One reason ILS capital is considered low-cost, efficient and competitive

by Artemis on July 16, 2014

We often discuss the efficiency of reinsurance capital sourced from capital markets, third-party or alternative sources, as well as its lower-cost nature which can allow it to have a competitive edge over the traditional reinsurance business model.

With some suggesting that the traditional catastrophe reinsurance business model is dying, others suggesting that efficient capital will take segments of the reinsurance market and make them its own, forcing unwelcome change on the markets incumbents, while still more say that low-cost reinsurance capital can out-compete the traditional reinsurer balance sheet, it’s worth looking at what this really means.

Here at Artemis we’ve been covering the downward spiral in reinsurance pricing as high levels of traditional capital competes with itself and with the growing levels of third-party ILS reinsurance capital. As this trend continues and prices keep going down, at some point the combined ratio must suffer as the traditional reinsurer expense ratio starts to look less attractive given the margin on reinsurance underwritten is declining.

At some point in the not too distant future we are likely to see reinsurance sector analysts asking tough questions of reinsurer CEO’s about their expense ratios and how they intend to moderate and control them. Questions about rationalising the workforce, mergers and acquisitions to acquire scale, new lines of business and new ways to become more efficient by leveraging technology are likely to come to the fore if the soft market persists.

One of the best ways to think about this is to consider the size of a global reinsurer, with its multiple locations, offices, sometimes thousands of employees and sprawling infrastructure, then compare this to a much smaller ILS or collateralized reinsurance specialist.

Typically, ILS fund managers have teams in single or double figures, with even the largest ILS manager in the world, Nephila Capital, having a team of just around 55. Then consider how much capital these ILS players manager and how much premium income that translates into, allowing you to work out a premium per employee ratio.

Then do the same with the major global insurance and reinsurance players, who often command hundreds of millions or even billions of premiums, but have a workforce into the thousands as well as all the additional costs that go with maintaining such a huge and complex business.

Then compare the two.

Thankfully, saving us the effort of looking too deeply at the numbers, a recent keynote presentation made by President of Willis Re North America, James Kent, at the International Cooperative and Mutual Insurance Federation (ICMIF), Meeting of Reinsurance Officials (MORO), in Miami, does the hard work for us.

Kent’s presentation looks at the challenges that the traditional reinsurance business faces due to the alternative reinsurance capital influx, discusses the changes in buying habits as a result of this trend and also makes a useful comparison between large insurers or reinsurers and an ILS manager.

Kent compares a large insurer, Esure the UK personal lines specialist, a large reinsurer, Munich Re the world’s biggest, and an ILS manager, Leadenhall Capital Partners LLP the London-based ILS fund and investments manager. We’ve repeated the comparison table from Kent’s presentation below:

Esure Munich Re Leadenhall Capital
  • UK personal lines insurer
  • 1,500 staff in the UK
  • Wrote ≈ USD 800m of premium in 2012
  • USD 0.5m / employee
  • German based reinsurer
  • 45,000 staff
  • > USD 68bn of premium in 2012
  • USD 1.5m / employee
  • UK based ILS fund
  • 11 staff
  • > USD 1.5bn funds under management generating estimated $300m of premium
  • USD 27m / employee


Comparisons like this make sobering reading for traditional reinsurers. When you consider that increasingly the ILS fund managers are building themselves out as specialist underwriting shops, who write business on a fully-collateralized basis, it puts them in direct competition in some areas of the market.

The comparison also makes it clear why ILS managers believe their capital can be lower-cost and can be more efficient. It also makes it clear why on certain perils and regions in the world ILS capital can accept a lower return than traditional, balance-sheet written reinsurance capital.

The question this brings to our minds is on competition and the willingness of the traditional reinsurer to be ultra-competitive in order to secure lines on reinsurance programmes where ILS capital is making inroads. Is it sensible or prudent for a traditional reinsurer, with a seemingly higher cost-of-capital, to drive down price and relax terms and conditions to levels at or below where ILS capital operates?

Recent reinsurance renewals have seen just this happening, with traditional reinsurers actually leading prices down in some cases and expanding terms significantly in order to secure business and demonstrate their competitiveness with ILS capital. Given the seemingly higher cost of traditional, balance-sheet, reinsurance capital is that a sensible strategy or one that may come back to haunt the reinsurance market?

Time will tell, but the table above really does make clear the fact that, on a simple metric such as premium income per employee, ILS players seem far more efficient. At some point in the future, we believe the willingness of some traditional reinsurers to compete at any cost is going to become much more evident.

Read more on the cost-of-capital and the efficiencies of the third-party or ILS capital reinsurance model:

Alternative capital is efficient capital: Frank Majors, Nephila Capital.

Traditional reinsurers challenged to compete on cost-of-capital.

Efficient reinsurance capital forcing change, M&A inevitable: Nomura.

The death of the traditional catastrophe reinsurance model.

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RM July 16, 2014 at 4:37 pm

Very good point about number of employees and employees/premium or revenue. However one more thing to consider is that as ILS funds do more of things that traditional reinsurers do like indemnity based collateralized reinsurance contracts and long tail non CAT deals they will need a staff composition similar to a reinsurance company.

ILS Funds also have to collateralize everything and therefore have a ROE much less favorable than a traditional reinsurer. As they write more collateralized reinsurance contracts, and not simply invest in CAT bonds or ILW’s, they will need staff similar to a traditional reinsurer which will escalate their cost and put more pressure on their returns. AA- rated reinsurance company with a appropriate risk measure and optimized portfolio will generate better ROE than a ILS fund and can also use more leverage.

Artemis July 16, 2014 at 6:04 pm

Yes, the gradual staffing-up of ILS funds as they become more focused on private transactions and collateralized re will certainly move the needle here. It would be an interesting metric to track across the ILS market over time, to see how the model changes with it.

Thanks for your comment!

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