Legacy market hits high gear

While it may not be the top story of the year, the legacy market is red hot, says TigerRisk’s Seth Ruff.

Seth Ruff, FCAS, partner at TigerRisk

If asked to list the biggest stories of 2020, the robust market for loss reserves might not make it to our list. Fair enough.  

However, new buyers are stepping up, past buyers are bringing new portfolios to market, and both seasoned and start-up legacy reinsurers are raising capital and adding staff. We’re seeing strong, simultaneous growth in supply and demand for reserve transactions, a dynamic brewing even before the madness of 2020, driven by multiple factors.

Our industry is currently navigating the uncomfortable pinch between pain and opportunity. Capital is a key ingredient on both sides – to soothe pain and seize opportunity – and reserve transactions are becoming a go-to tool to efficiently liberate and redirect capital.

Let’s talk about the pain. Insurers have traditionally relied on two main sources to drive earnings – investment income and reserve releases. Unfortunately, both sources are drying up.

Between 2010 and 2019, investment income represented more than 100 percent of US P&C industry operating earnings. But portfolio yields are drifting downward as new money yields have retreated. The yield on 10-year US Treasuries has hovered around 70 basis points for months. For comparison, the same securities opened 2019 at 266 basis points. The Federal Reserve has been clear that “lower for longer” is the plan.

This reality is increasing the focus on new business pricing and growth, while decreasing the value of holding huge asset balances to support prior year reserves.

Pressure on profits

Likewise, reserve releases have been a critical component of insurer profits for the past decade. Over that time, and with the added pressure of claims inflation, US casualty reserves have moved from redundancy to likely deficiency. Even workers’ compensation reserves are running out of steam.

Simultaneously, insurers are dealing with a general increase in uncertainty, stirred by an active storm season, a warming planet, nuclear verdicts, civil unrest, market fluctuations, and geopolitical tensions. And then there’s Covid-19, which some pundits are calling a $100bn+ insured event. The world feels riskier, leaving insurers searching for ways to reduce volatility and free up capital. So that’s the “pain”. The opportunity is clear. Underlying insurance rates are increasing across nearly all lines, including double-digit rate growth in lines like commercial property and umbrella. In some cases, we are seeing meaningful “rate on rate” increases. Underwriters say this the best market they’ve seen in over a decade. Organically or otherwise, companies are keen to grow, driving the need for capital.

TigerRisk promotes a thesis called “Insurer of the Future”, which enumerates the characteristics of the most successful insurers of tomorrow. Among these characteristics is the active management of reserves. Companies will not allow reserves to stack up and stagnate for years, tying up capital. Instead, companies will regularly execute reserve transactions to redeploy capital toward better opportunities.

Conveniently, the supply side of the equation is also growing. In the past twelve months we’ve seen a tremendous inflow of investor capital to both established and budding run-off specialists, including meaningful investments from Carlyle Group and T&D Holdings (Fortitude), Oaktree Capital (Marco), Zimmer Partners (Carrick), OMERS (RiverStone UK), 777 Partners (R&Q), Hudson Structured (R&Q and Compre), and others. Buyers and sellers exist, but the true market challenge is developing win-win solutions that work well for both parties. This is a multi-dimensional puzzle, not simply a matter of bid-ask spread.

Reserve transactions represent a compelling alternative to more traditional “hard capital”. Generally, reserve transactions are quicker to execute, not dilutive, highly customizable, lower cost, and, most importantly, a source of real risk transfer. Few people will look back on 2020 with fondness or nostalgia. A possible exception is the legacy market practitioner; we may remember 2020 as the year the legacy market grew up, shifting from a curiosity into a well-established capital management tool.