ROUNDTABLE: LONG-TERM REINSURANCE
Q5: ARE MARKET CONDITIONS FAVOURABLE TO THE LONG-TERM SECTOR AT THE MOMENT?
“We’re back to the chase for yield.”
Olunloyo: Absolutely. There are trillions in outstanding pension liabilities to be shifted into the insurance world. Most of us here are in asset-intensive business, where it’s all about asset returns.
With interest rates and spreads where they are, there is increasing focus on illiquid assets where the wedge between liquid and illiquid asset returns is narrowing. Being able to find that right yield becomes even more difficult, however, creating a challenge.
Earlier in the year at the height of the first wave of the pandemic, corporate bond spreads blew out significantly, that was a great time to be looking to shift PRT liabilities—we saw a lot of transactions in the UK.
Obviously, spreads have grown tighter since then and we’re back to the chase for yield. I expect that will continue to be the case going into 2021.
Howell: We probably have the most mortality risk in this group, which may not currently sound like a winning proposition as traditional life reinsurance has seen more claims because of COVID-19. I would say the nature of the pandemic has not been as bad as the models predicted.
We normally model impacts which are just a flat extra rate of mortality for all lives, but this is more like a multiplier which hits younger ages less and has been more mitigated by underwriting.
And, of course, we do cover a lot of longevity risk, so we’re seeing an offset there. We might not have fully anticipated how much the economic impact of the pandemic would affect our disability book, so we have some extra losses coming through from that line.
“Reinsurance capacity contracted worldwide as a reaction to COVID-19.”
Laframboise: I would echo that the low interest-rate environment is causing pressure on product profitability across the industry. The pandemic caused a downturn in high net worth business globally—except for our own company, which had seen significant growth during 2020.
It has been challenging, partly because of COVID-19, and partly because serving our clients in a non-face-to-face environment has meant implementing more innovative business contingency plans.
Our staff worldwide adjusted rapidly to working from home. Continuing the underwriting and other operations has been challenging, but we have done it very successfully, we are quite resilient, even though the underwriting itself for mortality risk has become more complex—not to mention that reinsurance capacity contracted worldwide as a reaction to COVID-19.
All things considered, it has been quite a challenging year.
Kelleher: There is continuing demand for reinsurance, but the market conditions make it more challenging to reach price points that would cause both parties to transact. There are, of course, exceptions and where the demand is greatest, the opportunities will be realised.
I am expecting to see some pent-up demand building in the life reinsurance market and I think we would all hope to be well positioned to satisfy that demand—whatever ‘new normal’ business conditions develop over the next year or two.
“Reinsurance clients are very curious about illiquid assets.”
Ponnampalam: I would say that current market conditions are definitely bringing opportunities—we’ve all seen solvency ratios deteriorate across certain insurance companies over the last nine months, again looking at Europe (which is Athora’s main focus).
Solvency II is quite punishing under the spread volatility we’ve seen over much of this year, and is hence a driver for our clients to look for balance sheet solutions.
There is also the question of whether companies can afford reinsurance at the moment—or are things so bad that it would be very difficult to crystallise a reinsurance premium in the current environment?
We are certainly seeing more activity in Europe in terms of companies looking to exit capital-intensive books either through reinsurance, portfolio transfer or sale.
As a result, it is causing many international insurance companies to consider refocusing where they deploy capital and start shedding parts of their business which may be trapping capital that they can’t really afford in the current environment.
Illiquid assets are an interesting asset class, specifically for life companies, as they are very important to us over the long term.
Reinsurance clients are very curious about illiquid assets: what they are, how we think about them in developing our investment strategies. The experience of COVID-19 is going to test how effective and transparent our valuation principles have been when it comes to illiquid assets.
“What does matter, however, is default.”
The types of assets I am talking about are asset classes such as commercial mortgage loans, residential mortgage loans, private credit—assets that are not publicly traded. These are assets which have been marked to model and valued using fundamental analysis, and in an environment like the one we’re in today, it can be more challenging to validate those model inputs and to know whether those assumptions make sense or not.
Those who have invested very heavily in illiquid assets are watching and waiting at the moment; they are very mindful and carefully monitoring how these counterparties to illiquid credit are reacting and responding in this environment.
There have been so many government stimulus packages across North America and Europe and it’s difficult to say when or if these stimuli are going to be removed or reduced. It’s going to test the effectiveness of asset valuation principles.
What makes the life industry unusual is that we are not so concerned if credit spreads go in or out from an economic perspective, because we’re not selling these assets; they’re illiquid by definition.
We’re not planning to trade them; we’re holding them to match very long-term liabilities. With the exception of default risk, whether the spread component of the yield is coming in or out does not really matter.
What does matter, however, is default. Do we expect to get our expected returns in the long run? That is what we—and much of the market—will be watching very carefully over the next six to 12 months.
“P&C insurers have seen a lot more exposure.”
Bracken: In terms of COVID-19, we’ve seen a bunch of interest-rate shocks in the US, and those companies that either have a poor ALM interest or IRO1 position have encountered challenges if they’ve been seeking to market the economic outcomes of their business.
I don’t think we’ve seen credit exposures thanks to significant support from the Federal Reserve, so that sort of credit risk impact on asset-intensive businesses has been virtually non-existent over the last 12 months.
There were some spikes, but by and large credit spreads are back to recent norms. I think a lot of people were surprised about the global nature of a pandemic and how it would impact not only mortality risk but also asset prices and asset risk.
