Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft in München (MUV2) Earnings Call Transcript & Summary

Fitting perfectly into that topic. The question is referring to the length of the tail, where will investors see that in their portfolio? How will capital be trapped on that basis? And going forward, how would that impact the appetite for such risks? I guess, you are the natural candidate for that, Adolfo.

I was going to say I hope you didn't ask me. It sounds fairly complicated, right? The thing is -- and as we're seeing in COVID right now, I mean we've just gone through the first season of it when we don't know whether there's going to be more seasons coming. If you go and look back at the pandemic -- the flu pandemic at the beginning of last century, that is something that lasted, all-in, 3 years. So you can see that it's a real issue, capital trapping, and it would be one that you would have to solve before going into it. At Nephila, we've been around for 20 years, so this whole idea of trapped capital, trapped collateral is not something that is new to us. We've just figured out ways to deal with it. And I would say that if you're going to enter into a transaction where there's a potential for a long tail like that, that is something you need to solve before you decide to enter. It's not something that you should be thinking about after the fact. In terms of -- I mean there are so many things to think about there, right? I mean there's a tail. And when I hear tail, I think that you're talking about the duration of the risk instead of the tail distribution. That's -- yes, that's something that needs to be engineered for. And I think this is -- in that point, I would just point it back to Philipp because he probably has a better idea how you would deal with something that has a long tail and you would turn it into a short tail proposition.

Yes. And then kind of on that point, I think there's really kind of 2 questions. I think, one, kind of how can you design a solution for a product like this going forward, to Adolfo's point? And I mean there's obviously potential ways to kind of deal with that. I think the more important question maybe is really, how will COVID affect collateral trapping at the moment or in -- and especially into 1/1. And I think 7 -- the June and July renewals have provided a little bit of insights to that. Although I think -- so certainly -- and again, I think every market segment will behave quite differently there. I think the retro segment and especially the aggregate kind of type conflicts with the capital market, for example, where, generally, the impact is expected to be significantly smaller.

I would like to add one perspective here. Recently, in our risk committee at Munich Re, we had a discussion about that topic. And we do see the downside for the investor, which is a lower return, definitely, and it would need to be priced in again. Then on the other side, the downside we see for ourselves or for the one that is in reinsured or insured via such a construction is, if then the reserves exceeds what is being determined in the loss table buffers and you sit on a loss that should have been shared, but then there's no payback from that. That's a big negative from our perspective when we are looking for protection.

I guess this is one of the gaps that a bridge needs to be built to really bring the interest of sponsors and investors together. Happy to take any ideas or even solutions that you have. Anyone on the panel who wants to comment on that gap, referring to the interest of both sides?

Yes. In terms of [indiscernible] metric. I mean it really is as long as you can find sponsors who could accept the not -- accept the unpaid for, the basis risk and the novelty risk, the biggest from we've seen parametric pandemic, which we have also seen in the cyber and other newer risk is that you've got cedents and sponsors who have never had to pay for the cover in place, right? It's always bundled in or lumped in or unspokenly chucked in. And they want to pay as little as possible, but it's unbudgeted relative to tax expense. And then you've got investors on the other side who want to charge a novelty premium who are fine with basis risk and who are going to deploy either this new novel risk or toward a cap, which is paying really well and is well-modeled. So the biggest opportunity, I think, for a British -- Philipp, it could be for you in the broking community. This sit in the middle actually bring these 2 sides together and say, "Okay. Let's."

Yes. I kind of -- I think from our side, I mean there's certainly, again, a lot of different topics within this discussion. There's, one, how do you design an efficient solution for pandemic kind of going forward, and can it be parametric and what's the best way? I think the question about the buffer tables really, in our mind, I think has to be subdivided into a more proportional type relationship or where I think there are some increased mechanics in place to allow like sharing of collateral in multiple years and things like that versus kind of the more nonproportional market where, again, I think you generally collateralized structure, certainly subject to some collateral holdback, and that's more difficult to engineer in that sense, unless more weighted platforms or other structures are kind of being used, which I think is another trend we're clearly seeing in the ILS market or I think the move kind of -- to some degree, away from a single collateralized platform to multiple platforms. This is clearly a development, I think, which will further accelerate.

