Letting the tail wag the dog: why there’s more to insurance than cat business
Many investors are not focusing on the broader re/insurance sector, which can offer many other valuable and lightly-correlated opportunities, says Michael Millette, the co-founder of HSCM Bermuda.
“Poor discipline in retro drives ill-discipline everywhere else in the chain.”
Michael Millette, HSCM Bermuda
The alternative risk-transfer world should stop obsessing about the “dog’s tail” (catastrophe business) and focus instead on the rest of the dog (everything else), which represents trillions of dollars of insurable risks that can be modelled and which are less likely to be overbid—and thereby more likely to generate sustainable returns. The best strategy is to focus on the whole dog.
That is the view of industry veteran Michael Millette, the co-founder and managing partner of Hudson Structured Capital Management, which trades in the re/insurance business as HSCM Bermuda. Millette, a pioneer of both cat and non-cat insurance-linked securities (ILS) structures during a 21-year career at Goldman Sachs, is a board member at a number of risk-related business.
“Insurance is a big sector, not very strongly correlated with the broad capital markets, that can create value and diversification in a number of ways. There is a tendency to focus on cat business but, for us, that is just part of the spectrum. There are many other sectors that offer attractive opportunities,” he said.
Millette added that the overall re/insurance sector is being disrupted in several ways at the moment, including climate change, technology, social inflation, changes in regulation and tax treatment, and consolidation. These disruptions are creating opportunities all the way from life insurance to loss portfolio transfers.
He explained that HSCM Bermuda divides the sector into six primary industries: property-catastrophe, specialty property, casualty, life and health, financial lines, and services and distribution.
He further elaborated that consolidation and technology-related disruption are creating alluring opportunities across all categories, and presenting significant opportunities in the last two categories.
Life insurers are increasingly partnering with investment companies, seeking to increase interest margins and to offer competitive retirement savings products. This shift creates investment opportunities.
Many specialty lines, spanning property and casualty, have benefited from increased discipline in the market on the back of large swathes of capacity exiting the market in recent years.
“The restructuring of the Lloyd’s Market acted as a catalyst for other companies to withdraw capacity. But it means that are pockets of opportunity as a result,” Millette said.
“Investors are quickly realising that a new baseline needs to be established for the real risk.”
Millette noted that the casualty run-off sector is showing “interesting” investment returns, driven by a disciplined set of market players and the fact that supply and demand are balanced. In contrast, he is wary of new-issue casualty businesses more generally because of social inflation, despite rate increases.
He believes that the property-catastrophe business is being impacted by climate and social inflation and has had trouble reaching the levels of pricing and terms that it should because the supply of and demand for capital. He outlined changes that he and his team are looking for in the cat sector in order for it to regain compelling relative value across the four pillars of retro, primary, industry loss warranties and homeowners insurance. The three big changes he wants to see apply to the retro space, homeowners and the way risk models are applied.
The structures the retro market has been using for the past decade are now unsustainable, he said. “The all-perils aggregate retro cover might be appealing to cedants but the risk-return simply does not work,” he explained.
“We think the retro market should migrate back to covering primarily named perils—and that will drive pricing in the primary market. The retro market is the tip of the risk spear and poor discipline in retro drives ill-discipline everywhere else in the chain.”
Second, the terms and conditions used in homeowners policies must be tightened. “Policyholders are being coached by lawyers, contractors and independent adjusters to see these policies as assets to be optimised rather than emergency funding.” he said.
“They now cover much more than outright loss events; terms have been stretched to provide maintenance coverage. In many cases across the southeast and west of the US homeowners in its current form is stressed, and policyholders are taking substantial price increases. Changing things will generate political tension but it needs to be done.”
Third, Millette believes that risk models have not kept pace with change and are now inaccurate for many risks. “It is not just climate change that they fail to factor in, but also economic inflation, legal costs and a number of other factors. Investors are not enthusiastic about their reliability.
“The risk is materially higher than the models suggest. The problems include unmodelled perils, post event inflation and frequency,” he said.
“The overarching problem is that for the past five years, investors have been told that the rates they are getting will clear attractive levels—but they have not. Why? Because there are too many severe cat events. Now, investors are quickly realising that a new baseline needs to be established for the real risk.”
“Cat needs work,” he added. “There is value, but investors need to be very selective and not just throw money at the sector. There are so many other values across the spectrum that they should be more engaged in. The whole dog is better than the tail alone.”