Demand for alternative reinsurance instruments and ILS to continue: Fitch

Investors demand for insurance-linked securities (ILS) and other alternative reinsurance instruments is set to continue, according to a report released by Fitch Ratings today. The strong demand will continue, and likely grow, as alternative reinsurance capital assets continue to produce attractive returns.

Fitch Ratings report, titled ‘Alternative Reinsurance 2013 Market Update’, takes a look at the major trends in the alternative reinsurance market and discusses the continued inflows of third-party capital into the reinsurance sector through instruments like ILS and catastrophe bonds, sidecars, hedge fund backed reinsurers and other collateralized reinsurance and reinsurance-linked investment ventures.

Fitch says that the comparatively high returns achievable from investing in ILS and reinsurance-linked assets, combined with the low correlation between catastrophe risk and the returns on other major asset classes, mean investors demand is set to continue and may strengthen.

“The convergence of the reinsurance and capital markets is likely here to stay and should continue to grow in the near term,” said Brian Schneider, co-head of Reinsurance at Fitch. “Powerful economic forces have driven increased acceptance and use of capital market alternatives to traditional reinsurance.”

Fitch notes that alternative capacity from the capital markets in the global property catastrophe reinsurance space has grown from 8% of the market in 2008 to near 15%, or $45 billion today. The demand from investors has now had the effect of reducing spreads on cat bonds and softening pricing across many property catastrophe reinsurance zones, making pricing of ILS and alternative reinsurance solutions more competitive, and sometimes cheaper, than traditional reinsurance.

Fitch discusses the risk of capital markets investors pulling capital out of reinsurance should a major catastrophe, or other, loss event strike. It considers this risk to be highest among investors such as hedge funds, who are perhaps more opportunistic, and considers pension fund capital more likely to be sticky due to pension fund managers longer investment horizons.

In Fitch’s view, alternative reinsurance capital brings mixed benefits to traditional reinsurance firms. It can be leveraged for fee income by managing capital, something many reinsurers are actively beginning to do, it can also be used to cheapen reinsurers own risk transfer costs.

However Fitch notes that alternative capital can also represent meaningful competition for traditional reinsurers, reducing pricing, taking slices of reinsurance programs that once traditional firms may have relied on. This competition is going to continue to put pressure on pricing as long as the market remains so well capitalised.

With the demand from investors for ILS and investments in reinsurance continuing, broadening to new structures and vehicles and showing no sign of abating, Fitch notes the risk this poses. Fitch maintains its stable outlook for the reinsurance space at this time, but it will be interesting to see whether rating agency outlooks move at all after the next major renewals in January.

The report from Fitch runs through the various sectors within alternative reinsurance capital, including catastrophe bonds which it says are heading for a record year, sidecars which it says have seen reduced activity at the mid-year renewals, industry loss warranties (ILW’s) which have been a little sluggish, hedge fund reinsurers which it says are yet to be tested and reinsurers moving into asset management.

You can access the full report from Fitch Ratings via this press release.

There are so many reports and commentaries coming out on alternative reinsurance capital and ILS in the run up to the Monte Carlo Rendezvous event that we felt it worth highlighting some other reading on the topic, all from the last week or so, which you can find below (most recent first):

– Alternative capital the biggest challenge for traditional reinsurers: Moody’s

– Lloyd’s Nelson warns on ‘systemic’ risk of alternative reinsurance capital

– Broker facilities an opportunity for third-party capital to expand reach?

– Opportunity for reinsurers to learn from ILS: Aon Benfield CEO

– Capital markets investors boost global reinsurer capital to $510 billion (including a useful list of links to many alternative reinsurance capital initiatives that we have covered previously)

– Strong capital inflows bring ILS & cat bond market to new high: Aon Benfield

– Alternative capital a disruptive force in reinsurance: Goldman Sachs