NEWS
Holistic capital strategy needed to navigate earnings volatility
Insurers are grappling with the higher cost of equity, says Guy Carpenter’s Blake Dimitrijevic.
As insurers grapple with heightened volatility on earnings from the recent shifts in reinsurance environment and sharp interest rate spikes, a more holistic approach is needed to capital management and risk mitigation.
Blake Dimitrijevic, freshly positioned as the head of capital advisory for the Asia-Pacific at Guy Carpenter after a 17-year stint with Swiss Re, provides unique insights into this changing landscape.
“Reinsurers have materially shifted their own risk tolerance and appetite, which has meant increased retentions and higher reinsurance pricing for primary insurers,” Dimitrijevic told SIRC Today.
This shift has been spurred by rising claims costs, largely from an increased frequency of non-modelled perils such as convective storms and floods and the pervasive cumulative losses from the COVID-19 pandemic. Coupled with a surge in interest rates—born out of inflationary pressures from supply side shocks and a prolonged phase of loose monetary policies—insurers are now treading a tricky terrain.
Dimitrijevic highlights the implications of these changes: “Insurers are now dealing with heightened volatility on earnings from the new reinsurance environment, and potential capital implications from distressed asset values hit by steep rises in interest rates.”
He emphasised the need for companies to re-evaluate their capital allocation strategies as the once readily available capital sources become scarcer and more expensive.
“Our team is positioned to help clients through capital allocation decisions, seek solutions to optimise the capital structure and partner with CFOs to help them reach their financial targets and capital management priorities,” he added.
“Insurers are now dealing with heightened volatility on earnings.”
Blake Dimitrijevic, Guy Carpenter
The path ahead presents challenges, especially for insurance CFOs grappling with escalating equity costs. Dimitrijevic said: “Meeting heightened investor expectations will require management to assess their organisation’s own value propositions, and potentially challenge their thinking of where and how they participate along the insurance value chain.
“When capital is deployed, it will be required to meet higher hurdle rates, which now exceed 10 or even 12 percent.”
“We need for more holistic strategies in developing innovative solutions at the lower end of programmes centred around capital optimisation, structured solutions or spread loss covers. This certainly rings true for Asia-Pacific as well, and we’ve held discussions with clients on both prospective and retrospective covers,” he added.
Regional concerns
Highlighting sector-specific concerns, Dimitrijevic underscored the need for P&C companies to place an immediate focus on addressing the earnings volatility resulting from claims events that were previously ceded in lower layers. He voiced concerns over the management of long-term assets, especially with the introduction of frameworks such as IFRS 17.
“In Asia-Pacific, life and health asset and liability management continues to be a key challenge, as insurers become more economically focused in steering their balance sheets, longer duration assets remain finite, and capital and accounting economic frameworks are rolled out across the region,” he said.
“This transition requires careful management that becomes more difficult during a period of extreme interest rate volatility,” he stressed.
“On the life side, coinsurance is an attractive proposition.”
However, not all is gloomy. Dimitrijevic identifies a potential upside: the dislocation in traditional capacity offers numerous opportunities, especially in Asia. Drawing from his experience of leading a coinsurance deal in Japan, he sees potential in places such as Korea and Hong Kong.
“On the life side, coinsurance is an attractive proposition for reducing interest rate and duration risk,” he stated.
“Reinsurers have traditionally been very adept in optimising the fungibility of risk, capital and liquidity, so I hope to bring those insights and solutions to the primary market across Asia Pacific.”
Dimitrijevic also acknowledges the role of M&A as an avenue for reinsurance to add value. “Some of the best win-win deals I have seen have come in the context of M&A,” he observed.
“Reinsurance can often get boards ‘over the line’ when signing off a potential target because of the non-leverage financing it brings to the table, and/or its ability to structure away parts of the deal the acquirer finds less economically attractive but is forced to onboard within a larger overall package.”
Lastly, Dimitrijevic highlighted that data-driven strategies can offer businesses viable capital allocation choices. “Data analytics, machine learning and AI can be applied to better understand the business you are underwriting today, and assist with future risk selection,” he said, cautioning companies against lagging in the digital transformation journey.
“The lower cost base of some markets in Asia-Pacific has tempered the urgency on digitisation and automation, but these companies could be left behind if investment is not prioritised,” he said.
Main image: Shutterstock / Artit Wongpradu