Ability to attract, deploy third-party capital important for reinsurers: Aon Benfield

Reinsurance companies ability to attract and deploy third-party capital is becoming increasingly important, according to reinsurance broker Aon Benfield. The broker has today published its latest Aon Benfield Aggregate (ABA) report, which analyses the financial results of the world’s leading reinsurers in 2012, and in the report discusses the increasing importance for firms to be ready to accommodate and do business with third-party reinsurance capital.

The report estimates that global reinsurer capital reached a record $505 billion at the end of December 2012, up by 11% of $50 billion from the $455 billion it recorded a year earlier. This measure includes both traditional and non-traditional reinsurer capital and signifies the amount that is available for reinsurers to trade risk with.

Aon Benfield says that the main driver of the capital increase has been a continuing, and increasing flow of third-party capital into the reinsurance space in support of both start-up reinsurers and non-traditional reinsurance activities. The report doesn’t try to put a figure on the size of the non-traditional, or third-party capital sector of reinsurance but it’s generally accepted to be more than $35 billion now.

The report says that new income streams and operating advantages are beginning to flow to leading reinsurers who have engaged with the new sources of third-party reinsurance capital. Aon Benfield said that this capital is mainly coming from pension plans, life insurers, endowments and high net worth individuals.

These reinsurers who are beginning to embrace the opportunity that this new capital source presents are generally involved in either managing funds where the reinsurers have established relationships with bond sponsors, or sharing their underwriting expertise, resources, experience and relationships with third-party capital through side cars and other managed vehicles or by sponsoring catastrophe bond transactions themselves to lower their weighted average cost of underwriting capital and build relationships with investors.

Aon Benfield said that the above activities show a beginning of a trend which it expects will develop into a true rotation in how reinsurance business will be capitalised in the future. This is the threat and also the opportunity that organisations such as Willis Re and Lloyd’s of London have recently spoken about and is destined to become a ‘new normal’ for the reinsurance market.

As this trend continues to become an increasingly influential part of the reinsurance market and cycle Aon Benfield said that having the ability to both attract and deploy third-party reinsurance capital is becoming increasingly important for reinsurance firms who wish to; a) grow their footprint in the market without taking on additional peak risk, b) diversify their income streams to help reduce earnings volatility and c) actively mange their capital bases thus improving returns on equity.

Those three items are key to any reinsurance firms success, profitability and longevity in the market, so those comments can really be read to apply to any reinsurance firm. In essence Aon Benfield could be saying that reinsurers need to work out how best to adapt to and embrace third-party sources of reinsurance capital or face being left behind.

The report notes the continuing trend for senior hires to capital markets roles at reinsurers who are looking to understand and adapt to this new third-party reinsurance capital landscape, citing Arch, Argo, Axis, Catlin, Everest Re, PartnerRe and XL as firms which have either launched third-party capital management activities or who are likely planning to.

Since the beginning of 2012 Aon Benfield said that nine constituents of its ABA report have launched sidecars raising around $1.8 billion between them, with the largest sponsors being Alterra, Catlin, Everest Re, Lancashire, RenaissanceRe and Validus.

It also mentions firms in the ABA who have launched fund management operations, such as Hannover Re, Lancashire, Montpelier Re, Munich Re, RenaissanceRe, SCOR and Validus, or who have formed strategic partnerships with existing independent operations (including Alleghany and Allied World).

Mike Van Slooten, Head of Aon Benfield’s International Market Analysis team, commented; “The low interest rate environment not only has impacted what reinsurers earn on their invested funds but it has added significantly to the competitor landscape. Diversified yield seeking investors are now adding material pressure (in terms of price and value competition) and benefits (in terms of lower cost underwriting capital) to the reinsurance market. We expect material changes to the capital structure of the largely equity financed reinsurance market as material new flows of capital are integrated into reinsurance underwriting capital.”

This is the latest signal from Aon Benfield that it is preparing its client-base for a changing reinsurance landscape of increasing levels of third-party capital and that a more capital markets and capital management approach is required by reinsurance companies who want to be successful and grow. The message that third-party reinsurance capital presents a threat that needs to be embraced so as to turn it into an opportunity is beginning to be spread more widely.

We’ll likely hear a lot more sentiment like this as we move through 2013 and expect to hear of more fund management and partnership arrangements as the year moves ahead.

You can access the report via Aon Benfield’s press release here.

Here are some other recent articles on the alternative capital trend in reinsurance that may be of interest if you missed them (oldest articles first):

– Consolidation and pricing pressure possible as reinsurance convergence continues

– Capital flow in the reinsurance market has changed: PartnerRe CFO

– Insurance-linked securities (ILS) set to grow its share of reinsurance capacity

– Pension fund capital inflows could dampen returns over time: KBW

– Innovative and client focused approach required to drive growth in ILS

– As ILS investors compete with traditional reinsurers will they stay the course?

– Fast capital? Welcome to the ‘new normal’

– Lloyd’s: Third-party ILS capital is both a threat and opportunity

– Emerging model of ‘fast capital’ threatens traditional reinsurers: Willis Re

– ILS pricing drops by up to 70% as reinsurance capital rises: Aon Benfield

– Rush to allocate capital creating a soft ILS market: Lane Financial