The line between traditional and alternative sources of reinsurance capital has “been greying more and more” in recent months, with the trend predicted to accelerate over the next five years, according to Hilary Paul of LGT ILS Partners.
Executives from the re/insurance, insurance-linked securities (ILS) and risk modelling space spoke recently at alternative asset manager LGT Capital Partners’ recent client event held in Lucerne, Switzerland, discussing the global reinsurance industry and ILS’ rise as an asset class.
During a panel event dedicated to discussing the ILS and reinsurance value chain, participants said that as the reinsurance market has changed, partly driven by the entry and growth of ILS capital, things would never be the same again as the lines increasingly blur between the two.
The expansion of alternative asset classes entering the space, including pension funds, collateralized reinsurance ventures and the increased establishment of sidecars and other risk transfer vehicles has spiked in recent years, ensuring the lines between traditional and alternative sources of reinsurance capital become increasingly vague.
LGT ILS Partners Portfolio Manager and Partner, Hilary Paul highlighted the growth of insurance-linked securities (ILS) and its evolving relationship with the global reinsurance sector during the discussion, saying; “The boundary between purely collateralized reinsurance and traditional reinsurance has been greying more and more and our ability to actually measure how much capital is in each segment is going to be more and more difficult.”
Growth that was recently noted by reinsurer Aon Benfield, which stated that during 2013 and 2014 the amount of non-traditional, or alternative capacity in the reinsurance sector increased by 28%, finishing last year with a total of $64 billion and considerably outpacing the growth of traditional capital.
Much discussion in recent months has circulated around the fundamental changes taking place in the international reinsurance industry, and part of that change is coming in the form of ILS and third-party capital.
“I think we are going to see two developments. One is that the reinsurance market just will not look like it does today. The second is that I think we won’t differentiate so much between traditional and non-traditional,” said panel participant Allianz Re CEO, Amer Ahmed.
Naturally, as waves of new capital from various sources enter the space competition intensifies and pricing becomes pressured. But despite the adverse impact this can have, LGT’s Paul argues that capital market providers have helped to modernise the reinsurance sector.
“I think the capital markets have been instrumental, not in disrupting the market but in modernising it a bit and we have seen some positive movements, certainly in terms of restructuring programs for the end buyer,” explained Paul.
While also noting that it’s a positive for the industry to have multiple players, Paul explained that it can’t be just the big five reinsurance firms for example, because “we need multiple providers of reinsurance capacity,” she added.
As the rise of global reinsurance as an alternative asset class accelerates and grows, so too does the investor base, and as the barrier to enter the market remains quite high, the importance of investor, client, broker and cedent relationships becomes apparent.
Paul said; “I think what people (on the outside) don’t really see is the depth of the relationship and the importance of the business relationship here. Relationships are still a very important part of this industry.”
Henry Kingham, Executive Vice President of Willis Re, also participating in the event, explained how a broker’s role needs to react to ILS’ disruption of the traditional value chain, saying; “If we are seeing the value chain being disrupted at certain points we need to amend our business model to reflect these changes.”
Adding; “One example of change is that we see ILS funds becoming the new reinsurance buyers as multiple ILS funds now hedge their own exposures embracing soft market exposure management,” suggesting that brokers will need to adapt to provide services throughout the newly formed value chain.
The rise of ILS looks set to continue and as alternate risk transfer mechanisms and the capital markets become more widely accepted, those who choose to ignore its benefits risk missing out on its opportunities.
Highlighting the long-standing nature of ILS and reminding of the important role it plays in the global reinsurance industry, Ahmed advised that “it’s now significant and it’s part of the way things are done.”
Adding; “If you look at the total capacity we buy, almost one third is what I would classify as non-traditional, so cat bond, collateralized, swaps or multi-year, so over time it’s found its place in the programme.”
And the influence of ILS goes beyond the insurer, reinsurer or ILS manager, as risk modelling specialist, Peter Dailey highlighted during the panel discussion.
“In the ILS world, stakeholders need to understand the medium-time horizon, rather than of individual weather events which occur in days and weeks or climatological shifts which occur over decades. Proper analysis of an ILS transaction requires projections over the coming 3 to 5 years — the time horizon where the typical cat bond resides,” Dailey explained.
Continuing to explain that as a result, a new kind of science is required combining short-term weather forecasts with longer-term climate projections. Dailey was optimistic that weather and climate researchers are embracing this trend and focusing more on the medium-time horizon.
For brokers, explained Henry Kingham of Willis Re, the evolution of ILS, and in particular collateralized reinsurance, means that a collateralized re placement “features on many of our client programmes.”
Which means, “We’ve been educating our brokers around the world about collateralized reinsurance and the benefit these products can offer our clients,” continued Kingham, noting that the brokers who successfully manage change will be the ones who learn to adopt ILS very quickly.
The consensus from the panelists during the session was that ILS is here to stay, likely to grow, and those who benefit the most will be the ones who learn to adopt the asset class and utilise its benefits.
Ahmed concluded; “If there is capital out there that is more cost-effective than insurance company equity and we don’t find a way to use it then somebody else will. The change has to happen.
“I think the industry is going to have an incredibly exciting rollercoaster over the coming years.”
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