Trends and Opportunities in (Re)insurance

This content is for institutional investors and information purposes only. It does not contain investment, financial legal tax or any other advice and should not be relied upon for this purpose. The materials are not tailored to your particular personal and/or financial position. If you require advice based on your specific circumstances, you should contact a professional advisor. Opinions expressed are those of the speakers as of the date of publication are subject to change without notice and do not necessarily reflect Mercer's opinions. Hello and welcome to Critical Thinking Mercer's regular exploration of the trends, risks and opportunities shaking client portfolios. I am your host David Moro. I am the Global Insurance Proposition Leader at Mercer. The backdrop today is very simple. We are talking about risk transfer, we are talking about the reinsurance market, and we are talking about the growing role of alternative capital. The world is not short of risk. We have conflict and amea that has led to supply chain disruption. We have cyber risk which is incessant. We have social inflation in U.S. casualty lines. There are concerns that the U.S. litigation trends will expand outside of the U.S. We have rising climate and extreme weather losses, and businesses are facing more volatility from more directions than ever. At the same time, the amount of traditional insurance and reinsurance capital is finite. The number of companies that are in the marketplace is finite. When major multiple events hit at once, that pressure intensifies. That is where alternative capital comes in. In this episode, we are going to explore how investors can participate in insurance risk, and how that can expand the capacity in the market and why the relationship between insurers and reinsurers and capital providers is becoming increasingly important. What does this mean? What are the biggest opportunities ahead? To help unpack these questions, I am joined by Laurent Russo, who is the CEO for Imea, and Global Capital Solutions at Guy Carpenter, and our Mars Sister Company, and Aaron Basewitch, Head of Insurance Solutions, within a Mercer's Insurance Investment Practice. Laurent, I'll start with you. In August of 1992, Hurricane Andrew decimated South Florida. It was the costliest natural disaster in U.S. history. It showed that the insurance industry had underestimated severities of hurricanes, exposure concentrations, and correlated losses. It was transformative to the risk transfer market. Can you explain how the risk transfer market has evolved since then? Boris, thank you, David. The first answer to this major hurricane in the 1990s was actually the creation of Bermuda, which has a hub for traditional capital, and Bermuda became a hub for traditional reinsurance. So you had a number of private equity investors, heteroninvestors, putting in traditional capital in a traditional way in Bermuda. And I insist on a traditional way, because this is what we call in our recent report, the Old Wars Limits, in a sense that since then, financial investors have actually realized the different way to back-end trans risks than by putting in hard capital in an offshore center. And so what we have seen, and really taking off in the early 2000s, is financial investors looking at natural perils as a source of diversified risks. And so the Cat-Bond market, the catastrophe-bond market, really started taking off in these early 2000 years, and really became a key part of the reinsurance industry since. And I would say since the mid-2010s, we have seen the growth of a different kind of market, far less liquid, far less catastrophe exposed, and much closer to reinsurance risks, with what I would call side cars or more ground-up reinsurance risks vehicles. And so to answer your question, the first answer since 1992 was Bermuda, as a traditional ban on sheet plays, Cat-Bonds in early 2000s, and since 2015 or so, having side cars really picking off. Thanks, Lauren. So I'll go backwards just for a moment here, and revisit Cat-Bonds, given the transformational nature that those instruments played sort of at the start of this risk transfer evolution. Aaron, would you mind summarizing what a Cat-Bond is? Who is issuing them, and who are the main investor sets for the asset class? Sure, thank you, David. Maybe I'll start first with a quick sense of scale, because it could help frame why this market matters. So over the last couple of decades, catastrophe-bonds have really moved from a niche structure to more of a meaningful part of the risk transfer ecosystem. The 144A Cat-Bond market is definitely growing, has grown to about $60 billion worth of risk capital outstanding today, with about $25 billion issued in 2025. And as Lauren mentioned, this was attractive, because it was not perfectly tied to traditional reinsurance pricing cycles, which speaks to more of a structural investor base, and that has been increasingly the case. So I guess backing up, what is a Cat-Bond? At its core, it's really a way to transfer insurance tail risk into the capital markets in a bond format. So the way this works is sometimes an insurer or re-insurer will sponsor a special purpose vehicle, typically dom and siled in places like Burmuda, as Lauren mentioned, or the Cayman Islands. And this SGV issues notes to investors, and they hold the proceeds in high-quality collateral. The sponsor will then pay a premium that becomes the investor's coupon, which is typically paying a floating rate. Historically, it was liboard, now it's sofa, plus a spread. In terms of who owns them, it's primarily reinsurance and sponsors, looking to lay off some of their marble risks historically and primarily wind and earthquake. And since then, I would say, so the investor base has brought in pretty substantially. There are specialized reinsurer backed funds. That's where they are reinsurers with in-house capital investment units. There are also specialized insurance link securities managers, as well as institutional investors. And I'll say, that's where I see primarily the investment in this space, so happy to talk more about that throughout the conversation. Thanks, Aaron. And, you know, Laurel, we've just heard from Aaron that, okay, the Cat-Bond market has grown to 60 plus billion. What's fascinating to me is that, you know, that is less than half the capital that has been deployed in this risk transfer space. So I imagine anyone listening to this podcast would have at least heard of Cat-Bond's. But I imagine a fair number of listeners wouldn't necessarily be able to put their finger exactly on what the remainder of the capital that's been deployed in this space has gone to. So, if