It’s no surprise that the topic of bonuses and remuneration gets people talking. Recently my colleague Gavin Davis hit a nerve among our readers over an editorial he wrote essentially arguing that the reinsurance industry did not make anywhere near enough use of properly designed performance-based remuneration structures. Underwriting executives had insufficient skin in the game, he argued.
There needed to be more use of clawbacks on incentive payouts linked to performance in strong years, he suggested, adding that equity-based schemes for top executives did not permeate far enough through to underwriting decision-makers.
But one critical segment of the industry does in fact make much more use of structures that work towards a similar end as he was describing.
In the ILS market – which has really been the essential driver of rate hardening in catastrophe lines – many fund managers have two main sources of income: base fee revenue, charged per dollar of assets, as well as performance-based income that gives them a slice of profits generated for investors.
(Some argue that performance fee income is not appropriate for the reinsurance asset class at all given the degree to which weather fortunes control ultimate returns, but that’s another topic in itself.)
At any rate, most ILS firms would rely on performance-based fees, but these are often subject to high-water mark levels that effectively means they have to make good their investors’ losses before they can begin to accrue performance-related gains again.
Similar arrangements also exist within the MGA market and other areas of the industry where profit commission structures are used.
Now, it’s true that there are a wide range of fee arrangements in place and these features won’t be universally true for ILS managers.
And you could also argue that – as Gavin suggested – the real pain of these arrangements will fall on the firm’s top partners rather than key underwriters, who a firm is unlikely to be willing to lose over short-term pain.
But the main point is that the firms are still sharing in the pain of underwriting losses – and this will filter down from the top.
And moreover, the issue of incentive clawbacks at a more junior level points to another underlying issue with trying to fully implement these schemes in reinsurance.
The real issue is that people’s career horizons and demands don’t match up well in a business where it could easily take over a decade or two to properly argue the toss on their long-term profitability record.
In so far as it can be done, I’d argue that the ILS market is ahead of the overall reinsurance game on this one.
