Alternative capital will continue to depress reinsurance pricing: Credit Suisse

by Artemis on April 10, 2015

Reinsurance pricing is not “near a bottom” according to analysts at Credit Suisse in a recent report, as in their view the growth of alternative capital should continue to weigh on reinsurance prices meaning further pressure ahead.

“Reinsurance businesses will continue to face substantial headwinds,” the analysts write.

Alternative capital has reached record levels, the analysts explain. They expect to see further growth of insurance-linked securities (ILS), as “the yield advantage versus high-yield bonds is still significant (even before taking into account portfolio diversification benefits).”

“We think the growth of alternative capital should continue to weigh on reinsurance pricing,” they wrote, adding that the relative attractiveness of catastrophe bonds for pension funds, versus other types of high-yield debt, will “further drive product and geographic innovation.”

While the majority of the ILS issuance has focused on property catastrophe risks to date, Credit Suisse expects this displacement of traditional reinsurance capital will have a prolonged softening effect on more lines of reinsurance. An effect that has been exacerbated by excess traditional reinsurance capital.

The effect on reinsurers of weaker catastrophe pricing will be compounded by reinsurers themselves shifting their business mix into casualty and specialty risks, adding further pressure on pricing across the board.

The analysts explain the benefits of ILS as a risk transfer tool for re/insurers, which is likely to increase their usage across the market.

The ILS market helps reduce counterparty risk and quickens claims processing. Collateral is invested in highly rated investment-grade securities. Therefore, the creditworthiness of the collateral and the ability of the SPV to meet payment obligations are largely uncorrelated with the occurrence of a large natural catastrophe. ILS structures also typically have unambiguous payment terms. Whereas traditional reinsurance contracts can give rise to coverage and payment disputes, cat bonds are structured to avoid such disputes and to pay out promptly, thereby minimizing the loss development period.

Credit Suisse say that while the pool of alternative capital providers has expanded, they expect the majority of ILS capital to continue to come from pension funds and sovereign wealth funds.

Given the continued attractiveness of ILS to investors and those using the capacity for risk transfer, Credit Suisse say that they foresee alternative capital exceeding $100 billion by 2017, as a base case prediction.

The continued ability of ILS to adapt and provide more benefit to cedents that choose to use it also suggests ongoing growth and a continued uptake of ILS products among insurers and reinsurers.

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