There are those investors that clearly identify reinsurance as a viable and valuable proportion of their portfolio

Neil Strong from Willis Re takes a look at the evolution of the intermediary in today’s challenging trading environment.

The recent hurricane losses have caused a distinct split in the reinsurance market: the extreme pressure on the distressed areas of retrocession, marine, energy and US Property show no sign of abating, while outside of these key areas, capacity remains adequate and price movements muted. As if echoing this divide, a continuation of this theme can be seen in the reinsurance broking community. There has been an evolution of the role of the reinsurance intermediary, with two paths developing in very different directions.

Some brokers remain transactionally focused, concentrating purely on price and the transactional services provided. Successful intermediaries, however, seek to expand their awareness, education and knowledge, whilst adding value to the service and advice they are able to offer. Clients, prospects and markets are also evolving and absorbing new skill sets. Houses are looking at analysing the services provided and either employing specialist staff to cater for these burgeoning client requirements or are training and developing existing staff to operate in such areas.

The mundane and tedious graduate trainee scheme is now largely obsolete; nowadays the reinsurance community is able to successfully compete with other industries in the financial sector to attract the best graduates from top universities.

Not only can we compete financially, but we are now able to offer intellectual diversity and a varied and interesting career path for the ambitious and cerebral graduate. The reinsurance community can compete for the best talent.

The skill and intellect requirements for intermediaries has led to the production of a more rounded individual. Transaction contributes only a small (but important) part of an overall service package. In addition to the transaction process, pre – and post – execution, there remains a lengthy list of tasks that must be well-performed. The information-gathering, research, quoting, modelling, modelling analysis, security analysis, claims, accounting and technical skills all form part of a minimum requirement for the backbone of a client’s needs and are part of a minimum service level .

This evolution is driven by the fact that the re/insurance industry is starting to leverage products which were traditionally only found in the capital markets sector and secondly the industry of risk management now plays a far greater role within the boardroom than it ever has before, highlighting the issue of capital management.

Chief executives and finance directors are taking an increased interest in risk management, not only to comply with reporting requirements, but also to protect their business from any risk they believe they face. Management is now required to assess the risk of their businesses and translate this into an assessment of capital requirements. Reinsurance intermediaries increasingly play a vital role in providing the necessary tools and skills to manage this process.

The recognition and identification of these risks and perils has necessitated the intermediary getting much closer to its clients’ business. The traditional reinsurance market is now supplemented by the increasing prominence of the capital markets, albeit usually imbedded within a different regulated and structured environment. Capital markets participants generally do not yet demonstrate the same flexibility, experience and understanding that underlie the reinsurance underwriting community and fuels the transactional activity therein.

Why have things changed and why are the capital markets interested in these new ways?

Management is putting pressure on underwriters and ceded re departments to source alternative capacity, which has been driven largely by the high cost of purchasing reinsurance following the hurricane seasons of 2004 and 2005. There has been a significant increase not only in the interest of the capital markets, but also in the utilisation thereof. This has taken the form of captives, collateralised covers, catastrophe bonds and,  of course, the influx of capital in respect of the various start up companies. The capital markets have become recognised as a standard and accepted part of a client’s analysis of risk finance options.

As these capital markets become a viable alternative, sometimes converging with the traditional reinsurance market, intermediaries have had to adapt and educate themselves in these new areas of expertise. Rate online, market availability and profits become parlance of a different kind and translate into indemnity premium, liquidity and return on equity. Florida wind exposures can be related to an orange juice future or Japanese liability schemes to a pharmaceutical hedge.

The similarity between the two industries is great and the understanding of the reinsurance industry as a subset of the capital markets ever more apparent. There have been the wellpublicised recent non-life securitisation deals such as OIL, Hannover K5, Swiss Re, Axa and Dekania. Of course, there are the opportunistic players who see a market dislocation and will only be around in the short term, but there are those investors that clearly identify reinsurance as a viable and valuable proportion of their portfolio. Such examples include CIG Re part of Citadel, Nephila, a Bermuda-based fund and a number of more recently announced projects. The list of funds, be it investment, hedge or bank trading risks, is growing on a regular basis.

In addition to participation in “traditional” risk, the capital markets are able to bring to the table such opportunities as subordinated debt, capital provision, sidecar vehicle investments, catastrophe bonds,CDO structures, securitisation of reinsurance recoverables and many others. Therefore, as a requirement to educate and be educated in the capital markets world, the intermediary has to be at the forefront in anticipating scenarios for clients that could cause significant loss.

Clearly, elemental risk has significantly altered the balance sheet of many risk carriers and awakened many - both inside and outside the industry. The effects of climate change and global warming through increased levels of industrial output, air travel and other such transport emissions are areas of risk management that intermediaries are now highlighting.

Risk Managers should be aware of initiatives such as the EU Emission Trading Scheme, where companies in various different areas of business are bound under the Kyoto Protocol to reduce their emissions annually. Due to the trading of carbon emission permits (“licenses to pollute”), a market has been created whereby a business that can reduce its emissions by more than it has to can sell its excess permits to one that cannot. As the amount of permits in circulation reduces, the price goes up and so the cost of non-compliance increases. In the first phase of the EU-ETS, industries such as aviation and shipping were not included, yet they are major polluters. Advice from an intermediary aware of the emissions trading market might include urging players in those industries to comply now by buying carbon credits voluntarily because by the time these two sectors are included by legislation in the EU-ETS, the price of carbon may have increased.

Furthermore, directors and officers have been warned that they could be held liable for damage caused to the planet by the effects of climate change. Members of the boardroom may well be taking increased risk if pollution attributed to their business activities causes class action, especially if such acts of pollution have remained undisclosed.

Insurance companies themselves can consider positive action by offsetting their carbon footprint, generated through intensive air travel electricity usage and commuting. Intermediaries such as Willis have been able to drive change in this area through environmental leadership and action, engaging companies such as the European Climate Exchange, Europe’s biggest trader of carbon credits and their corporate arm, Climate Risk Advisory.

The capital market interaction and the environmental issues are just two parts that contribute to the role of a reinsurance intermediary in today’s ever changing, ever educating and ever developing environment. The industry is now supplemented by a list of skill sets and talents that is lengthy and lengthening. What is clear though is that to be successful, the intermediary model has moved from one of “transaction only” to “transaction and advisory” to now one of “transaction, advisory, capital market requirements” and this evolution continues apace.

This Special item appeared in issue 106 of JTW News - June 2006

Author: Neil Strong - Willis Re