So we've talked a lot about COVID-19 and COVID-19 related topics. There are no further questions from the audience on COVID-19. But one which leads over to also a very interesting topic, I would call, innovation. So let me quote this one here. Besides topic around lack of modeling capabilities and data, et cetera, why are there no more ILS transactions for cyber or other coverage -- covers other than nat cat if the capital supply is there? So I guess this is something that everybody can respond. Probably, I would be interested to get Ewoud to first. Perhaps, I mean, I don't know if you made up your mind on different risks you would think to bring to the market. I mean, here, it was mentioned cyber, for example, but there are the casualty risks, et cetera. Is there a kind of, let's call it, wish list or so which you would have in mind?

Yes. We are constantly thinking about how this market could help us in new risk. It can be also more type of life risks. And that's also one of the reasons that we entered the ILS market again with the one for a transaction we did earlier this year, Windmill. I think this market is very important. And I think for us, it's necessary to know that market better. And I don't want to sound arrogant, but I think it's also important that the ILS market knows [ me ] better. You mentioned cyber. We as an insurance company also is struggling with cyber. Cyber is one of the key risks for commercial and industrial risks. But we don't see a real demand of companies that are buying this kind of covers. So in our case, the exposure we have for cyber is still very, very limited. But we know that cyber is one of the most important risks they have to find protection for.

Sorry. The lack of ILS capacity is the single biggest constraint on the growth of the cyber market right now. Insurers don't have enough capacity to fuel all the demand from original insurers, let alone, the pent-up risks that are reflecting in virtual insurer demand yet. Reinsurers are filling their boots pretty fast. They can allocate more to insure. Now let's get real. Insurers are relying on reinsurers. Approximately 40% of original insurance cyber premium is ceded to re, all right? So insurers can't grow without reinsurance affirmative cyber growth. And reinsurers are doing these small bespoke retro deals and can't get enough retro out there. Why not? Because everyone's writing the same stuff. The reinsurers turning to a retro writer is probably on the same program. They don't want to share their data with each other. So retro doesn't happen in that regard. When you need? Do you new, fresh, noncorrelated capacity to come in to fill the gap. The biggest problem there is price, cedings and even retro cedings still don't want to pay. And when you take the ILS funding, look for Adolfo there, are you going to get the returns on cyber that you will on to [ Swear to Win ]? You're not going to find a cedent who's willing to pay that, because they don't feel they should have to. So what you need now is, again, meeting of the minds here, where the market can get real and say, "Okay. I just need to know there's a downstream market opportunity that I can capitalize by actually paying a reasonable price for retro." And on the other hand, you got capacity providers who need to face the fact that, "You know what? Yes, my initial price is the most I'm ever going to make before the brokers beat me down and the cedents beat me down." But I have to pick a more realistic insertion point. You do that, and we're close to it. Do that and the cyber ILS market just run like crazy. We know there's demand. In Q1, we got to the first realistic spread we've ever seen out of cyber ILW, literally within 3 percentage points between cedent and the markets we're bidding. Usually, it's about 10. So it's still too far and then COVID mucked it up with uncertainties by capacity driving prices up. But up until that point, we had an opportunity. If we don't get that right in 1/1 as the market, the cyber market will remain fundamentally dysfunctional. My two cents.

Thank you. Ivan, perhaps you could share from your industry perspective, where you deem it most probable that the -- or most reasonable where the ILS/ART market should expand into in order to add value in the overall insurance and reinsurance community. And perhaps, you, Adolfo, then can let us know whether you deem that as realistic or...

Maybe first, I'll add to Tom's point, where I think on the capital availability, well, clearly, the amount of fiscal and monetary stimulus that we have just seen over the past several months, I think, will, to a large degree, take care of that, I imagine in the next 12 to 24 months, because already, if you look at property risks, the coupon less -- expected loss is around 5%, whereas the yield on a BBB dollar that of a similar duration is sub 1% or around 1%. So it is indeed the question of price. And there are multi-strategy investors who I think over a certain period will start delegating a lot more money. As to your question, Andreas, I think if -- it seems like there is now demand for 2 things from the reinsurance capacity perspective from Stephens, if I -- maybe some arrogance just to give my view. It seems like you have the protection for the balance sheet and you have the earnings volatility protection. So far, the ILS markets have been, I guess, mostly helping out with peak risks helping on both sides, but it doesn't really help to write the long tail lines as well. And this is a perennial debate, of course, about whether you could see casualty ILS of some certain style. And maybe I'll just leave it there. That seems to be a huge part of the market that doesn't have an effective backstop.

