The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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Hank Greenberg at InsiderScope New York ''There will always be insurance cycles as long as you have people in the insurance business who have never lived through one."

So says the voice of experience, and they do not come any more experienced in the global property casualty (re)insurance sector than Maurice "Hank" Greenberg.

The industry legend cut straight to the heart of the challenge that underwriters face to break the pattern of soft and hard markets, as he joined a stellar cast gathered at InsiderScope 2010 to share their strategies on defying the cycle.

For the former American International Group CEO and current head of CV Starr, the buck stops with (re)insurers' senior management in navigating away from the depths of the current soft market.

Greenberg said: "Industry leaders ought to be taking the lead in stemming the downward trend in pricing."

That means actively turning away business that is underpriced, Greenberg told the audience of senior executives at The Insurance Insider's event in New York.

"When it becomes known that companies are not going to write at inadequate rates and are willing to turn business away the cycle will change - so it's in your hands," he concluded.

"It's better to send your people on a fishing trip than have them with a pen taking orders at rates that prove to be inadequate."

Historically, the challenge for (re)insurers has been to curb the instinct to pursue top-line growth, where too often promotion of rates discipline by management has conflicted with the reality on the underwriting floor.

"We'd be better off buying an existing platform or investing in an existing platform at below the cost of putting it together"
Stone Point's Chuck Davis on the death of the start-up

Another industry veteran, Tony Markel, picked up on the theme.

Markel, the former president and COO of the eponymous US specialty insurer, explained that for management to influence underwriters they must clearly communicate the desired combined ratio and how it fits into the return on equity target an insurer sets itself.

"Underwriting return must be a sacrosanct piece of the corporate culture - you need to be able to accept reduced premium volume," said Markel.

"So you cannot reward for premium growth without underwriting profitability because it clearly sends a contradictory message to the troops. You've got to give employees comfort that their jobs are not in jeopardy if they walk away from inadequate prices."

Markel added that the majority of incentive compensation for line underwriting and marketing people has to be driven by underwriting profits, even at the cost of an increased expense ratio when an insurer cuts its top line.

"I've never seen a company yet that failed as a result of a top heavy expense ratio," he observed.

The view was supported by Andrew Horton, CEO of the Lloyd's and international specialty (re)insurer Beazley.

Using the highly competitive specialty market as an instance where competitors had "ballooned enormously", Horton extolled the virtue of patience in successful underwriting.

"Not targeting top-line growth is absolutely built into the DNA of our underwriters. Being rewarded on profit is critical to them."

Out of reserves
Along with the role of underwriting discipline in breaking the down cycle, Markel painted a grim picture of the industry's reserving position, which he said may ultimately be the catalyst that reverses softening rates.

Commenting on recent industry underwriting results, Markel said: "Clearly, the difference between the combined ratio that the industry is posting and the reality in rate reductions over the last five-year period is hard to rationalise."

This could only be the result of a "real reserve deficiency industry-wide that is not being recognised", he suggested, adding that with some acquisitions "there is some real internal bleeding that cannot be seen from the outside".

He said the industry had been "robbing Peter in the older years without paying Paul in the current years" as it looked to shore up its combined ratio.

Markel predicted: "The rising to the surface of what I see to be deficient reserves industry-wide is going to have a greater impact on getting back the rates than any one event, unless it is of significant magnitude."

Valuation, valuation, valuation
While underwriting gurus focused on strategies to turn the tide of rate softening, InsiderScope also welcomed a panel of rainmakers to explore the dynamics of investing and capital flows in a sector whose stocks are currently trading at historic lows.

Even if the industry experiences a market-changing event, a repeat of the wave of start-ups that flowed in after Hurricane Andrew in 1992, 9/11 in 2001 and hurricanes Katrina, Rita and Wilma in 2005 is not expected at current valuations.

Bermudian (re)insurers are currently trading at an average price-to-book multiple of just 0.8x, compared to as high as 1.8x in early 2002 - when investors piled in seeking high returns during the post 9/11 capacity crunch.

Stone Point Capital CEO Chuck Davis, whose firm launched Axis Capital in the aftermath of 9/11, said that now it would make more sense to put money into an existing operation.

"There is no premium to book value... Any three or four of us in this room could put capital together and write as much property cat as we want in a few months. But we'd be better off buying an existing platform or investing in an existing platform at below the cost of putting it together," he explained.

Lloyds Banking Group's Bill Cooper echoed the view.

"The platforms and the talent are generally in place, so we would expect to see investors gravitate towards the platforms they believe have the ability to write the good business post an event as opposed to a wave of new companies," he predicted.

And Barclays Capital analyst Jay Gelb suggested: "Maybe we'll see more of a move towards sidecars."

Ariel Re founder Don Kramer also spoke on the panel and challenged the ratings agency mantra that diversification is the optimal strategy for (re)insurers.

Click to enlarge Kramer observed that, at least in the eyes of investors, the two most specialist companies launching after Katrina had outperformed their stock market peers.

Highlighting Lancashire Group and Greenlight Re, Kramer noted that the former had taken insurance risk but neutralised investment risk, while the latter had tried to keep its insurance risk at a minimum, with all its growth in book value coming from investments.

The two companies have adopted strategies ostensibly at the opposite ends of the spectrum, in contrast to the diversified model, "and guess what, they were the number one and number two best performers over the last four years," Kramer said.

The audience had earlier heard from Marty Becker on the day that he formally became CEO and president of Alterra, as the all share merger of Max Capital and Harbor Point closed.

Despite the deal, Becker said that depressed valuations mean that widescale (re)insurance merger and acquisition (M&A) activity is unlikely in the near term.

"Traditional M&A doesn't work right now. Nobody has the currency to be a clear buyer or the desire to be a clear seller," he said.

With a paucity of distressed players in the industry and low valuations, there is little incentive for shareholders to sell - despite the attractiveness of relatively cheap stocks to prospective buyers.

"Buyers and sellers are not on the same playing field," Becker concluded.