UK: Insurance Market Update - The Deloitte View for Non-Life Insurers, May 2010

Welcome to the May 2010 edition of the Insurance Market Update in which we focus upon issues in the general insurance industry. In this issue we comment on challenges facing the reinsurance industry.

With rare exceptions, the insurance industry came away relatively unscathed from the financial crisis. However, recently described as a potential "perfect storm", the market faces the usual visible bottom line risks, low investment returns, soft pricing combined with potential environmental and natural losses, as well as regulatory and political intervention.

On top of these systemic risks, we see a shift in the nature of reinsurance markets with implications for all businesses operating in these markets. These changes and uncertainties are collectively creating a significantly more complex environment for reinsurance management teams as they consider how to deploy resources and where to invest for future growth and success.

In this article Colin Gleeson and Stephen Ross explore four key drivers of change which together are creating a new environment for reinsurance businesses and suggest a number of important considerations for management teams in developing the strategy and future structure of their business.

As always, we look forward to receiving your feedback; your views, comments and suggestions for future themes or topics are most welcome.

Kevin Elliott


The emergence of Bermuda as a major reinsurance hub during the past decade was a major change for an industry that historically had been dominated mainly by large mature European and North American businesses.

Immediately following 9/11, approximately $27 billion of capital was raised by the (re)insurance industry. Of that amount approximately two thirds was deployed in Bermuda. This process was repeated in 2005 post Katrina, Rita and Wilma with others joining the growing ranks of Bermuda based businesses.

The reasons for Bermuda's success are well rehearsed. An efficient and supportive regulatory regime allowed businesses to set up and deploy capital quickly after major catastrophe events, an attractive low tax environment that delivered enhanced profitability versus other jurisdictions and a convenient location between US and European markets.

A Changing Game

More recently however, the Bermuda growth story has given way to a more global shift in the nature of reinsurance markets with implications for all businesses operating in them. We see four key drivers of change, which together are creating a new environment for reinsurance businesses:

  • a challenging and unpredictable regulatory environment;
  • Lloyd's of London becomes increasingly attractive;
  • new reinsurance hubs emerge; and
  • brokers up their game.

A Challenging and Unpredictable Regulatory Environment

It is now clear that the financial crisis has fundamentally changed the political and regulatory environment for financial services. Governments continue to spend unprecedented sums to stabilise the economic system. One consequence has inevitably been a strong push for greater regulation of financial services. Whilst still evolving it is increasingly clear that (re)insurance businesses will be affected to some degree.

The day to day tone and approach of regulators has changed, reflecting a new assertiveness and intrusive scrutiny on the part of regulators who have been stung by criticism of their performance in the lead up to the financial crisis.

Solvency II predates the financial crisis and represents a transformation in European regulation towards a consistent risk based approach to capital and risk management. Due to 'go live' in 2012, the impact of Solvency II on capital requirements has become increasingly onerous as the draft rules become clearer.

In addition, Governments have also been taking a harder line with offshore domiciles. Many of them have unprecedented budget deficits to reduce and are eyeing offshore insurance domiciles as a potential source of revenue. The recent Neal Bill in the US, for example, suggested denying certain tax deductions on reinsurance cessions to foreign owned reinsurers effectively imposing higher taxes on group offshore cessions. The Obama administration has incorporated similar measures in its 2011 budget.

Offshore domiciles will also need to gain regulatory equivalence status when Solvency II is implemented in Europe. Many offshore jurisdictions see this as a key focus and are working towards equivalence.

Lloyd's of London Becomes Increasingly Attractive

Lloyd's performance after the financial crisis has added new lustre to a venerable insurance brand. It has avoided the missteps of certain rivals and the subscription model of the market has become increasingly attractive in a more risk adverse world.

Having achieved their potential in Bermuda many of the businesses which began life there have entered the Lloyd's market over recent years as they began to seek new opportunities to deploy capital. Lloyd's, with its efficient capital structure and licence network, was an obvious platform to quickly broaden their reach. Recent acquisitions are good examples of this trend.

