As the pace of change in the reinsurance market accelerates, there is an expectation that the amount of capital seeking direct access to insurance and reinsurance risks from third-party investors and institutions will more than double to $150 billion by 2020.
Speaking at the SIFMA Insurance and Risk Linked Securities (IRLS) 2015 conference held in New York last week, Michael Millette, who was with Goldman Sachs at the time of speaking but has now left the firm, discussed his views on where insurance-linked securities (ILS), hedge fund reinsurers and the capital markets direct participation in re/insurance was heading over the next five years.
Being near the end of his tenure at the firm, after 21 years which saw him act as an instrumental player in the development of catastrophe bonds and ILS, Millette happily discussed his forecasts for where the ILS market and the participation of third-party capital in reinsurance is heading over the coming years.
In his time at Goldman Sachs Millette was responsible for more than a hundred transactions which brought capital markets capacity to the reinsurance sector, such as cat bonds, sidecars and company launches. As such he is as well placed as anyone to be able to predict where the current market trends take us by 2020.
First, Millette explained where he sees the market right now; “Right now,what I think we see is the direct capital markets footprint of $65 billion, $58B in the funds, $7B outside of the funds, of which about $60 billion is nat cat. And we see about 6 hedge fund, or investment oriented, reinsurers, with over $200m of equity up and running and operating.”
These figures seem extremely reasonable, based on Artemis’ ILS fund managers listing which has over $55.2 billion of capital under management in the included firms. Add in the few funds we do not have sufficient data for, as well as the large direct investing pension funds, and $65 billion is easy to imagine.
Millette went on to explain where he believes these numbers move to by 2020, saying; “I think that where we go with that is $150 billion, of which $100B+ is nat cat, but there’s materially more non-nat cat, direct footprint. With 15 investment oriented reinsurers, of which 9 are public.”
And Millette feels his forecast may be conservative, as there’s room for more growth if the market conditions should become conducive and investor interest in accessing ILS and reinsurance risks continues to grow.
On his forecast for hedge fund reinsurers, he said; “To give you some thoughts on that, there’s 6 up and running, I don’t think 15 is very brave, because there’s one in the market, there’s one going in the market tomorrow, there’s at least three more material sized ones well along in preparation. I’m pretty confident that 7 out of the 9 that are forecasting for 2020 being public stand a chance of being public at that time.”
And on the growth of capital markets direct capacity in reinsurance via ILS, Millette explained; “So that’s a material shift, that’s more than a doubling of capital. That’s actually not as brave as it seems, as if you assume that the sector is earning and reinvesting 7% per annum and if existing LP’s are putting an incremental 5% per annum to work, that’s just a tiny bit more. There really aren’t very many more investors entering the market fresh to take it up to those sizes.”
Millette’s forecast for $150 billion of direct capital markets footprint in the reinsurance space through ILS by 2020 is aligned with other forecasts we’ve seen in recent years, such as Aon Benfield’s discussion of another $100 billion coming into the market over a five year time frame.
How that level of capital inflow impacts the market is the interesting piece of the puzzle, given the disruption that the current $65 billion of alternative capital has had in the reinsurance market, but Millette is convinced that by 2020 the money will be better received.
“When we get there, there will be less anxiety about it than there is today, as the reinsurance world as a whole is changing very rapidly right now,” he explained.
On this rapid change in reinsurance Millette referred to the mergers and acquisition trend, something he expects to see continue and that will result in a restructuring of the reinsurance market playing field.
“We have seen four major mergers in the last three months, I think we will see several more,” he said. “If we go back to the 80’s, we had an industry that was at least two-thirds large balance sheet carriers and one-third market-based at Lloyd’s. We evolved over several decades into an industry that had several dozen material size balance-sheet companies, a very shrunken market at Lloyd’s and an incipient capital markets.”
Millette said that the old balance may return, as the market-based sources of reinsurance capital grow once again in importance and influence.
“I think we will be on our way back to a balance, which will be a good two-third balance sheet reinsurance markets and one-third marketplace, which is a composite of Lloyd’s and the capital markets.
“It’s a historic arrangement, it’s very suitable for the sorts of risk that the industry handles and it’s very good for balance-sheet reinsurers to be able to use the market,” he continued.
Millette commented on the rapid change as something demonstrated by reinsurers deeper participation in ILS and third-party capital, perhaps the deeper convergence of the reinsurance and capital markets that Artemis has discussed before.
