For an industry predicated on the management and containment of risk, the insurance market does not appear to deal with change all that well. Now, though, it is having to learn. With the arrival of Alternative Risk Transfer (ART), the reinsurance sector in particular now competes for work with the capital markets in a way that it has never had to before.
Of course, ART is still a relatively small part of the scene at the moment. Although the work is high value and high profile, there is not really that much of it around – for instance, there has been only around 30 insurance-related securitisations worldwide since 1994. But how much longer will this be the case?
At present, precisely because they are new and innovative, ART and related finance techniques are both resource-intensive and expensive. They are therefore only really suitable for high-value transactions.
However, the conventional thinking is that as more ART models are developed, research and development will reach a critical mass, and at a more basic level, more professionals will gain significant hands-on experience, and so the market for the products will expand. Hence the market will become an increasingly attractive and realistic option for a much wider number of transactions.
Indeed, one can well argue that the development of ART is being held back by factors – commercial, environmental and political – which will eventually swing in its direction. Certainly, the soft market for conventional (re)insurance products does ART no favours. There is little incentive to seek alternative sources of insurance when the traditional models are both more economical and efficient. (They are also, of course, proven.) No one, though, is taking bets on the market staying soft.
However, there are also regulatory and structural reasons why ART has yet to really take off. First, of course, the basic premise of ART is that there is – or will be – a degree of convergence between the banking, insurance and asset management sectors.
While this is clearly happening already, the fact that each operates under different regulatory regimes – and that in some instances there is simply no regulatory framework under which to work on some transactions – is surely a handicap. Also, the fact that regimes also differ internationally does little to help (although it has to be said that Bermuda has undoubtedly benefited from the recent repeal of the Glass-Steagal Act in the US). This is not necessarily a cry for more regulation, simply regulation that is made clearer.
There seems little doubt, though, that the markets are winning the argument on convergence with the regulators. And it is really the capital markets and not the insurance market that are driving the debate, since the odds are that it will be the small to medium-sized players in the latter market that will suffer. At some point, the pressure for institutional consolidation will become irresistible, not least because likely economies of scale will make ART transactions yet more attractive. Few people think the takeover traffic then will be anything other than one-way.
And let us not forget that public companies are increasingly focused above all else on delivering shareholder value. The ability, therefore, to take risk off the balance sheet and to collateralise it in some form creates significant opportunities, which few would refuse – assuming, of course, that such techniques are available at an acceptable price.
So is the writing on the wall for the conventional insurance market? There is no doubt that it is facing probably the most extensive period of change in its history, but it seems unlikely that ART will sweep all before it. It is just a tool, not the whole toolbox, and there will always be transactions that are more suited to traditional techniques.
For the law firms, though, ART should represent a really exciting challenge. The opportunity exists for firms to take a significant competitive advantage by undertaking groundbreaking, innovative projects, thus creating the framework within which competitors will have to work.
And it is clearly a challenge that the best firms in the sector are rising to. There are probably few surprises in the best firms table below, although the big question is how long the classic insurance firms can sustain their current leading positions once ART becomes more mainstream and convergence more of a reality. Will they ultimately lose out to the usual suspects – the international law firms with stellar banking and finance practices?
The jury, of course, is still out. But for the moment, EC3 is putting up a great fight.