Solvency II changes are likely to preserve the relative attractiveness of this market. Lloyd's is developing a Society level internal model which will see the Corporation retain its role as a quasi-regulator of the market.

Businesses operating under the Lloyd's umbrella will have access to significant diversification benefits relative to operating standalone and as such, should continue to be advantaged from a capital perspective versus competitors.

New Reinsurance Hubs Emerge

As offshore domiciles become more challenged, onshore reinsurance hubs appear to be gaining critical mass. In Europe, both Switzerland and Ireland have emerged as hubs for reinsurance business. Ireland has a relatively low tax environment and a market orientated regulator although given the challenges of Ireland's current economic position, the sustainability of these are open to question.

Equally important is the fact that Ireland is a member of the EU and hence can be an effective domicile for a European business following Solvency II, where capital is held centrally to maximise capital efficiency using branch structures to access markets across Europe.

Switzerland has also emerged as a growing European hub for accessing Continental European reinsurance business that does not come to London. Switzerland has always had a significant reinsurance industry but more recently, a spate of new entrants have set up shop in or around Zurich creating a greater critical mass of businesses.

Elsewhere, Singapore has emerged as the leading Asian hub, with Lloyd's of London and a range of other international insurance and reinsurance businesses active in the market. Asia will become an increasingly important market in the future, as asset accumulation in Asian markets continues driven by enviable economic growth rates in the region.

In the longer term, there are likely to be additions to this list. Some of the candidates include:

  • Shanghai, where the Chinese government is committed to developing its status as a financial and insurance hub;
  • the Middle East, where a number of candidates including Dubai, Qatar, Bahrain and Saudi Arabia are competing to establish leadership as a financial centre; and
  • New York, where an insurance exchange has been proposed. This is in its very early stages with a number of challenges; however, should it gain traction, it could be a significant competitor for Bermuda and Lloyd's of London.

Brokers Up Their Game

The major international brokers have been focusing on improving their use of market data. These businesses have access to a great deal of information regarding pricing and placement of risk and have begun to deploy this to support and inform placement decisions and find the most advantageous home for a given risk.

Essentially this process systematises the skills that the better reinsurance brokers regularly brought to placement decisions. This will improve the average ability of brokers to find the best price and terms in the market.

This presents challenges for reinsurers which operate across multiple reinsurance hubs, as consistency of technical pricing and terms and communication become significantly more important to ensure that different parts of an organisation are not played off against each other.

A More Complex Environment for Senior Management Teams

These changes and uncertainties are collectively creating a significantly more complex environment for reinsurance management teams as they consider how to deploy resources and where to invest for future growth and success.

This is particularly true of businesses which are considering or have recently begun expanding internationally including a number from Bermuda and Lloyd's. For more mature businesses, the challenge of adapting their current strategy and structure is also important.

This environment suggests a number of important considerations for management teams in developing the strategy and future structure of the business:

  • selecting the optimal mix of platforms to maximise future access to business. This requires a view on which jurisdictions/platforms will be successful and also consideration of contingency plans where jurisdictions/platforms are damaged either through loss events or through regulatory/political intervention;
  • understanding the capital and tax implications of chosen structures under Solvency II. We expect to see continuing restructuring of reinsurance businesses to make structures Solvency II friendly and provide options to management teams in an uncertain environment;
  • developing an efficient and effective process environment that meets increasingly onerous regulatory requirements but does not impair the ability of the business to deliver innovative and efficient service to brokers and end customers. This is a real challenge for businesses which are not experienced in operating across multiple jurisdictions; and
  • in particular, given the anticipated increase in effectiveness of brokers, reinsurers operating across multiple hubs will need to be in a position to identify where risks are coming into more than one point in the business and ensure that a consistent price is offered. This will typically require both effective systems and processes.

In a difficult environment where pricing is challenging and environmental and natural catastrophe losses are pressuring bottom lines, it is important not to lose sight of the strategic need to position businesses for future success.

We believe these are important considerations for reinsurance businesses today, as making the right calls now can provide significant future competitive advantage against peers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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