Argo’s Mark Watson: ‘The reinsurance industry has a short memory’ | Insurance Day

With the market counting the cost of this year's devastating hurricane season, Argo's chief executive says there is more to the group's acquisition of Ariel Re than just increasing scale, and why he has bought more retro cover this year

By Rasaad Jamie

This article was republished with permission of Insurance Day.

These are exciting but also challenging times for Bermuda-domiciled specialty insurer and reinsurer Argo Group International. In February this year, Argo completed its acquisition of Ariel Re – the Lloyd’s reinsurer that writes property catastrophe and specialty lines risks through syndicate 1910 – in a transaction that symbolizes both the opportunities and the challenges ahead for Argo.

Combined with Argo’s existing reinsurance operation, Argo Re, the transaction means the group’s overall portfolio is now split 88 percent insurance, 12 percent reinsurance. It was also a deliberate move by Argo to add scale to its London and Bermudian insurance and reinsurance operations to enable the group to better manage two of the biggest challenges facing global specialty lines companies today: the fierce competition for business and the high transaction and compliance costs associated with processing that business, particularly in the Lloyd’s market.

Indeed, before the acquisition of Ariel Re was announced in November last year, Argo Group’s chief executive, Mark Watson, warned the viability of Lloyd’s as a marketplace was under threat because of its high expenses.

Data-driven

Speaking to Insurance Day, Watson is also keen to stress there are other, significant dimensions to the acquisition of Ariel Re beyond just increasing the scale of Argo’s international specialty lines business. Watson describes Ariel Re as a very data-driven business from which other businesses in the Argo Group can learn a great deal. “If you look at the risk evaluation and modeling expertise that has been developed in the property cat space, there are probably a handful of firms that have, with the help of third-party vendors, built pretty good risk-modeling systems for property cat risks,” he says.

Ariel Re has taken that a step further, Watson says. “It has extended the application of the system way beyond just property cat reinsurance. It is a great example of what happens when you apply continuous improvement to a process. The system it started out was not too dissimilar to the one we are using at Argo.

“But over the past few years, it has built out various modules and has continued to refine them. It has added different risk profiles and scenarios to the system and is able to apply the principles driving the system to other lines of business. What is really great for us is we think we can eventually put the majority of Argo’s risk portfolios on the new system.”

The acquisition of Ariel Re, which made Argo the 12th-biggest player in the Lloyd’s market, is also the latest step on the path to realizing Watson’s vision of transforming Argo from a mid-sized U.S. insurer specializing in the underwriting of workers’ compensation risks into a major global insurer and reinsurer of specialty lines business.

“I would like us to go from being a well-respected participant in the market to being a well-respected market leader. I think in the markets in which we are investing today, there is a really good chance of that happening over the course of the next five years.”

The first step on that journey was made in 2007, when Argo’s predecessor company, which seven years earlier had promoted Watson, a former insurance lawyer and venture capitalist, from board member to president and chief executive, bought Bermuda-based PXRE Group. Since then, Argo’s transformation has proceeded apace, notwithstanding the advent of the global financial crisis, the ongoing challenging investment environment and the deterioration in re/insurance market conditions.

In addition to its U.S. operations – which have been significantly expanded and diversified over the past 10 years – Argo has established an underwriting platform in Bermuda, and acquired two syndicates at Lloyd’s and an insurance company in Brazil. The group has also set up underwriting entities in regional hubs such as Dubai, London, Malta and Singapore.

Room for improvement

But there is still a way to go and challenges to overcome in realizing his vision, Watson insists. Argo will continue to identify and establish itself in other key markets and product areas where the group has a demonstrable competitive advantage, he says. The company’s operating margins, while “good,” are only “about average” when compared to its peers – “which means there is plenty of room for improvement.”

He continues: “I would like us to go from being a well-respected participant in the market to being a well-respected market leader. I think in the markets in which we are investing today, there is a really good chance of that happening over the course of the next five years.”

There is no doubt that Argo is braced for the long haul. The group, which generated gross premium income of slightly less than $2.2 billion in 2016, showed its resilience during the first quarter of this year when its operating income result – although 25 percent down on the same period last year owing to adverse claims development as a result of Hurricane Matthew and the negative impact of the changes to the Ogden personal injury discount rate in the U.K. – was nevertheless well ahead of analysts’ forecasts.

