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Insider In Full: Ten themes for 2020 in (re)insurance

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    • Alternative Capital
    • InsurTech
    • Mergers & Acquisitions
    • MGAs
    • Rates
    • Strategy
    • Topical Trends

The year of 2019 proved to be a period of transition for the (re)insurance market, with a clear turn in primary lines, the formulation of a wide-ranging Lloyd’s transformation agenda and major disruption in the broking market...

Catrin Shi, Adam McNestrie and Fiona Robertson

The results of that transition will probably play out in the next 12 months. A number of industry sub-segments are facing difficult and sometimes existential questions as they try to position themselves for a competitive environment which is arguably evolving faster now than ever before.

This is likely to be the year when the casualty reserving crisis really impacts P&Ls and the rubber hits the road on Lloyd’s transformation. It will also probably feature sector-defining tests for the Florida market, the ILS space and senior management teams on their commitment to culture.

The Insurance Insider has identified 10 themes in (re)insurance which are likely to shape both the industry and the news agenda for the year ahead:

  1. Casualty crisis
  2. Rates
  3. Lloyd's transformation
  4. Lloyd's pain
  5. Florida pressure
  6. Brokers
  7. Binders
  8. Culture
  9. Activism
  10. ILS

1. Casualty crisis

Signs of a brewing casualty reserving crisis in the US were the story of the final three months of 2019, and the way this plays out in 2020 will be pivotal to sector dynamics.

Only Stephen Catlin – who has no exposure – has ventured an estimate of the size of the hole to date ($100bn-$200bn) and most believe this is high by an order of magnitude. However, industry reserve deficiencies are expected in the aggregate for some time to come.

The speed with which the issues play out will depend in part on the stance taken by external watchdogs, including auditors and regulators, as well as the interplay with management incentives. Strategies are likely to diverge around the speed of pain recognition, although those that look to bleed it out over years will hurt their credibility.

Dissent remains as to where rate rises sit relative to loss-cost inflation in highly stressed areas like general liability, commercial auto, D&O and med-mal, prompting divergent underwriting strategies from reinsurers which are likely to continue through the year.

2. Rates

The US P&C market turned in 2019, with momentum starting to build late in the first quarter and then accelerating month on month, with a surge coming in casualty lines at 1 July.

A key question for 2020 will be the sustainability of rate momentum as accounts that paid substantial rises come up for renewal. The first major test of whether carriers can secure "rate on rate" will be 1 April, but the mid-year renewal – when public D&O was running at +30 percent and general liability was attracting big double-digit rises – will be the acid test.

The guidance to reinsurers in submissions for 2020 deals was for these kinds of rises to persist through the year – and they seem to have been sustained through 1 January – but stronger guidance was likely to yield better reinsurance terms, requiring some scepticism.

The amount of pain emerging in casualty reserving will be a big determinant of the sustainability of rate rises, with any upward movement in reinsurance pricing after modest rises at 1 January also a factor.

Lloyd's renewal rates were up 5 percent in H1 and likely accelerated into H2, with the US market momentum a major driver. Lloyd's carriers are reluctant to be drawn on rate movement even privately, but some expect a slight slowing of momentum in primary lines through 2020.

3. Blueprint One execution

This year marks the first execution year for Blueprint One, the maiden delivery roadmap for the Corporation’s wide-ranging market transformation project.

“Phase 1”, which runs between January and December 2020, will largely involve procedural change, alongside some early build work on some of the platforms and services outlined in the process.

The pilot classes on the revamped lead-follow (selected as marine hull and casualty binders) will also be rolled out this year.

Even though there is unlikely to be radical wholesale change in 2020 to how the Lloyd’s marketplace operates, it will be the first time that individual Lloyd’s companies will be required to make changes to their own businesses to fit the new era – which will test the overall market positivity seen to date on the Future at Lloyd’s strategy.

CEO John Neal will be keen to secure early, demonstrable wins during the coming year to sustain this market optimism, particularly as the departure of performance management director Jon Hancock has been a blow to the building momentum in the market to date.

Finding a credible replacement for Hancock will also be a major challenge for the Corporation during a time when it is preoccupied with one of the most ambitious reform agendas in its 330-year history.

4. Further Lloyd’s pain

Last year was a remarkably brutal period for Lloyd’s syndicate closures, with three entering run-off during the course of 2019 and Neon’s surprise closure announced at the beginning of January.

Mergers have also resulted in a slew of additional syndicate numbers being struck off the list, as previous M&A transactions have brought together businesses in search of critical mass. Alongside this reduction in numbers have been rafts of class exits and headcount reductions, even from some of the most well-established businesses in EC3.

Lloyd’s syndicates have been under intense scrutiny for their performance, and during the course of 2019 that scrutiny came not only from the Corporation, but also from capital providers.

With the Lloyd’s market as a whole still underperforming and unlikely to post a sub-100 combined ratio for 2019, the pressures of the past 12 months are unlikely to ease in the short term. Further closures, class exits and syndicate mergers are almost inevitable.

Even with Hancock’s departure, the level of rigour applied to business planning will continue in the short term, with the freedom to grow reserved only for the best-performing syndicates.

And with the shackles still in place, under-performing Lloyd’s syndicates will continue to struggle with the structural cost problems at Lloyd’s.

Those which launched in the soft market of the 2010s and are still unable to gain critical mass are under particular pressure, but even larger syndicates are likely to concede further class exits and headcount reductions.

5. Florida stress

After 10-30-percent rate rises in 2019 and isolated instances of major issues at Floridian standalone insurers, stress could emerge more broadly within the state’s insurance market.

