Reigniting our reputation for risk-taking

Are you struggling to understand the reinsurance market? I am. It’s hard—I know. And I’m not talking about prudent adjustments in a normal market cycle. I’m talking about avoiding or running from risk—underwriting by class, ignoring the merits and history of good risks, and favouring exclusions over solutions.

Workers’ compensation is one of the largest and best-performing product lines in US P&C right now. The National Council on Compensation Insurance reports industry-wide underwriting profits in each of the past nine years, and workers’ compensation currently has one of the lowest combined ratios (calendar year) compared to other commercial lines.

Despite this, large players, who essentially exited workers’ compensation years ago due to poor results, have yet to return. New capacity also seems reluctant to participate. Do results matter? Are the large players being smart, stubborn, or just silly?

January’s property reinsurance renewals proved to be one of the most challenging ever as pricing, attachment points, and coverage were all under attack. The imbalance of supply and demand drove a stressed market. Good loss experience, as is often the case, provided little relief.

Maybe some cat-exposed property should never be rebuilt, or maybe it shouldn’t have been insured in the first place. The insurance law of large numbers doesn’t work when the only large number is your rate increase on a loss-free property.

I have several risk retention group (RRG) clients, including a commercial trucking client. Can you guess which has historically had the most difficulty finding reinsurance? I understand results for commercial trucking have been historically challenging. What happened to individual risk underwriting? This RRG has had nothing but successful results since it was created eight years ago.

Define success, you say? How about underwriting profit resulting in a buildup of significant surplus capital—significant enough that the RRG no longer needs to purchase reinsurance? It now takes 100 percent of its risk net. Bet on yourself and win.

De-risking

De-risking refers to the phenomenon of terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk. De-risking is divided into two categories: policy de-risking and financial de-risking.

We read a lot about de-risking today as a strategy with China—reducing reliance on Chinese manufacturing especially for key technology goods. This approach towards China is a good example of both policy and financial de-risking. The supply chain disruption caused by the COVID-19 pandemic has made this risk exposure painfully obvious. Political tension has made it a pressing one. This is risk management I can both understand and support.

Risk management is now a standard part of the C-suite, which makes sense given the number of new risk exposures. What I don’t understand is why this has generally resulted in more risk avoidance and a “follow the pack” mentality. Where are the risk-takers?

Risk-takers

In a roughly 24-hour period between Wednesday, April 19 and Thursday, April 20, Elon Musk took huge bets at three of his major companies: Tesla, SpaceX, and Twitter. Tesla announced it was chasing sales growth over profitability. Selling software, not cars, is the future of Tesla, and the stock took a dive.

SpaceX launched a giant new rocket that blew up shortly after takeoff, but Musk still declared success from what was learned in its failure. Twitter is ending free legacy verification for its high-profile users, risking both revolt and the future of the social media platform. If any of these bets fail, those companies could be crippled.

It could also change the legacy of one of the greatest entrepreneurs of our time. Musk has made a career out of tolerating risk that makes others cringe. I admire people who take risks.

I started my carrier at AIG when Hank Greenberg—an innovator and risktaker—ran the company. AIG may not have created the alternative market, but it was a major driver behind its growth. Greenberg put fronting and unbundled services such as claims on the map. Many of Greenberg’s peers questioned why AIG would give up fat guaranteed cost premiums and fee income to allow its best customers to take risks.

History has proved Greenberg right. The alternative market is no longer just an alternative. Sometimes you need to step out and be different, take a risk and follow your vision.

Not always getting it right.

In an interview with The Wall Street Journal, Warren Buffett said, “It’s not about getting every decision right.” He went on to say that most of his investments at Berkshire Hathaway have been marginal or mediocre at best and that he hopes to make one good decision every five years. That approach has earned Berkshire shareholders a more than satisfactory 3,787,464 percent return since Buffett took over the company 58 years ago.

A big part of Berkshire’s success has been insurance and reinsurance, as it resulted in 25 percent of Berkshire’s total revenue in 2022 of $75 billion. Berkshire acquired Trans Re when it purchased Alleghany Corporation in 2022. Buffett certainly sees value in the traditional reinsurance market. However, I’m more interested in the future.

Blended risk

The International Risk Management Institute defines blended risk as a combination of traditional reinsurance products with capital markets products such as securities and futures. It includes finite risk reinsurance programmes that include a small amount of risk transfer. It can be argued that some blended approaches to risk are better than others.

The US Federal Housing Finance Agency has changed its loan pricing. The change raises mortgage costs for good credit borrowers while making mortgages cheaper for lower credit bowers—reducing cost for one at the expense of another. This type of risk-blending is not good risk management.

When the cost of loans is disconnected from the likelihood of default, bad things happen. Student loan default rates are a good example. I believe an individual’s chosen major is one of the best predictors of that borrower’s ability to repay a loan. This factor is ignored in the underwriting process.

Does it make sense to lend an 18-year-old $100,000 for an education when that same person could never qualify for a business loan, never mind a credit card? I feel the same way sometimes about the traditional reinsurance market’s approach to risk selection and pricing.

Current property market challenges, combined with unaddressed emerging exposures, ESG, cyber, and future pandemics, have created the newest rush to the exits for premium from traditional reinsurers. Blended solutions, parametrics and captives will continue to fill the void. The future is bright—just make sure you are running with the real risk-takers.

Greg Lang is the founder of the Reinsurance and Insurance Network (RAIN). He can be contacted at:  glang@rainllc.com