Thank you. Adolfo, your assessment?

Yes. That's -- it's funny. I mean you just brought up a great point that I was trying to make. We're talking about whether there is demand to transfer cyber risk. And through all the interventions from every panelist, I got the impression that what we're talking about is that -- but it didn't sound to me like at any point, anybody was saying, there is a real need, like this is a new peak that it could be -- beyond like an earnings protection. This is a real capital protection purchase. And it seems to me that, until we get to that point, there isn't really a demand, right, until it gets to the point where, because this is a capital protection issue, the insurance upfront are making sure that they're charging for that use of capital. And then they decide that, okay, we have enough of this risk that we need to transfer it to somebody else. The demand isn't the reason I'm going to charge a fee for doing it. And that's not really what ILS is here for, at least not what it originally was here. ILS was here to just transfer the peak risks into deeper pockets beyond what the insurance and reinsurance market could do. So obviously, cyber is a risk that has the potential to become a new peak. But based on what I'm hearing here right now, it doesn't seem we're there yet. Does that make sense?

It does. I think what I'd qualify that though with Adolfo is that the market can't grow yet to the point where it can become a peak, peak risk to be transferred, because it's so fundamentally dysfunctional. I think in a more normal world, we would just see the insurers allocate a more realistic amount of capacity, not rely on a ceded re so much in order to manage that market. So my understanding is cyber is ceded at 4x the rate of cap, for example. And that tells me, "Hey, there's not enough money there." They're over relying on reinsurers, but also like they're not investing in this market the way they would for a cat or other established clients. So to your point, yes, it lands like insurers are relying on reinsurers, and then ultimately with later ILS funds to assume the bulk of the risk and establish that market without taking a significant chunk of that risk themselves. If ILS were to step in and say, "Hey, you know what? We can provide capacity here to help you grow. But the ceding to reinsurers, you're going to have to pay for the privilege." This is a lot cheaper than what we should be doing, which is allocating significantly more capacity to that market.

I can confirm what has been said just by what -- Tom and Adolfo. I'm convinced it will become a big risk. I don't know that's going to happen in 5 years' time or maybe 10 years' time, but it will happen. And it is growing really at a very fast pace. And Ewoud is absolutely right, this is within our reinsurance portfolio, it's still diversifying very well. Capacities we allocate are quite small. The risk are still small to medium in aggregate. So again, there's no real need to develop a retrocession market for us right now. But if the growth continues like -- with effect, there will be a need, or we simply have to restrain our underwriting approach. And again, how we are trying to manage it together with our insurance clients, insurance partners is the way it has been explained. It goes far beyond capacity and earnings volatility. It's about a common product development, common development of services, and therefore, shared risk on a proportional basis together with our clients. And I would conclude cyber is still in the early stages. Therefore, this is the way it is. It's still small compared to the other peak risks of the world, but it will grow in Q1. And definitely, there will be a need for retrocession markets or for ILS opportunities.

That topic, innovation, new risks, et cetera, where you still have to develop risk profiles, develop data sets, et cetera, the question says, flight to quality found its place in many headlines over the last 12 months and even more recently. What does it mean? And what the criteria for being assessed as a quality player? Ewoud, you just did a capital market transactions a couple of months ago. I guess you could also take that one first.

Yes. Yes, of course. Thank you. Yes. We have a very good relationship with the traditional reinsurance experience as possible with our risk data and our loss data. And we share with them a lot of information. And actually, what we did with the ILS market was exactly the same. So we shared exactly the same information with them. And bearing in mind that we do not buy a cat bond because there is not enough capacity in the traditional market. We think that this is a very good basis to find a solid ground and a robust relationship for the longer term. But I think if you want to have a relationship for the longer term, you need to be transparent. And we think it's very important to do it on an indemnity basis. And therefore, the quality of the data and the data we shared with them is very, very important. I think if you are purely on a parametric, then the quality of your information is not relevant. But we think...