With some Florida carriers near the top of their programme from Hurricane Irma, there is scope for a couple to exhaust their limit and take further deterioration net.

Worsening loss creep since 1 June 2019 and surging retro costs will create upward pressure on rates, with reinsurers targeting similar gains to those achieved last year.

Consolidation of smaller players in the market and some growth for Citizens looks likely, particularly if Demotech – which has shown its teeth already – chooses to bite with a round of downgrades.

Some insurers may be obliged to buy additional cover at the wrong time, including surplus-relief-type deals to satisfy ratings-agency requirements. Where consolidation does occur, there could be some modest downward pressure on reinsurance demand.

After a year in which Nephila dropped significant market share in Florida, there is scope for further panel shifts to emerge as cedants try to navigate the stress and minimise their reinsurance spend.

6. Broker fight

The ripple effects of Marsh & McLennan Companies’ (MMC’s) £4.9bn ($6.4bn) acquisition of JLT are likely to continue to make themselves felt, with the pending uplift of synergies guidance and forthcoming margin accretion seeming to show that the financial rationale for the deal is playing out.

A lot of the talent fallout has already happened, but there is scope for a new wave of departures from staff who initially tried to make it work at Marsh.

Aon is now around 60 percent the size of MMC and a key question is if it needs to respond – or if it believes Aon United and the hardening market can be a sufficient motor of value creation. This is likely to be framed via the question of whether it will mount a second bid to acquire Willis Towers Watson. To do so, it would need to believe that it could unlock enough value (primarily via synergies) to justify the regulatory issues, execution risk and potential dilution to existing shareholders.

This will play out against the backdrop of questions around the Willis leadership, following this publication's revelation that a full external search is being run by the board to help identify John Haley's successor.

It will be too early to get a definitive view on how the start-ups including McGill and Partners and Lockton Re have performed – as well as the success of other challengers that picked up ex-JLT staff – but we are likely to get some kind of read on whether revenues are starting to follow staff.

7. London’s delegated authority squeeze

After a pressured 1 January renewal, there is no indication that the difficulties faced by London-backed MGAs or binders will cease in 2020.

Delegated authority capacity has contracted significantly in London in light of heightened pressure from Lloyd’s to remedy underperformance across the loss and expense ratios. Company markets are facing similar pressure to improve results internally and, as a result, paper providers across London have become far more discerning in their MGA relationships.

The struggles faced by Pioneer at this January renewal have underlined how track record and performance is vital for MGA survival. Meanwhile, those MGAs or binders willing to be more flexible on remuneration are also viewed more favourably by paper providers.

To date there have been no major casualties within the space, but market observers believe the number of delegated authority arrangements will have to fall in 2020 due to capacity constraints. Further downwards pressure on acquisition costs is also expected, with sources speculating that the going commission rate for a North American property binder will come down to 25 percent by mid-year.

8. Culture

After Lloyd’s and other industry leaders made bold statements in 2019 on stamping out inappropriate behaviour, 2020 will be the year when the market is tested again on whether it can live up to its word.

The market has not yet passed with flying colours. The revelations in a court case of racist and abusive language used by AJ Gallagher’s UK management, including CEO Simon Matson – and the absence of any changes in that team – left uncomfortable questions around the distance between rhetoric and reality.

The Prudential Regulation Authority and Financial Conduct Authority have also warned they will keep a keen eye on “non-financial” misconduct, and placed the onus on leaders to ensure standards are met. However, whether the regulators have the teeth to effectively hold companies to account is yet to be tested.

9. Activism

The Argo-Voce saga dominated headlines for the entirety of 2019, but even though that particular battle has come to an end, the sector looks ripe for further activism.

It has previously been the perceived wisdom that (re)insurance is too complicated and heavily regulated to be an easy target for activism, but there have been recent examples to the contrary at AIG, AmTrust, Scor and RenaissanceRe.

This publication has previously speculated that Bermuda could be a prime target for activist investors as returns are starting to stutter.

And sister publication Inside P&C noted in its analysis of the Argo-Voce battle that its outcome will likely create a case study for other activists looking to make a move on the (re)insurance sector. The removal of Mark Watson III as CEO may prove to be the development which opens the door for a new type of “embarrassment”-led activism targeting (re)insurers that have been slack around executive compensation.

10. ILS

The key questions that surrounds the ILS market in 2020 are when and how fast it might return to growth mode.

Some 18 months into the clean-up phase, changes are apparent: Markel Catco is in run-off, work has been put into improving practices such as more widespread use of actuarial consultants, and the fundamentals are improving.

But in terms of the fundraising pitch for this year, there could well be a tug of war between the better returns that are now available to investors and continued concerns over climate change.

On the most public-facing side of the market, nominal cat bond yields have risen significantly in the past year to surge well past junk debt benchmarks (partly due to higher risk-taking).

Gross rates on line for the past year's issuance came to 8.7 percent by year end 2019, versus 2.02 percent on the Bank of America Merrill Lynch US High Yield BB index.

On the other bogeyman of 2017-2018 – loss creep – the expectation after another bad year in 2019 is that there is less risk of continued deterioration.

The uneven rate dynamic might drive further changes to where ILS capacity is deployed – perhaps pushing more to the primary market as underlying rates move faster than in the reinsurance world.

Other topics for debate between ILS cedants and risk-takers will include negotiations over things such as buffer loss tables, which need to evolve after issues around capital release.

Concerns over collateral efficiency might also lead to further launches of ILS-owned rated paper.

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