The Panelists for the first education session of day two of our virtual Spring Membership Meeting included Michelle Harnick, Managing Director, Guy Carpenter
David Luce, Partner, DLA Piper and Ed Torres, Executive Vice President, Willis Towers Watson. AIRROC Executive Director Carolyn Fahey who served as moderator facilitated the discussion.
Michelle kicked off the discussion by providing an overview of the implications of 2020 market conditions on capacity in the reinsurance space and how that impacts the legacy market. She provided some high level observations regarding the last year in which the reinsurance market started off with strong capitalization and how the complex and developing impact of COVID-19 affects both the asset and liability side of the balance sheet. Other trends taking shape include smaller reserve cushions, a risk of growing social inflation and a period of low investment yields over the last decade, which puts pressure on operating profits. Even before COVID-19, the market has experienced rate increases which helps offset and relieve the pressure. Market conditions are driving the need for concurrent, intensified focus on retained earnings and capital management strategies. How to manage capital in a hard market is where the legacy market comes in by deploying solutions on how to take advantage of high margin business. The main reason for the up-tick in legacy transactions is to help manage capital in a difficult low investment rate environment.
Michelle explained that historically in the insurance cycle, after a natural cat event, surplus grows because of the anticipation of higher rates and better terms. In 2020, there was an influx of $46.6 billion in new capital. David concurred that there was a tremendous amount of investment in 2020 and noted that besides the traditional debt and equity capital raising, there was a lot of activity in the ILS market, joint ventures and private equity investment because of the belief in hardening rates. As new capital comes into the market, there is greater focus on managing that capital going forward. This, in turn, translates to a greater demand to pursue legacy deals to achieve profitability targets.
The impact of the COVID-19 crisis is largely unknown and the ranges of analysts’ loss estimate predictions are vast. With courts closed during the pandemic, COVID-related coverage issues remain uncertain, particularly with business interruption and workers comp claims. The industry could be dealing with COVID-19 losses for years to come. Long tail liability lines consume a significant amount of capital on the balance sheet. These concurrent themes have been a major driver in the demand for legacy deals.
Next up was Ed’s presentation, which provided additional context to Michelle’s overview. March 2020 was a watershed moment that was dire and the abrupt drop in surplus was dramatic and pronounced. At that time, there was an immediate increase demand for legacy solutions. This demand did dissipate as the market recovered but there were some lasting consequences. Insurers were spooked by the realization that circumstances could change so dramatically and it validated the ability of legacy products to provide real quantifiable capital relief. To boot, legacy solutions could generate capital even if other financial markets were locked. While the surplus crisis was adverted, greater attention was paid to legacy products throughout 2020 and it is expected that these products will be used strategically going forward.
By all measures, the COVID catastrophe has been unusual and there remains significant uncertainty as to the industry toll of COVID losses. There is a substantial gap between what has been reported and where industry professional expect the ultimate loss will fall. In fact, financial records many not fully reflect COVID losses or more specifically, the pandemic related losses may not be able to be segregated as precisely as with other catastrophe events. COVID coverage issues are expected to be contentious which will cause the hard market to persist longer. Exclusive of COVID-19, 2020 was an above average active loss year based on frequency verses severity. This has also lead to a capital depletion. Inclusive of COVID, 2020 was a market-changing year on par with the record catastrophe losses in 2005.
David addressed the growth in the runoff market through the lens of supply and demand. On the supply side, a handful of early market entrants have done very well and have experienced significant growth, which logically piques the interest of new entrants. As the early market entrants look to do bigger deals it leaves a vacuum for smaller deals. Increase supply leads to much more competition. The sub-$100m deals are seeing fierce competition, which is reflected in competitive pricing. Private equity has taken a look at this market; they see the profitably and are now firmly entrenched. The outlook is that there will be a continuation of private equity investment in the space. On the demand or sell side, sellers have more security in a robust process and that they will get a fair deal. The market has now expanded beyond the insurance industry as corporations, industries and others look to get out of long-term liabilities. Increasingly, runoff players will be getting closer and closer to the risk. Many of the Business Division statutes do not just apply to insurance companies but to all business. There is huge opportunity because there are many new tools in the tool kit to shed liabilities and put them in the hands of the runoff market.