P&C CFO’s attribute reinsurance softening to alternative capital & ILS

by Artemis on March 12, 2014

A Towers Watson survey of property & casualty (P&C) insurance chief financial officers (CFO’s) shows they attribute the softening property reinsurance market to the growth of insurance-linked securities and other alternative forms of reinsurance capital.

The survey looks at trends in the property & casualty reinsurance market, as well as the drivers and the ultimate consequences of current reinsurance market conditions. Towers Watson has released the results of the sixth installment of its North American P&C Insurance CFO Survey today and unsurprisingly, ILS and alternative reinsurance capital feature heavily.

55% of the P&C CFO’s surveyed said that they believe that the property reinsurance market is softer than the primary insurance market currently and interestingly 34% of respondents said that they believe the same to be true of the casualty reinsurance market as well.

The CFO’s surveyed attribute the softness in the reinsurance market as being driven in part by the growth in use of ILS and alternative reinsurance vehicles, with capital coming from institutional investors and capital markets.

Nearly every CFO surveyed (97%) said that they use traditional reinsurance in their risk transfer programs and Towers Watson said that still the majority are not using ILS or alternative capital. However, 59% of CFO’s are either already purchasing collateralized reinsurance protection or are likely to consider using it within their reinsurance programs, while 27% of those surveyed are currently using, or look favorably on the use of, both insurance-linked securities, such as catastrophe bonds, and hedge fund-owned reinsurers.

“The opportunities in the risk transfer market are just starting to be realized. Many fresh sources of capital are seeking investments that are uncorrelated to their existing investment holdings,” commented Stuart Hayes, a senior consultant at Towers Watson. “With risk transfer arrangements continuing to evolve, we anticipate P&C insurers hastening their participation in various structures across the risk transfer spectrum, thus complementing their traditional reinsurance programs.”

The survey looked at how alternative capital is affecting reinsurance buying, particularly the impact that increasing volumes of lower cost capital is having on pricing and options available to P&C insurers.

90% of CFO’s surveyed said that they already see, or expect to see, reinsurance pricing decrease as a result of the influence of alternative reinsurance capital. 88% said that the lower cost of capital associated with ILS and alternative reinsurance capital is the most important benefit of accessing this type of reinsurance protection.

In terms of the limitations of ILS and alternative reinsurance structures, 69% of respondents said that the complexity of the contract or deal structure limits their use of these tools, while 62% cited ambiguity related to contract triggers.

Consolidation and mergers & acquisitions among reinsurers is one of the topics that Towers Watson quizzed CFO’s on. 21% said they do believe there is a need for consolidation among reinsurers while 24% said that they expect to see consolidation within the next two years. 52% said that if the soft market conditions are prolonged then it could drive consolidation in the market, while 48% cited the competition posed by ILS and alternative capital as a potential driver of consolidation.

“Reinsurers need to be aware of the near-term realities of a relatively soft reinsurance market and the longer-term potential of the alternative risk transfer market,” said Matthew Ball, a director at Towers Watson. “Given the increase in reinsurance and alternative capital supply, reinsurers are faced with a property catastrophe market that is likely to soften unless there are major catastrophic events with very large losses. Reinsurers may face a classic economic example of reduced demand and increased supply that drives prices lower.”

The efficiency associated with alternative reinsurance capital and ILS is mentioned with respect to future insurer reinsurance buying habits. The survey found that more insurers are thinking of increasing their use of reinsurance and Towers Watson said additional changes in reinsurance buying may occur once new accounting regulations are in place.

48% of respondents said that the use of catastrophe reinsurance is expected to increase, while 38% said they expect to use more aggregate loss covers and 31% more quote share arrangements. At the same time under than 15% said they expected to decrease their use of use of aggregate loss covers and aggregate risk transfer structures.

“The new market realities are requiring the reinsurance market to adapt and operate more efficiently. Reinsurers that realize the efficacies of alternative capital, while maintaining the relationships and platforms already built around traditional reinsurance solutions, will distinguish themselves by providing primary P&C insurers the best risk transfer solutions,” added Ball.

Of course it is not just the influx of alternative capital into reinsurance and insurance linked securities which has created the softening reinsurance market on its own. Other factors which have led to the persistent softening now being seen are the low-level of catastrophe losses suffered by global reinsurers in 2013 as well as the high levels of traditional reinsurance capital in the marketplace.

It is clear from the results of Towers Watson’s survey that insurance sector CFO’s are watching the softening reinsurance market closely and are keen to take advantage of the attractive pricing and flexibility on offer from alternative reinsurance products. CFO’s are now looking more favourably than ever on alternative products and ILS as complements to their traditional reinsurance programs, said Towers Watson.

The results of the survey are no surprise and show the increasing adoption of collateralized reinsurance, as insurers look to the lower cost of capital associated with the capital markets but without the complexity they often see in ILS and catastrophe bonds. It also shows that the awareness of alternative reinsurance options among primary insurers has grown and as ILS and alternative capital increasingly features in the insurers consideration set the market should see a continuing upturn in deal flow and capacity backed by third-party capital.

Towers Watson says that the opportunities in alternative risk transfer and ILS are just beginning to be fully realised and that there is a considerable amount of additional capital, from investors such as pension funds, ready to be deployed into insurance linked investments.

With the complexity of transactions in ILS expected to become less of an issue over time, as potential sponsors learn more about the market and documentation is simplified at every opportunity, the survey participants should become more comfortable with tapping the capital markets.

Towers Watson said it expects the ultimate winners will be reinsurers that can operate effectively in either, or both, the alternative or traditional reinsurance markets, realising the efficiencies of alternative capital while maintaining the relationships and platforms built on traditional reinsurance business, to offer real solutions to primary insurers.

The survey included 29 CFO’s, from commercial lines insurance (31%), personal and commercial insurance (24%), and P&C insurance and reinsurance (21%), and mixed between stock (48%) and mutual (42%) companies. 38% have core operations in the U.S.; 17% operate locally, and 14% are multinational/global. The largest number had total direct written 2012 P&C insurance premiums between $100 million and $500 million (39%), and 11% had 2012 premiums of over $5 billion.

You can find the survey results on the Towers Watson website.

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