“I think one of the things that’s stunning now is the creativity and engagement with reinsurers using bond markets, using sidecar markets. The whole so-called hedge fund reinsurance market, is now being driven by the reinsurers, it’s not being driven so much by the hedge funds,” said Millette.
By 2020 Millette expects to see in ILS; “A market a bit more than twice as large as it is now, but with a less anxious relationship between the traditional and the market elements.”
The panel discussion moved onto whether recent times have seen the reinsurance industry being ‘broken’ by the entry of alternative capital and the disruption it has caused.
Millette disagreed, saying; “The industry is not broken. The industry is evolving.”
“We are evolving from an industry that was primarily balance-sheet carriers, into an industry that has fewer large balance-sheet carriers and more of a marketplace, and that’s a very natural formation for the business.”
When asked how he felt the ILS market could broaden its scope in the coming years, as its capital base grows, Millette seemed positive on investors ability to learn to model and accept newer classes of risk to the space.
“Investors have had a reasonable experience with this array of risk and actually have a reasonable experience where they’ve broadened out. The existing LP’s that have gone into non-elemental sidecars have gone well. And there’s an increasing amount of sophistication around the space.
“I do expect we will see more weather and crop, marine and aviation, attritional property. I think that we will see the resurgence of life and health. We saw a lot of life activity pre-crisis and we’re starting to see an uptick in life transactions. And in health, not only indemnity health, but there are really touch areas of the life market like long-term care, where we’ve seen some capital markets activity. So I do expect to see a broadening out.”
Millette said that in five years time he would expect to see a market still dominated by catastrophe risks, but perhaps two-thirds natural catastrophe risks, rather than the nearer 90% nat cat dominated that we see today.
He went on to discuss the bigger macro economic and investment universe picture, which drives some of the attraction investors have for ILS. As these factors have a key bearing on how much capital comes in over the forecast five years, Millette said it’s important to think about this bigger picture.
“In order to think about this space over the next five years, we’ve got to think about the private market that we sit in. What are investors going to do, over the next five years with their money.
“Investors that we talk with across sectors sit down and they’re really, really hunting for opportunities with some level of return and diversity.”
Millette quipped that this is how the ILS market can attend a SIFMA conference each year, where participants continue to bemoan low pricing and rates but the amount of capital in the ILS space from the capital markets continues to grow.
That desire for a steady rate of return and a diversifying asset for their portfolio isn’t going away and could continue to drive interest in ILS, Millette said.
“There are good reasons to believe that over the next few years investors could feel that they are in a similar situation and they could come to crave even more diversifying investments,” he explained.
And pricing may not be as much as a concern as some make out, Millette insinuated, as the sector could remain a draw for investors even if the returns remain lower; “Looking forward it’s quite possible that we could continue to see this sector be relatively attractive, in a price environment that is consistent with where it is today.”
The final trend that Millette discussed during the panel is the topic of individual, or retail, investors entering the ILS space.
“One big trend in the sector is individual investors, although its hard to see. This was an institutional sector but that is increasingly not quite the case,” he explained
He acknowledged that there is probably more money from high-net-worth individual investors already in ILS than the market is truly aware of, with investors accessing reinsurance through hedge fund reinsurers and ILS funds structured as mutual funds in the U.S. or UCITS in Europe.
“On $65 billion of (cat) bond and collateralized reinsurance footprint we probably have $8 or $9 billion of high net worth or individual investors,” Millette estimated.
He continued to say that the inflow of money from high-net-worth individuals is likely to continue, for all the same economic and market factors that attract the institutional players to the ILS space.
“The fact is that right now the sector is attractive and I think it’s likely to continue to be,” Millette closed the session.
Michael Millette has been a key figure in the ILS market for most of his 21 years of service at Goldman Sachs and is certain to return to the sector in some venture, or with an existing firm, later this year. His forecast is bullish, but he’s likely as connected as anyone to both the money and the risk bearers in this market and so extremely qualified to forecast a $150 billion ILS market in 2020.
As the growth of third-party or alternative capital continues in reinsurance and the market continues to change rapidly, as Millette noted, the capital markets footprint seemingly has exponential room for growth.
As the structures also evolve, enabling the capital to get closer to the risk and large insurers to more directly leverage it, the size of the market in five years and beyond could be much larger than anyone has forecast to date.
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