you look at Cat-Bond's as Aaron described in rightly, there is essentially a bond, a financial instrument exposed to high severity events with a low frequency. So exactly, wins and quakes. But investors have found that that could be also getting exposure to other types of risks that would be more frequent and less severe. And so, as opposed to coming in and having to pay claims in very extreme situations, actually they could get a premium for risks that would be a lot more frequent. And those premiums would consequently be higher. And so, what we've been seeing is the so-called side cars. And side cars is quite a nice image. It says what it is. It's another SPV to vehicle that is capitalized by exactly the same way as Cat-Bond issues notes to investors. But those investors would pick up the claims of an insurance company from zero, from the ground up. And as opposed to the claims being paid as we call it in the excess of loss, i.e. Cat-Bond pays the claim when there is an excess of a certain trigger. A side car would really pick up the claims in a proportional way alongside the insurance company. And so, let me take an example. If an insurance company decides to create a side car that would pick up 20% of the claim. of the claims it would receive 20% of the premiums and would really be sitting paripassou with the insurance company. So the site card essentially enable through simple securitization principles and vehicles, they enable financial investors to take risks alongside an insurance company and receive the same kind of premiums and claims exposures. It is just a very complementary way. It requires a bit more understanding of the insurance business and there is a lot more frequency and flow of premiums and claims. But essentially it is a different risk return profile than a CAD bond with similar securitization principles. And so Laurent, stick with yourself for a moment here. So if I am an investment professional within a non-life insurance company and I am underwriting risks that will often find themselves embedded inside of a CAD bond or a securitization. I may not want to invest in a CAD bond and effectively double down my exposure from the underwriting side and the investment side. But I presume some people do do that. But it is not necessarily obvious to me that that is the main investor base for the market. So I would like to summarize the key investor types for re-insurance risk and what factors are driving investment by those different investor types. Initially, in CAD bonds in particular, the type of investors would be those seeking volatility in a way that is non-correlated to financial markets. So it comes from this high severity low frequency events, hurricane quakes that would happen in extreme circumstances. And when they would happen, more often than not, they would not be correlated with financial markets. I say more often than not because if you look at the early 20th century quake on the west coast in the US, or if you look at the 2011 to Hoku event in Japan, there has been a correlation with financial markets, but that correlation is very remote. So you can have a re-correlation in the tail of the event, but this is extremely rare. But essentially, the prime motivation for those investors were to seek non-correlated returns on very volatile events which in a portfolio construction can be very efficient. The more recent side cars motivations are a bit different here. And Ewing will talk about it, I'm sure. There are two kinds of motivations. Some of them is to really get exposure to the same business of receiving premiums and paying claims. This is what insurance companies do. And insurance companies, again, more often than not, would make a profit. What we call a technical profit on this business of paying claims and premiums. But there is an on-side business that Warren Buffett has called the float, which is long established, which is that there is time value of money between the moments an insurance company receives, the premiums and has to pay the claims. If your portfolio is well-derversified, well-structured, actually you could have three, five or even more years than this to invest the premiums in between. And so we see an increasing number of investors rediscovering the value of the float since 2022 with interest rates being higher. And here basically discovering the charms of insurance as a way to create float and for them to deploy their investment strategies. You know, as opposed to Berkshire Theroy, there would be more credit type strategies. But essentially it could be any provided that the liabilities are well modelled, that the liability profile is well understood, and that the investor has the liquidity to pay off the claims when they have to. So Aaron, let's drill down on that a little bit here. You're a consultant who sits at the inner section of insurance companies who are investing and asset managers who are deploying into the space. So can you talk a little bit about some of the key drivers that you're saying with respect to investors wanting uncorrelated returns that come from, that come from insurance risk, as well as, you know, managers that have potentially ulterior or additional motives to that. Yes, absolutely, David. And maybe just to provide a little bit of background. So throughout my career, I've worked with a number of different institutional investors, not only insurance clients, but also pensions and diamonds, who do not get the primate, the majority of their net income from insurance underwriting. So historically in the early phases of the ILS market, many of my non insurance clients were actually very interested in ILS type investments because they were attracted to the idea that catastrophe risk could deliver a premium for taking the insured event risk. That wasn't necessarily driven by equity markets or the corporate credit cycle. We've talked about that several ways now in this podcast. But I will say so that market has changed and since interest rates rose post 2022. Now a second value proposition has emerged. And this is, you know, long the same themes that we've been talking about throughout the conversation. But really looking at insurance assets as a source of investment flow and stable income. That component of it is very important, particularly in an investment environment where rates are provide or interest rates. We're between four and five percent. Of course those have come down a bit since now or since then. But you can still generate pretty meaningful economic benefits from where rates are today. From an asset management perspective, and this is the interesting component we look at, you know, the development of the market from cat, cat bonds to more of these