The rise of alternative capital is a key risk for the traditional reinsurance market, according to Fitch Ratings, but while the new capital has contributed to lower rates and increased competition it also has its benefits for reinsurers the rating agency said.
The growth of alternative capital, deployed through vehicles such as insurance-linked securities (ILS), catastrophe bonds and reinsurance sidecars, is a key risk for reinsurers according to Fitch Ratings.
The capacity supplied by capital market investors is expected to become a permanent fixture in the reinsurance market, as investors increasingly see the ILS and insurance-linked asset class as an attractive investment offering portfolio diversification, as well as the lack of correlation between catastrophe risks and other investment risks.
The growth of ILS and cat bonds has exacerbated the decline in pricing, and this ongoing trend will likely lead to further price declines across the reinsurance sector, Fitch warns, particularly if catastrophe losses remain around their recent low levels.
This impact is going to be felt most acutely by property catastrophe reinsurers, as they compete more directly with ILS forms of capacity. However, there are also benefits which can help to mitigate the impact on reinsurers, Fitch says.
Fitch cites the example of London market insurers benefiting from lower priced reinsurance and reinsurers benefiting from lower priced retrocession. On top of this the other benefit that can be realised is fee income, as some players have partnered with facilities focused on investing in insurance-linked securities, Fitch explains.
Despite this, the current market sees insurers and reinsurers well capitalised though, resulting in an increasing ability to return capital to shareholders. While this keeps investors happy it is perhaps masking the impacts of ILS to a degree.
The factors that Fitch notes in a recent article all point to re/insurer returns declining once catastrophe experience returns to more typical levels, especially as the chance to recoup payback in the form of higher rates now seems less likely to be long-lived.
The benefits that insurers and reinsurers can realise from embracing alternative capital and ILS may not outweigh the risks in a market which is more pressured by losses. However, while re/insurers remain well-capitalised it is perhaps masked to a degree.
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