Things looked even better for Argo by the second quarter of this year. The group’s operating income increased by slightly less than 49 percent as losses from catastrophes fell and Argo’s investment performance, enhanced over the past 18 months by the adoption of alternative investment strategies – including the buying and selling of a sizeable share in a surety company – saw the group’s investment income rise 30 percent over the first six months of this year in a very tough financial market environment.

But Watson, who was speaking to Insurance Day shortly before Hurricane Harvey made landfall in Texas, warns the financial results for the first half are no indicator of what those results are likely to look like at the end of the year for any global re/insurer with portfolios of business that are in any way catastrophe-exposed. The only certainty, he says, is results are either going to be a lot better or a lot worse than companies have planned for.

“Memories are short – and sometimes you come across the assumption in our industry that by the time we get to Monte Carlo, which supposedly happens toward the end of the Atlantic hurricane season, we should have a pretty good sense of what our financial results for the year will look like. Are they kidding?

“One year in Monte Carlo, people’s roofs got blown off their houses in Bermuda. Things happen during Monte Carlo. September 11 happened during Monte Carlo. And don’t forget that hurricanes Rita and Wilma happened after Monte Carlo, as did Hurricane Sandy,” he points out.

“In fact, this year, our expectation is of a busier wind season than over the past few years. And, because we have just completed the acquisition of Ariel Re, we have bought a little more reinsurance and retro cover than we otherwise would have.”

U.S. operations

One notable theme over the past 18 months for Argo has been the ongoing restructuring of its U.S. operations and the investment in new underwriting systems and platform.

Indeed, in 2016 the highlight of Argo’s annual results was the significant improvement in the performance of the group’s U.S. operations.

Last year, Argo’s business units in the U.S. accounted for around 60 percent of the group’s total gross premium income of just under $2.2 billion and for more than 80 percent of its underwriting profits. This is despite the fact Argo’s U.S. operations are focused on two highly competitive, complex and volatile areas of the insurance market: the underwriting of excess and surplus (E&S) lines and commercial specialty risks.

“The smaller the risk, the more expensive it is to process per policy, so you have to be as efficient as you can be when it comes to processing the risk…for the smaller risks, where the premium is thousands of dollars and not tens or hundreds of thousands of dollars, efficiency definitely pays.”

Watson emphasizes the importance of the significant investment in technology and in state-of-the-art analytical and risk-modeling platforms to the enhanced performances of both the E&S and commercial specialty businesses. But he does not agree the ability to automate and to process business efficiently and cost-effectively, as critical as that proved to be in 2016, is the most important factor for success in either the E&S or the commercial specialty market.

“Success in those markets is all about risk evaluation and selection. It is about the underwriters’ ability to use their expertise and their experience. It is about selecting the right risk at the right price,” he insists.

“But having said that, the smaller the risk, the more expensive it is to process per policy, so you have to be as efficient as you can be when it comes to processing the risk. And you also have to be more efficient in terms of applying that expertise and experience to a portfolio of smaller risks than you have to be when you are underwriting big, individual risks. So, for the smaller risks, where the premium is thousands of dollars and not tens or hundreds of thousands of dollars, efficiency definitely pays.”

Since the acquisition of Ariel Re, Argo has been in the process of similarly reorganizing its international specialty businesses. Indeed, the group is just coming to the end of restructuring its London market and Bermudian operations, including appointing new people to a number of key management roles. While this is part of the process of integrating Ariel Re into the group, it is also a move to reconfigure the shape of Argo’s international specialty insurance and reinsurance operations. This includes the implementation of new data analytics, risk profiling and underwriting systems based on those already in use at Ariel Re.

Watson is confident that, as a result of these changes, Argo is now in a position to more clearly communicate its competitive advantages to stakeholders and clients. But while there are some areas of Argo’s business that are working very well, there are other areas that are performing not so well. The issues with the latter, he says, are mainly driven by external market conditions than by anything directly to do with Argo’s business model or by the execution of that business model. He highlights the group’s direct and facultative property book underwritten in the London market, which writes a mainly a U.S.-centric portfolio.

“The market pricing on that portfolio of business is down 40 percent over the past three years, so it is a little harder for us to make money. We need to make a few changes, but we are optimistic we can make money in that area of the market,” he says.

Interested in learning more about insurance industry trends from Mark Watson, CEO of Argo Group?

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