That's the point. I mean the parametric or an industry loss is that your data is not relevant because you're protecting your intellectual property, your competitive advantage and making the transaction easier to digest with an independent third-party is the reporting agent. No, I wouldn't say one is better than the other, but they serve 2 different purposes.

Yes, exactly. They're sort -- for different purposes, but we prefer not to have a mismatch between the model output and the actual loss if it happens.

Yes. I agree with Ewoud. Some audit committees and risk committees don't like basis risk.

You got that.

I wouldn't say that's universally true. We see plenty of basis risk heavy transactions executed regularly. I think it has a lot more to do with the company's strategy for assuming, managing risk and capital, capital availability and what they hope to accomplish. I'd take to Adolfo from here on the bias party, of course.

No. No, I would agree. I agree with you. I agree with Tom. I mean it's different ways of buying, and it's a different objectives. I mean, there's people who are more than really to take the risk. I mean there are so many people that transfer risk that they know that if a certain scenario happens, whether it's their book or whatever, they know they're going to take the loss. So they're more than happy to say, yes, there is basis risk here if you look at modeling. But we know that if things get to that level, we're going to take a loss that is probably in excess of what we're getting. So what's the point of trying to match the modeling output? They just know that we're in the risk anyway. So...

Yes. And in fairness, what modeling out would have shown the development on Irma. I mean basis risk may be a problem, but if they're going to have decades of development, I mean my son is going to sort out that loss, not me. I would say that audit risk need to balance loss development sale and duration of that post-selling process, and realize that a balanced approach does have some accelerated claim velocity that may provide some cash flow benefits from strategic alternatives, the ability to redeploy, and so on and so forth.

I guess it's also pretty much depends on whether you get the volume you're reaching out to your market and at which price, obviously. I mean, then the decision probably is easier to also think about other triggers and mechanisms.

I think it's fish or meat. You cannot compare them. But some people prefer meat and other prefer fish. And I think the people each other should not try to convince some meat eaters that fish is lovely. We choose on purpose for an indemnity based transaction to avoid the basis risk.

Some enjoy fish. Some enjoy meat. And in Q4, you're going to find out that you'll eat what you can get when you're hungry.

Yes, yes. Absolutely. Yes, absolutely.

So there is one interesting question coming in referring to the cat bond market and such. So the question is, how far are we away from a really functioning secondary market? And what needs to be done in order to get there and maximize appeal to the whole spectrum of investors? I guess, this is a very interesting one, in particular, as we've seen this dynamic market, capital market on the trading side, mid of March. Who wants to take that as the last question from the audience?

Yes, Andreas. Maybe I can start. I mean, yes, certainly, I mean, as you mentioned, though, I think, I mean, the -- I think a robust secondary market certainly is helpful and appreciated. But similar to your comment, what occurred in March was really also a robust primary market in that sense. And then that the 2 are not directly kind of -- or like functioning basically in parallel. And I think what needs to happen to kind of further increase it is really more volume and generally, I would say, and more investor participation also outside of kind of the core participant. Anything else will kind of grow naturally with that.

So I guess then we can allow for one additional from the audience. It refers to expectations with the new ideas forming hubs for ILS transactions. And the question is, what's your opinion on new regimes entering the ALS market? Do you see an increased interest there? I guess this is something for you, Philipp, as well as probably Ewoud. I don't know whether you've looked at different locations to set up the SPV. Perhaps you can both comment on that.

Yes. Maybe I can kind of start. So I mean, generally, I think you have variety is always a good thing in that sense as long as it's tested and robust and that's -- so certainly, I think all transactions generally run on a [ LA type ] time line and then comprises a kind of approval processes and things like that, certainly, ideally are minimized. And I think the important thing is really are the robustness of the process and also any kind of regulatory risks surrounding that. And I think having more jurisdictions available like the U.K., for example, might be more familiar to some sponsors. But again, in our mind, that's more kind of a secondary, I think, development and importance to the marketplace.

Ewoud, do you like to comment on that as well?

