The increasing flow of new capital into insurance-linked securities (ILS) and collateralized reinsurance markets benefitted reinsurance buyers at the recent June and July mid-year reinsurance market renewals, according to the latest market outlook report from reinsurance broker Aon Benfield.
Allocations to ILS, catastrophe bonds, collateralized reinsurance vehicles and reinsurance-linked funds have continued with increasing velocity, as institutional investors such as pension funds, endowments, family offices and life insurers continue to discover and increase their appreciation of reinsurance and catastrophe risk as an asset class.
According to Aon Benfield, ILS pricing is down 40% year-on-year at the mid-year renewals, with new ILS and cat bond issuance in the first-half of 2013 reaching $4 billion by their reckoning ($4.08 billion based on our Deal Directory entries), the highest issuance for a first-half apart from in 2007.
Despite the drop in ILS and cat bond pricing, Aon Benfield says that investors are still finding the returns possible from insurance risk attractive and a valuable source of diversification. The reduced cost of capital that investors and ILS funds have makes it possible for them to deploy capital at lower rates than the majority of traditional reinsurers can manage. More on the cheaper cost of ILS capital in two of our previous articles, here and here.
Many reinsurers have begun to position themselves so as to be able to incorporate third-party capital from investors within their underwriting and corporate structures, with the launch of dedicated capital markets focused teams and fund management entities. Aon Benfield said that it expects the pace of these third-party reinsurance capital activities, at traditional reinsurers, to increase as they find the most effective ways to bring external capital into their capital structures.
Interestingly, Aon Benfield said in the report that for reinsurers who have not yet begun to embrace third-party and alternative capital it may already be too late. The shift in the reinsurance market dynamic, towards third-party capital, will leave those reinsurers who have not already begun managing third-party capital struggling to react, the broker said.
The growth of ILS and alternative reinsurance capital and the resulting pressure it has put on traditional reinsurance pricing has benefitted reinsurance buyers. Even in lines of business where alternative reinsurance capital has not been deployed, the traditional reinsurance market has reacted to the increased competition bringing meaningful value to buyers. Aon Benfield said that relationships and continuity continue to be important, which will please the larger reinsurers, and the leading reinsurers are taking active steps to lower their costs of assuming risks and volatility.
The reduced pricing on ILS, cat bond and also across many traditional reinsurance lines, is now resulting in new opportunities which have become available to cedents and reinsurance buyers. Aon Benfield said that everything points towards the new lower pricing on ILS and collateralized reinsurance continuing, which will help to increase the growth of the ILS market and the breadth of its impact on traditional reinsurers.
The combined effects of broader access to ILS and collateralized capacity markets, alongside stronger support from traditional reinsurers, may result in new and improved options for managing risks for cedents, with multiple year terms available well inside the cedent’s cost of equity capital. This is key and will likely be another factor that helps the alternative reinsurance market and ILS become even more embedded within many reinsurance programs.
The complementary nature of ILS and third-party capital, along with more willing and flexible capacity support from traditional reinsurers is going to allow reinsurance buyers to achieve much more complete and supportive risk transfer solutions. As traditional reinsurers work out how best to work with third-party capital, instead of against it, these risk transfer opportunities are going to become even more attractive to large reinsurance buyers.
As the ILS and third-party reinsurance capacity is increasingly used on peak-risk catastrophe zone coverage, with this capacity perhaps providing a better capital match in many cases, insurers may find this capacity less restrictive on growth in catastrophe exposed regions. As competition for catastrophe risks grows it will result in reinsurers growing their appetite for non-catastrophe risks, which in turn could result in new opportunities for insurers in non-catastrophe lines of business, as they will have the support of greater reinsurance capacity.
This is another important point made in the report by Aon Benfield, and something we have alluded to many times on Artemis. The impact of ILS and third-party capital on reinsurance needs to be looked at holistically and the reinsurers who are nimble and innovative will find that their capacity is needed in areas of the market they may not have expected. Opportunities will emerge for those reinsurers who are willing to support new products from insurers and it is quite possible that the ILS and alternative reinsurance capital trend may just spark a period of real change and innovation across the broader insurance and reinsurance markets as it frees up capacity to work elsewhere.
Aon Benfield expects insurers and reinsurers will continue to find innovative ways to use ILS and collateralized markets. Some of the trends Aon expects to see emerge include, securitizations of complex commercial property, commercial liability and other new risks, something we have perhaps begun to see with the recent Tradewynd Re cat bond and its diverse underlying book of insurance business.
For insurers, the increased availability of capacity and coverage options both from ILS and traditional sources, will result in diversifying coverage options and the influx of reinsurance capacity may help them to compete and grow. The savvy insurers are already analysing where they can use new sources of capacity and we expect to see collateralized and ILS markets taking a growing share of reinsurance programs on many peak risk zones at the next key renewals in January.
Aon Benfields report looks at the increase in traditional reinsurer and insurer capital, both of which have grown by 2% just in the first-quarter of 2013. This has taken global reinsurer capital to $515 billion, on Aon’s reckoning, which is a new all-time high.
Despite this continued growth in reinsurance capital, alongside a growing ILS and third-party reinsurance capital trend, demand for reinsurance protections at the mid-year renewals remained generally flat, said Aon Benfield. So it’s no surprise that the trend towards cheaper reinsurance pricing is beginning to broaden beyond the peak risk zones where it had first become so evident. It will be the January reinsurance renewals that will tell us how broad the impact of increased capital in the space and continued inflows of third-party capital will be.
You can find the full report, Reinsurance Market Outlook – June & July 2013 Update, via the Aon Benfield website here.
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