Reinsurance

Global Insurance Market Opportunities

Doing business in a volatile world: Performance and strategy

Trading during volatile times: Reinsurer performance and strategy

Tom Griffiths

Manager, Aon Inpoint

Jamie Douglas

Senior Associate, Aon Inpoint

Lucy Griffin

Senior Associate, Aon Inpoint

The first reinsurance company was established in Cologne in 1842 after a great fire destroyed the city and bankrupted most of the local insurers. Early reinsurers were established to provide cover to insurers against the existential risk posed by natural catastrophes. Reinsurers were better able to bear these catastrophic risks because they would aggregate uncorrelated risks across many geographies, taking what was an existential risk to the insurer and transforming it into part of a managed portfolio. This diversification effect is still critical to reinsurers' strategies.

Reinsurers now support their insurer clients with both protection against existential risks to their capital base from events such as natural catastrophes, but also more focused treaties that allow insurers to manage volatility in their earnings performance.

Historically, early reinsurers were established as mutual companies, owned by their insurer clients, and so their only responsibility was to their cedants. These days most reinsurers are publicly traded and as such, they must balance the need to provide both financial protection to their cedants and financial returns to their shareholders.

Like all people, shareholders of reinsurance companies have different appetites for risk, ranging from those who are happy to accept high volatility in return for high returns (such as private equity and hedge funds) through to institutional investors which prioritize the stability of regular earnings (such as pension funds). Therefore, different reinsurers operate a multitude of strategies to deliver returns for their shareholders.

Aon Inpoint has undertaken a study of the top 50 reinsurers from 2009 to 2018 (this group in 2018 assumed 82% of all non-life reinsurance premiums). Using publicly reported financial information, combined with proprietary Aon data, we have assessed reinsurer performance during a period when reinsurers have sought to balance growth, profitability, and volatility.

Accelerating premium growth for the top 50 reinsurers

Between 2009 and 2015 the average non-life reinsurance gross written premium (GWP) of the top 50 reinsurers remained fairly flat, between $2.4 and $2.6 billion (average growth over the period of 0.9% annually). 2012 represented a relative high point, following significant market hardening in the wake of major catastrophes in 2011, notably the Tohoku earthquake and subsequent tsunami.

From 2015 onwards, the top 50 reinsurers’ average GWP has boomed. Three factors contributed to this growth: market consolidation, rate hardening, and national reinsurers' growth. This period started during the bottom of the soft market cycle where reinsurance rates were low and competition for profitable business was intense. There was a significant wave of M&A activity, with notable examples: XL merged with Catlin, RenaissanceRe acquired Platinum, and Mitsui Sumitomo’s acquired Amlin. From 2016 as the market hardened nearly all top 50 reinsurers grew as the improving rate environment increased premiums. Throughout the period national reinsurers grew significantly both in their home markets and in international markets, with Korean Re and GIC expanding into the London market. Over this period the top 50 reinsurer average premiums increased from $2.5 to $3.1 billion by 2018. Growth in this four-year period was 7.2%, more than seven times higher than the period from 2009 to 2015.

Historical growth of the average premium of the Top 50 reinsurers (2009 - 2018)


 

The reinsurance market remains inherently volatile

Between 2009 and 2018, the level of natural catastrophe losses varied significantly. Impact Forecasting, Aon’s catastrophe model development center of excellence, collects global insured losses due to catastrophes and their data shows that the yearly losses range from lows in 2009 and 2015 of $39 and $45 billion, respectively, up to highs in 2011 and 2017 of $152 and $159 billion. Read more from Impact Forecasting's annual report. During the 10-year period, we observed that the top 50 reinsurers achieved an average combined ratio of 95%, however, in those two major catastrophe years the combined ratio increased to 107% and 108%, respectively. Reinsurers faced additional challenges to their profitability due to an excess of capital in the market, both from traditional sources and (from 2012 onwards) from significant growth of alternative capital.

Historical profitability of the Top 50 reinsurers (2009 - 2018)


 

 

Understanding the profitability-volatility trade-off

To assess individual reinsurers’ performance within the top 50, we analyzed the standard deviation of the combined ratio from 2009 to 2018 (the volatility) and compared it to the average combined ratio over the same period (the absolute profitability) to identify where reinsurers have been positioned in the trade-off between absolute profitability and volatility.

The Top 50 reinsurer profitability volatility trade-off

 


 

There is a clear trade-off in the reinsurance market between profitability and volatility. This relationship can be seen over the last 10-year period, with a strong -0.43 correlation between weighted average combined ratios and volatilities of the top 50 reinsurers. We have segmented the top 50 into four quadrants based on their combined ratio and volatility performance over the last 10 years. With the average combined operating ratio (94%) and average standard deviation (0.13) delineating between high and low.

