working with those new markets, it would seem to be inevitable that the industry will respond.
Maybe John Nelson knew what he was talking about when he said that he saw an additional $1.5 trillion of new premium coming into the commercial insurance market by 2025. In fact he just may have been too conservative!