Well, we started the discussions internally about renewing the cat bonds. And we also consider the domicile. And as you probably know, our first 2 transactions were private deals and were both domiciles from Windmill Re in Bermuda. But when we took all the regularity aspects and also the tax implications or the interpretation of the tax laws into account, we pay for having a carrier domiciled in the Solvency II European area. So that's why we choose for Dublin, Ireland.

Okay. So thanks a lot. So we have still 3 minutes left. And sorry for not taking the last questions which were dropped to my screen because the last one is a routine. It's always the same. So speakers who listened our event in the recent past actually should have an answer prepared. So the last question to everybody on the panel today is, as always, what would you expect the market to be in 5 years from now? And how would you like the markets to be? Ivan, would you like to start?

Well, I think it will probably not be entirely surprising. I think the market will be larger. I think there is going to be more money chasing financial assets, and therefore the pool of capital with better models will probably be able to better address the needs of the cedents and the reinsurers. In terms of, would we like to be more classes and more risks covered? I guess, very clearly so, obviously, we've touched on cyber. I'm sure it's going to be more than just property. Although the pace of this, I'm probably not the best person to judge as to how quick this could happen.

Thank you. Tom, how about you?

I think over the next 5 years, but I'd prefer to see what I think will actually happen are a broad increase in perils. Again, not to the extent where it's going to seriously erode this year and helped by the stuff that's out there now. But you will see cyber ILS with scale. You'll see Japanese index transactions with scale. And the reason you're going to see all this is because my team and I are going to make it happen.

How about Adolfo?

I would say that definitely agree that it's going to be a larger market. There's going to be more capital flowing in. It should be broader. There should be other perils as there is new peaks or semi peaks coming up. There should be ILS solutions coming to it. And for all that to happen -- another thing is that it should be more streamlined. The placement should have a lot less touch from the beginning of the transaction to the ultimate risk there, meaning, from the buyer protection to the person providing the capital to cover that is going to be -- it's going to be more streamlined. And for that to happen, there's going to be a lot more transparency and a lot more data dependency.

Thank you. Ewoud, would you?

Yes. Besides the points that were already addressed, I think in 5 years, the friction cost will be lower than they are now today. And maybe the data will be more robust by using blockchain technologies. And on top of that, I think more perils will be introduced into markets.

Philipp?

Yes. We would agree. So certainly, I think that we would expect the market to grow as well. I think the low interest rate environment and I think the continued appeal, I think, to -- from investors of the ILS sector because of its non-correlation even throughout COVID, I think, will remain. So yes, so certainly agree with the growing market. I think, hopefully, we see a continued development on the product side, which, I think, -- yes, will cover more lines of businesses, but also will bring more risk into the marketplace and then hopefully bundled with also trading abilities to capture some of kind of more of the long tail lines and specialty lines as we have seen already in some segments of the market. It's something we kind of are certainly working towards and hoping for. The last point maybe to make as well is I think we will see more investors participate in the market. And I think we're seeing increased interest from institutional investors to form partnerships and then understand the market better. And yes, given that alternative asset strategies will grow, certainly, those discussions will kind of continue in our mind.

Thank you. Last but not least, Thomas?

It's hard to add anything. I mean, especially against such content on how you see the outlook. Maybe a few items. I think the ILS market and our industry will continue to learn and hopefully further develop to get terms and conditions right, clearer, transparent, and make more independent modeling available, especially for the big risks. And that is the foundation, of course, for more ILS opportunities. But I think it's going to be only a gradual development. Maybe one or the other setback is already out there in the next few years. And also it's -- it can come and go, but the long-term trend is growing. On COVID 19, I think the solution is more in the direction of state support and development of pools were -- and private-public partnerships. The insurance and reinsurance industry can take a share and can help to build that up. But on cyber, I wish that we really develop a strong ILS market because I do foresee that as one of the real big peak risks in the next few years for the whole world.

Thank you. So with that, ladies and gentlemen, I would like to thank all the panelists for the time, providing the individual views, thoughts, et cetera, and close this session officially. Also thank you to the audience for participating at Munich Re's 12th ILS or First Virtual ILS Roundtable. Stay safe and healthy. And hopefully, we will meet for the 13th roundtable in Monte Carlo. Again. Remember, always, Mondays, between 10 and 11:00 a.m. Thank you, and bye-bye.

Thank you.

Thank you.

Thank you.