Where capital ideas come together
Insurers now have even more reasons to optimise their capital structures, says Eric Paire, head of Aon’s Capital Advisory unit.
The Capital Advisory unit was created in 2018 to advise clients on their asset and liability strategies. How does it align with the work of other Aon teams?
The Aon United philosophy is to develop specialised teams with core areas of expertise, which can work harmoniously together globally to optimise client value. Aon Securities for instance is our gateway to the capital markets, and the emphasis for our capital markets experts is on bringing capital into the retro market, which is under some pressure right now. Capital Advisory, on the other hand, is an early discussion point for clients to discuss their capital needs before they opt for specific solutions involving reinsurance, the capital markets, or equity and debt raising for example.
We advise clients on how to optimise their capital structures while remaining neutral on the type of solution. On reaching a conclusion about the most suitable solution, clients can then execute with our extensive specialist teams, such as those working in treaty, facultative, or capital markets. or Capital Advisory itself for instance on Lloyd’s FAL or ADC.
What are the major factors at play for insurers in 2020?
Not surprisingly, the fall-out from COVID-19 is a big issue today. On the asset side, volatility – reflected in mark-to-market trends – and uncertainty, are the big issues as insurers can’t be sure just how much capital they really have available.
On the [underwriting] liability side, gross and net COVID-19 losses are also uncertain. Again, this complicates any calculation around available capital and, because the range of uncertainty is quite wide, insurers are more cautious than ever about how to proceed.
In this challenging environment, are insurers changing their capital optimisation strategies?
Some have opted to raise equity. It’s not for everyone because price/earnings (PE) ratios have decreased globally and it’s not the best time to raise capital. Debt issuance is another route, but that might not send the best message to rating agencies right now. Reinsurance solutions are an option that are attracting more attention.
Our experience is that more clients now want to explore a full range of possible structures with us, bringing the CFO, the reinsurance buyer and the asset manager into the discussion to allow for a deeper understanding.
We’re not seeing a sudden surge in interest in radical new structures; it’s more to do with clients turning over every stone on what’s available.
Specifically, how is the market reaction to COVID-19 informing insurers’ choices?
There is a hard market coming and many clients want to be ready to benefit from it. The real question for them is: how do I not only protect my balance sheet but also strengthen my balance sheet so that I am not left behind in a hard market?
This could involve freeing capital that’s tied-up in reserves through a run-off or reinsurance transaction and allocating that capital to new business. Or equally the solution could be a quota share deal, or setting-up a sidecar with a third-party investor.
Are clients acting with a sense of urgency?
Clients started to raise questions with us back in March when it was becoming clear that the pandemic lockdown was going to have big implications. Some clients do have an eye on renewal dates next year, while others – at Lloyd’s, for example – want to plan ahead for possible capital constraints. Also, rating agency reviews tend to happen towards year end. It is possible to move quickly on preparations and execution, but generally our clients are looking into 2021.
Do you expect more insurers to go down the run-off route in response to challenging market conditions?
There is an established legacy market for insurers that want to manage their balance sheets, and it’s no longer restricted to distressed situations – it’s actually an effective way to reassure rating agencies, because it caps losses from past years.
There is a healthy number of players in the run-off sector with a strong appetite for older year liabilities, which benefits clients. But there is limited appetite for COVID-19 related losses, so the 2019 underwriting year might be difficult to mitigate. In general, recent year portfolios have limited economic efficiency.
Are potential rating agency actions an issue for carriers in this environment?
Financial strength rating stability is always very important, particularly in the context of reinsurance or commercial insurance. It’s worth remembering that where there used to be several AAA and AA reinsurers, the market has drifted to an A/AA range. Put bluntly, more companies have moved closer to the cliff.
Is Solvency II taking on renewed importance, in challenging times?
Solvency II is a big part of the conversation because there is a link between the regulatory solvency level and the rating agency level. So Solvency II is a metric that arises in every conversation we have about capital with clients.
