Unfortunately for growth-focused reinsurers, insurers are choosing larger retentions—which is driving down reinsurance demand. “I've seen no reversal of that trend,” says Tad Montross, chairman and CEO of General Re Corp. “I think the industry is overall pretty well-capitalized and feels comfortable with the larger retentions.”

Advocacy groups have been exploring new opportunities for growth. “We've been pursuing a lot of initiatives on government programs, such as flood and terrorism risk, state residual markets and other areas where the government is providing insurance,” reports Frank Nutter, president of the Reinsurance Association of America (RAA). “There's an appetite with regulatory bodies for laying off risk to the reinsurance market.” 

However, even though reinsurance is a global industry, organic growth will be difficult with the slow expansion of many economies, and the push into emerging markets is still a nascent effort.

“People are working hard to expand in these [emerging] areas. However, while the percentages of growth are certainly high, the actual volumes of business generated are still comparatively low in comparison with more mature markets,” says James Vickers, chairman, international at Willis Re.

The New Reality

The reinsurance industry cycle has typically included an influx of capital after a natural catastrophe, as demand spikes and companies chase expected premium increases. However, the current cycle, which began after the catastrophic losses of 2010, differs from others in that it has seen a flood of capital from non-traditional sources, including hedge funds and pension funds providing catastrophe bonds and other insurance-linked securities (ILS). Those sources have been drawn to the market by the opportunity for greater returns on investment than the market has been delivering.

Today, alternative capital accounts for an estimated 20 percent of the market, and analysts expect that amount could easily reach one-third in the months ahead. As with any cycle, this one will have an end—but it is not projected any time soon. Willis Re points out that it would only take a .5% allocation of global pension funds' assets under management into ILS products to deliver $150 billion of ILS capacity.

Reinsurers are exploring other ways to combat the impact of the capital infusion, including becoming cedents themselves to take advantage of cheap money. Says Montross, “We would consider buying protection if the pricing and terms are attractive.”

He believes that reinsurers can also stress the value of the traditional reinsurance model to their insurance company clients who are by nature risk-averse: “There's a disconnect between the liabilities the industry is assuming and the duration of investment that hedge funds and equity firms want to make. Investors want to be in for 18 months to two years and get out, whereas we have long-duration liabilities.

“Buyers should think through that disconnect,” Montross urges. “If investors offload those obligations, who are [insurers] going to wind up with? Will you have a reinsurance recoverable from someone else than you originally dealt with?”

And if you can't beat them, join them: Within two years, half of reinsurers will have some nontraditional vehicle associated with their business, Nutter predicts. “Reinsurers will have to choose whether or not to assimilate these alternative capital models into their business, but buyers will come to expect that option,” he says.

Powerful, but Solvent Enough?

A power shift has also challenged reinsurers. “We've seen tremendous consolidation in the broker area, with three big brokers [Aon, Willis, and Marsh] dominating the market. That's brought about an imbalance. As a result they are in a position where they can ask for increased commissions or fees. They have a tremendous amount of power,” says Montross.

Aon's Ehrhart justifies those broker fees by citing the services provided in return. “The scale of client risks has required a commitment to analytics that many smaller brokers have realized they cannot supply without sufficient scale,” he says. Aon Benfield employs around 500 people globally across its analytics function, developing financial and catastrophe models and providing a range research and advisory functions for clients.

Another current challenge for reinsurers is the state of flux surrounding solvency standards. Solvency II and RMS Ver. 11, NAIC Solvency Modernization, the Federal Insurance Solvency Act, the International Association of Insurance Supervisors and other oversight are keeping reinsurers busy and keeping consultants in business. According to Vickers, the biggest impact of regulation over the past year has been frustration. “A lot of people have spent a lot of time getting ready for Solvency II, and it keeps being postponed,” he says.

“We've made a tremendous investment in developing an economic capital model, which makes cat models look simple. Solvency II has been delayed because of the complexity, but yet closer to home we are looking at what the Federal Insurance Office is planning to do and the debate between them and the NAIC,” says Montross. 

Nevertheless, he believes the reinsurance industry is capable of meeting the spate of challenges it faces.

“I feel like the industry has performed well in responding to various catastrophes we've seen across the globe, and incredibly well through the financial crisis,” Montross adds. “The world is going thru a de-leveraging that has created a challenge for the insurance industry like many industries, but I'm optimistic about the future.”