“Not those who begin, but those who persevere” is the motto of the most beautiful sailing ship in history, the Amerigo Vespucci. If you are reading this first issue of Life Risk News, it is probably because you also embody this motto in your professional insurance, reinsurance or insurance-linked capital markets career.
The journey towards capital markets playing a role in life insurance risks started more than 20 years ago, but in reality, the harbour we left behind us is still in our sight; the course leading capital markets investors to play a key role in the life insurance risks arena is still at its beginning.
The life insurance landscape has changed in the last 10 years. Market needs are changing and M&A is morphing the landscape, but most importantly, players’ mindsets are now different.
Life risk transfer transactions – i.e., structures where the key risk driver transferred by one party to another is a life risk – are now more frequent, with the global life and health reinsurance industry remaining the main beneficiary. The macroeconomic backdrop and its uncertainties are exacerbated by equity investor pressure on return on equity, regulatory and rating concerns, as well as upcoming accounting changes, all of which provides fuel for what should translate to increasing reinsurance activity.
Today, as never before, reinsurance companies are starting to focus on their own capital optimisation and, more widely, on creating additional investment platforms with which to share risk. Sidecars for annuities reinsurance are just an example, but the depth of the trend goes much deeper than longevity risk.
Longevity has often been considered the obvious area where insurance meets capital markets. The reason is actually very straightforward: there is a very sizeable gap between the longevity risk supply globally, and the capacity available in the traditional reinsurance market. Just to put some numbers out there: if we focus on the UK, where more public data is available, the pension and insurance annuity reserves are estimated by the market to be approximately £1.3tn. This compares to an estimated annual reinsurance capacity of US$40-60bn. If we zoom out of the UK, the imbalance becomes even larger.
This article does not want to be a celebratory piece about the capital market’s involvement in the insurance space. Frankly, too many have already done that, and arguably, they did it too soon, especially on the longevity front.
So, let’s be honest with ourselves. If you are presented with a long list of pension and insurance longevity deals done by capital markets investors over the years, it is actually a lie. A “white lie,” admittedly, which is based on a generous definition of capital markets, simply because of the involvement of an investment bank or another non-reinsurance intermediary’s balance sheet. Forgive me for being orthodox here, but I would not call a “capital market trade” a transaction where the final risk taker is actually a reinsurance company.
That said, various “genuine” capital markets transactions have actually happened: Aviva-RBS, Aegon-DB, and more recently, a couple of other longevity structures where the final risk taker has truly been a capital market investor. This trend is here to stay and will only strengthen.
Here’s why. Although our insurance and reinsurance industry is central to our lives and to the resilience of our societies, it is still a negligible fraction of the size of wider capital markets universe.
Capital markets involvement in the financial industry in general is not new, of course. Capital market investors have been a key partner for the banking industry for decades. I don’t mean the so called “shadow banking” definition often used by detractors; I mean the credit funds playing a key role in supporting bank lending activity over the years across non-performing loans, consumer finance, RWA driven structures, etc. There is also a general trend of capital market investors being active in direct lending activities, substituting for traditional bank lenders in supporting small and medium sized businesses.
Growing capital markets participation in life risk necessitates involving more sophisticated and larger asset managers that have the appetite to walk a less-trodden path that still offers the destination of true alpha.
First mover advantage will be there. We have already seen the first public life ILS notes issued at much higher credit spreads than their follow-ups. It is the novelty premium that first movers can harvest; the return on those standardised structures has now materially reduced.
Is there a secret sauce for an investor to have success in this area? Short version: no. There is common sense and market knowledge, though. Price-based competition was considered in the past to be the best way for capital markets to “prove themselves” and become more relevant in the insurance space; in reality, this is not a sustainable option. Reinsurance pricing has tightened with the general market trend and as a result of new market entrants. What (sustainable) value can capital markets bring to the table? Realistically, the flexibility across insurance and market risks, structuring skills and the ability to provide complex solutions. And execute these quickly compared to traditional players.
The opportunity is there, and it can be a win-win situation for investors and (re)insurers. Equally, and just as importantly, it can contribute to creating a more resilient society.
If not now, when? Let’s persevere.
Luca Tres is Head of EMEA Strategic Risk and Capital Life Solutions at Guy Carpenter