  1. High profitability and low volatility
  2. High profitability and high volatility
  3. Low profitability and low volatility
  4. Low profitability and high volatility

Most reinsurers (35 out of 50) fall within either quadrant two or three, depending on their underwriting strategies and financial objectives, with only seven falling into quadrant one (outperformers) and eight into quadrant four (underperformers).

High profitability and low volatility

Quadrant one reinsurers (outperformers) have managed to outperform the market, achieving low levels of volatility at a higher profit margin relative to peers. Typically, these reinsurers have the most diversified portfolios, offsetting higher margin property catastrophe with the low volatility of casualty and specialty lines of business. The national reinsurers in this quadrant benefit from their ties to government that offer a significant competitive advantage in their local markets, whereas the global reinsurers in this quadrant have the scale to benefit from stronger relationships and a wider distribution network to access higher quality risks.

High profitability and high volatility

Quadrant two reinsurers tend to write major property catastrophe portfolios, achieving high profit margins in the long-run but at the same time driving up volatility. Many of these reinsurers have increasingly developed alternative capital propositions to increase their ability to transfer risk for their cedants.

Low profitability and low volatility

Quadrant three is where most reinsurers operate. There are two main types of reinsurers within this group. 1) Reinsurers that center portfolios around casualty business and avoid exposure to catastrophe risks. In addition to underwriting income, these reinsurers generate significant investment income. Included within this quadrant are a number of “total return reinsurers”. 2) European / national reinsurers, which are some of the largest in the market, who typically write large proportional treaties for their cedants that have lower margins and much lower volatility.

Low profitability and high volatility

Quadrant four reinsurers exhibited higher levels of volatility while achieving lower profits and are considered to have underperformed relative to the market. Their portfolios, on average, had the greatest proportions of specialty business. However, it is hard to generalize as these reinsurers have distinct situations and numerous factors have contributed to relative underperformance.

Each of the reinsurer quadrants has a distinct line of business mix

 

How can reinsurers achieve outperformance?

Reinsurance is an inherently volatile industry, and reinsurers must strike a balance between the needs of their cedants and the needs of their shareholders. Developing a strategy and building a portfolio that delivers the right risk reward trade-off is key. The composition of a reinsurers portfolio is a prime driver of their ‘profitability-volatility’ trade off, with 35 of the top 50 reinsurers fall within the quadrants that characterize this trade off.

However, 15 reinsurers have managed to either under or over perform this trade-off. Other factors are clearly responsible for driving these performance differences, such as:

  • Clear strategy
  • Strong distribution
  • Differentiated underwriting
  • Effective internal operations
  • A low cost base
  • Retrocession and ILS strategy

About the authors

Tom Griffiths is a manager within the Aon Inpoint team who specialises in providing strategic advice to reinsurance companies. Providing advice to a broad spectrum of reinsurers from Global reinsurers and Bermudians through to European reinsurers. Recent project deliveries have covered a number of key topics including portfolio optimisation, growth strategy, expense reduction and market entry. Tom has worked for Aon Inpoint for seven years and prior to that trained at Deloitte.

Lucy Griffin is a Senior Associate in the London Aon Inpoint team, currently focused on delivering reinsurance strategy consulting projects and supporting engagement across Aon for a major global reinsurer. Prior to joining Aon, Lucy worked as a Credit risk modeller in the Retail Banking sector. Lucy started out her career as an actuary and has experience working in the reserving departments of a Lloyds syndicate and an international reinsurer based in the Middle East.

Jamie Douglas is a Senior Associate in the Aon Inpoint team based in London, currently serving clients on strategy consulting projects and leads the UK engagement for a major global (re)insurance carrier. Prior to joining Aon, Jamie was Assistant Manager at KPMG’s Insurance Audit function having completed the graduate scheme in 2015. Jamie is a chartered accountant and holds a M. Eng. in Mechanical Engineering from the University of Bath.

About Aon Inpoint

Aon Inpoint delivers strategy consulting and insight to over 50 (re)insurers, including helping many of the world’s top reinsurance companies on their portfolio design, strategy, and operations. Aon Inpoint is dedicated to helping insurers and/or reinsurers be more competitive through providing data, analytics, engagement and consulting. Working collaboratively with colleagues from across Aon, we bring together unique insights and foresights that might otherwise get missed. We always look to structure the challenge of such a complex topic to ensure that near-term benefits are realized by insurer and reinsurer clients, while adapting and preparing for the longer term. If you are interested in learning more, or seeing how Aon Inpoint could potentially help your organization, please get in touch with one of the Aon Inpoint team below, or your usual Aon relationship contact.