Two days ago we wrote about the latest report from reinsurance intermediary Guy Carpenter in which the broker looked at the April renewals and commented on trends which are emerging within the global reinsurance marketplace. One of the trends receiving attention is the growing influence of third-party reinsurance capital and Guy Carpenter said that the convergence of traditional and alternative capital sources is now changing the reinsurance marketplace.
The broker now estimates that the total size of the global property catastrophe reinsurance marketplace has reached $312 billion. Traditional reinsurance capital is estimated to account for 86% of this, or $268 billion, while the remaining 14%, or $44 billion, is attributed to non-traditional sources of reinsurance capital.
The figure of $44 billion is impressive enough on its own, but if you compare that to the number we published from Guy Carpenter last year, when the broker estimated the amount of non-traditional reinsurance capital in the market as $34 billion, the growth over recent months is stunning.
This non-traditional reinsurance capital is third-party sourced, from institutional investors such as pension funds, specialist insurance-linked securities (ILS) investment funds, endowments, sovereign funds, life insurers and other institutional investment sources. The non-traditional capital tends to be put to work in instruments or contracts such as catastrophe bonds and other insurance-linked securities, collateralized reinsurance contracts, industry loss warrants (ILWs), sidecars and retrocessional reinsurance.
We wanted to drill down into this with Guy Carpenter, so we interviewed David Flandro, Guy Carpenter’s Global Head of Business Intelligence, who kindly shared some more data and deeper insight on the topic enabling us to find out a little more on the brokers thoughts about how non-traditional reinsurance capital is changing the reinsurance market.
First we asked David whether he could break down the $44 billion into its core constituents for us. He responded; “By analysing ILS capacity further, Guy Carpenter has calculated the breakdown of sources between catastrophe bonds, collateralised reinsurance, retrocession and industry loss warranties. Catastrophe bonds account for more than a third of total non-traditional capacity (at USD15 billion) whilst collateralised reinsurance, retrocession and industry loss warranties each account for USD13 billion, USD10 billion and USD6 billion, respectively.”
What’s really clear is that the third-party reinsurance capital sector, or non-traditional if you prefer, has grown considerably in a relatively short space of time. The increase from $34 billion to $44 billion is a leap of 29% across all these different sources which is very healthy growth. We suspect however that this growth could have been higher had catastrophe bond issuance begun the year more briskly and had there been more opportunities available in ILWs, some investors have said that deploying capital could have been easier in 2013. It’s also worth remembering that it is early days for the deployment of third-party capital within the reinsurance markets and these numbers are all likely to grow over the years to come.
David Flandro is of the same opinion and told us that Guy Carpenter; “Expect to see significant growth in non-traditional capacity in coming years.” This sentiment is inline with other companies with a focus on this alternative capital space within reinsurance. The general feeling in the market seems to be that institutional sources of capital have become more familiar with reinsurance and catastrophe risk and we’re likely to see an increasing volume of it looking for opportunities to be deployed. Of course there are also many institutional sources of capital who are only now beginning to look to the catastrophe risk and reinsurance space as a potential source of yield, so the pipeline of inflows has the potential to increase considerably.
We asked David whether Guy Carpenter has a feel for the breakdown of this capital by investor sources, such as pension funds and specialist ILS investment managers. He commented; “Pension funds will play a prominent role in driving this growth. Indeed, estimates suggest around 15 percent of cat bonds are currently held by pension funds compared to little or none five years ago. Pension funds are also investing in sidecars, with 27 special purpose vehicles created in 2012. One of the biggest ILS fund managers (Nephila) has reported that 80 percent of their USD8 billion in funds comes from pension funds.”
One of the issues that is often raised with respect to the increasing involvement of large institutional investors such as pension funds is whether their capital will be ‘sticky’ or purely opportunistic. David told us; “Overall, we believe capital supporting alternative capacity is increasingly stable institutional money which has made a long-term commitment to the catastrophe risk space and is therefore expected to remain in the sector, even should a large catastrophe event occur.”
As we’ve discussed in a number of recent articles on Artemis (such as here and here), the general consensus is that non-traditional capacity is now beginning to impact renewal rates more meaningfully. We asked David what impact Guy Carpenter see this capital having on rates. He responded; “It is clear that there the increasing competitiveness of non-traditional capacity is having a significant impact on the property market in the United States. Indeed, traditional reinsurance pricing at 1 April decreased roughly 5 percent to 10 percent on similar coverages from the 1 January renewals.”
David continued; “Nevertheless, it is important to note that the majority of transactions being completed via non-traditional capital at the most aggressive pricing currently tend to be centred on certain U.S. segments of nationwide, hurricane exposed single state writers or Florida programs. While the rest of the U.S. market is impacted by the overall influx of capital, traditional pricing in other zones is more competitive. In addition, the impact has been less dramatic internationally as evidenced by the relatively stable renewal for Asian business at 1 April.”
Recent press and market discussion has focused on the threat that third-party backed reinsurance capacity could present to traditional reinsurers. We asked David whether Guy Carpenter felt that this capital posed a threat and if not how it felt reinsurers could turn this new trend into an opportunity.
“While some see this new capacity as a threat, Guy Carpenter feels that an accurate understanding of how the market is converging and where the capacity will be deployed is essential to creating new competitive advantages at future renewals. We believe opportunities are available for large reinsurers to improve returns on property catastrophe business through ILS by utilising their own expertise to develop fund management platforms while the smaller carriers may be able to target adequately priced business to boost earnings. We believe that by closely analysing the sources and uses of capital, as well accurately quantifying available and deployed reinsurance capacity, clients can target opportunities for profitable growth,” he responded.
Another topic receiving considerable attention right now is the pricing of recent catastrophe bond transactions and whether coupons could drop any lower. We asked David whether he felt current pricing was sustainable, to which he replied; “Rates in the alternative capacity market have declined between 25 percent and 40 percent year-on-year. This has been driven by increased demand from investors as they are attracted by strong returns compared to depressed yields elsewhere and the low correlation to other asset classes. Given we expect significant growth in the cat bond market over the next few years, current pricing levels could well be maintained. Much will depend on whether yields recover elsewhere during this time and how investors respond following a major catastrophe event, should one occur.”
Finally we asked David what strategies Guy Carpenter would advise insurers and reinsurers to adopt to ensure they are able to profit from this influx of capital rather than lose out on business because of it. David said; “High on our list is possessing an understanding of where the capital is coming from and how it can best be utilised. It is no longer enough simply to aggregate all of the capital tied to the sector. The best capital advisers must incorporate an understanding of all classes of convergence capital and specifically where they create profitable growth opportunities.”
The takeaway here for our readers is that the non-traditional reinsurance capital trend is likely here to stay and those companies who do feel threatened by it need to make efforts to leverage this capital to the best of their ability and work out how best to turn this threat into an opportunity to profit.
See our follow-up to this article where we look at the data on the growth of the convergence market: The growth of non-traditional reinsurance capacity to April 2013.
Our thanks to David Flandro and Guy Carpenter for his time and insight into this important trend.
Subscribe for free and receive weekly Artemis email updates
Sign up for our regular free email newsletter and ensure you never miss any of the news from Artemis.