side cars. The asset management community has really found a way to participate not only as investors, but also as the asset manager. So, so, you know, essentially these asset managers look at it in a similar way as, you know, my non insurance clients did historically in that this is a differentiated source of income. Tapping into insurance liabilities, but then they're also able to make money on the float while also generating an investment premium. So, you know, overall, you know, I think when we look at asset managers who are involved in these reinsurance side cars. And as investors, they're really co they're really co investing alongside the reinsure, right. So again, they're they're sharing in the underwriting profit and loss, which does help from the reinsures perspective open up capacity for more underwriting. Which so it's a mutually beneficial partnership and I will say we've been seeing more and more of these from my seat where asset managers are coming in to provide sort of that that co investor role equity capital, allowing the reinsures to generate more capacity while also providing investments management. Now, the thing that's important in this and this is where we as consultants step in is ensuring that the the guidelines for the assets that are that are being managed by one of these asset managers within the reinsurance side car are appropriate. So to the rons point, we want to make sure that first and foremost, there are reserve backing assets that are aligned to the structure and the expected sort of patterns of the liabilities. So, you know, first and foremost, want to make sure that liquidity duration, etc are taking care of and then we and then from there, it's really just more of the traditional sense in the traditional optimization process where we're trying to achieve really the highest income. And then in some cases for some investors that the investment objectives can be a bit different but really always focusing on spread and looking to take advantage of of investing that float to the best of its ability within the const the constraints of the specific. So there's been a lot of interest in the space. It's a growth market and you know within any growth markets, there are limits and there are tensions and so they're on I'd like to end with you if you could elaborate on these limits and tensions on the one hand. On the other hand, you imagine that we are fortunate enough to re record this podcast in five years and give us a snapshot into your thinking about, you know, what we'll be talking about when we do that in five years time. So, with the first one, I think the on the limits and tensions, there are two kinds. The first kind is those that are inherent to any kind of insurance, insurance, business, i.e. the ability to model perils, i.e. the ability to to price properly and at the moment the prices in the property and care to insurance and range and space are going down doesn't mean that it's not profitable. No, it's not. It is still profitable, but prices are coming down. And so I think that these are the traditional risks for you, you expect to have a well-modeled, well-structured, and well-priced business. And that will never go and is not new in many ways. The other type of difficulty in imitations is those arising from two worlds meeting each other. And what I mean by this is financial world and insurance world do overlap. They are complementary. But they have a lot of different languages. What I mean by this is the claim payment, the claim process in the insurance world, is very different than a liquidation in a credit event or a payout of a financial instrument. It is more sticky. It is taking more time. It is far less transparent. And it's not always easy to make sure that financial investors understand the specificities of insurance business. And bringing in capital providers have a different lens, we create as well some kind of complexity and some kind of ambiguity. Very often, financial investors are driven by a contract, driven by a price while in the insurance industry. The relationship can be taken over as well. There is more broader factors coming into the did making and the price making. And so I think as long as the insurance sponsors and the financial investors align themselves on the expectations and motivations and the sustainability of their interest, we will have a happy collaboration. And that is really to your question, "File yours down the line." For me, the key question is not so much to predict that capital markets will eat their insurance industry for breakfast. That's not true. There will be a greater space for financial investors in the insurance industry. So at the moment, you talked about a finite amount of capital in the insurance industry, David, that's correct. Out of just under $700 billion, you have over 120 that is coming from financial investors. So this kind of 20% plus share is likely to increase. But I also think that there will be some further learning process and getting to understand each other process. That often comes with some kind of rupture in the markets. I wouldn't call them necessary crisis, but that could be as well. And so what I would really hope for is that we learn from those market events. We learn that the two universe of financial investors and insurance companies, insurance companies get to know and understand better each other. And in the end, I would easily imagine that the third of the insurance capital is provided by financial investors and there is a good balance between the two. And each form of capital playing a very different role where rangers continue to play as leaders. They know how to quote the business. They know how to appreciate risks. And sometimes they're constrained in the size of the branch sheet. And investors would be educated followers, whereby they know how to pick the best leaders. And they know how to follow the best leaders with a full alignment of interest, with sharing the fortune of the rangers and behaving as smart followers. And that for me is probably where the industry is trending towards. Thank you, Laurent. And I wish we had more time. I could keep asking you and Aaron questions. We may have to do a sequel in the coming weeks and months. We would like to thank you for joining us on critical thinking. Laurent has also published a paper called the emergence of financial and re-interference capital that you can find within the Mars ecosystem. And if you would like to explore any of these themes in more detail, please do reach out to your local Mercer or Mars representatives. And until next time, I'm David Moro. And we look forward to continuing the conversation and welcoming you back against it. [MUSIC PLAYING]