The modelling of systemic pandemic exposure is something that the industry needs to do better, and it probably flows through into other areas.
P&C insurers have seen a lot more exposure and they need to figure out how to deal with that. This is really a warning shot across the industry’s bows about understanding what pandemic risk can really mean globally to a very integrated economy, and I think we have been pretty lucky so far.
Kelleher: I do see opportunities as the underlying retail markets shift and companies continue to re-evaluate strategy and seek to shift their portfolios. I also think that these shifts in the underlying retail markets are going to cause the wholesale markets to continue to have new opportunities.
Technology has been an enabler in our business, more so than is generally realised. Some two decades ago, I was the CFO of a much larger global reinsurance group and it’s amazing the amount of time, effort and energy it took to build, say, actuarial studies, experience studies, and the types of valuations that we can do today with large databases and cloud-based systems.
“New technology improves our ability to understand risk.”
In short, new technology improves our ability to understand risk, to underwrite risk and then to manage risk afterwards.
In the end, it will enable our company and other professional reinsurers to be more responsive to shifts in demand and opportunities in new markets than perhaps professional reinsurers of yesteryear were able to achieve.
Ponnampalam: There is a real opportunity to find innovative ways to offer policyholders greater returns than they are currently getting. Whether it’s annuity products or savings products, it’s very difficult for policyholders to pick up good returns at the moment.
It is our role as reinsurers to provide solutions to insurance companies—ultimately with the aim of improving the policyholder experience and giving policyholders better value for money.
There’s a real opportunity for reinsurers to design reinsurance solutions, and bring to the fore the expertise that we have around ALM and provide that expertise to insurance companies to ultimately result in better returns for their policyholders.
As Pat mentioned earlier, there is a strategic shift in the way companies are thinking. In this market, companies are looking at ways to refocus their capital and refocus management attention, which means that we are likely to see more and more disposals.
This is where we can play a big role; our reinsurance solutions can allow insurers to exit risk and refocus their attention while hopefully improving outcomes for their policyholders.
“We’ll be looking at Asia, and maybe Latin America.”
Howell: COVID-19 has reminded everyone that life insurance has a real place both in the retail level and at a corporate level as well. Unfortunately, those kind of reminders don’t always last very long, so it’s a short-term gain.
Before the pandemic, the real opportunity for us as a company and as an industry was growth in Asia, and that is set to continue post-COVID.
As a company, we have numerous opportunities including more growth in continental Europe where we have very low penetration, but I think we’ll be looking at Asia, and maybe Latin America depending how it comes out of the other side of the COVID-19 crisis—or Africa, in the longer term.
Laframboise: In terms of opportunities, I would say first of all that we continue to expand our leadership position in high net worth life insurance. Globally, the wealth has been almost double digits so keeping up with that growth is a challenge.
We are also continuing to grow and diversify our global presence in high net worth markets. I mentioned Asia-Pacific, but there are also emerging markets such as the Middle East.
As for technology and innovation, we have seen more demand for non-face-to-face transactions during COVID-19, so that is definitely an area that we are looking into. Our ‘client for life’ strategy will also focus on diversifying our product suite.
Market conditions are particularly challenging, so we need to keep our product relevant.
Olunloyo: From a pension fund perspective, we think about how well-funded these pension schemes are, whether in the UK, the US or elsewhere, and that comes down to what assets they are holding and how well that matches their portfolio.
Pension scheme funding levels bounce around all the time: sometimes they get close to buy-out pricing (the price the initial reinsurer will take the liabilities on for), sometimes they are quite far away.
A lot of pensions were quite well funded pre-COVID volatility, but that funding position has since eroded significantly.
“Pension scheme funding levels bounce around all the time.”
It has served to highlight the fact that if you’re close to being fully funded, if you’re close to the point where you can shift those liabilities into the insurance world, go ahead and do so.
Schemes have this built-in inertia—they’re always waiting, but what we are now seeing is the kind of volatility that emphasises the necessity to shift those liabilities if you can afford it, whether that’s by using the assets of the scheme, or getting some additional contribution from the sponsor to make it happen.
I predict more PRT transactions in our key markets, specifically in the UK and US. For example, 2019 was a record year in the UK and 2020 is not that far behind, despite everything we’ve seen. And I anticipate that 2021 may be even bigger still.
That’s one big bucket of opportunity for us. More broadly, one thing that reinsurance has always been about, maybe more in the past than it is right now, is the intellectual capital that we can bring into the global risk management discourse.
In an age of COVID-19 where the world is changing so much (not just in terms of mortality rates) there is a real opportunity for reinsurers to add value in terms of our understanding of risk, as well as communicating that more broadly—not just to our customers but beyond that too.
The importance of reinsurers is going to come to the fore going forward, because we have some of the best risk management experts in the world.
We have the opportunity to share this expertise and, ultimately, that will drive more activity and more growth in our business around the world—and, of course, here in Bermuda.
Bracken: I agree, most of the sponsor-backed platforms have an opportunity to build, to continue a flow of reinsurance business and bring it to better homes where specialised reinsurers can price the risk, manage ALM issues and source better, more applicable assets to back the liabilities.
We’ll continue to see a good flow of transactions into specialised reinsurers and it will free up capital in those primary direct writers to focus on distribution channels, product innovation and policy servicing.
In short, I think you are going to see a continued shift of insurance reserves to specialised players.
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