Quality of capital, over quantity, to drive future of convergence: Hilti

Alternative capital will continue to expand its share of the overall reinsurance market, albeit at a slower pace than seen over the last 12-18 months, but a key driver of the convergence market moving forward lies with the quality of ILS capital over quantity, according to Niklaus Hilti.

Since its introduction to the marketplace roughly 15 years ago, the growth, presence and permanence of alternative capital and insurance-linked securities (ILS) in the global reinsurance and insurance space has reached a stage where it now forms a significant part of the overall market, explains Niklaus Hilti, Head of Insurance Linked Strategies at Credit Suisse Asset Management (CSAM).

Industry estimates state that currently the amount of alternative reinsurance capital in the sector stands at between $68 billion – $70 billion, with some predicting that by 2020 this could reach as much as $150 billion.

Following its impressive, rapid rise within the overall reinsurance marketplace, it’s not surprising that Hilti notes that presently, “it’s almost impossible to think of the market being without the alternative capital,” and that personally, he believes there will be more convergence moving forward.

However, a key element of the development of the convergence market in the future will be a shift from the quantity to the quality of ILS, explains Hilti.

“I think it’s probably less the growth or the ratio of the capital market within the reinsurance and insurance market but, personally I think there is still a lot of quality and a lot of new ways to grow together.

“So I think it will be more the quality rather than the quantity we saw over the last couple of years, which will basically drive the future of these converging parts of the market,” said Hilti.

The qualities of the structures and capital of the ILS market are increasingly being utilised by global reinsurance companies, of which the establishment of hybrid models, funds, sidecars and so on are becoming more common within the space.

ILS transactions, such as catastrophe bonds for example, can be tailored to specific needs and are highly suitable, cost-effective solutions to catastrophe exposures across a range of regions.

Furthermore, the fact that ILS solutions, like cat bonds, sidecars, or collateralised reinsurance agreements are fully collateralised vehicles, means the collateral is always there to payout, a reassuring quality when compared to a more typical, traditional reinsurance transaction.

The growing acceptance and understanding of ILS structures and solutions from investors, and the rising willingness of insurers and reinsurers to utilise it within their risk management frameworks reflects the growing sophistication, maturity and robustness of the asset class.

Quality driving the future of alternative capital over quantity is an interesting point, and one that’s backed in part by the slower pace at which alternative, or third-party capital has been entering the marketplace during the last year or so.

“We’ve already seen a slight cooling down over the last one year or one-and-a-half years, so from that perspective I think it’s going to be the normal growth pace, and then it is more about the qualitative aspect of penetration of the insurance and reinsurance market,” said Hilti.

The slower inflow of capital from ILS players into the reinsurance sector will go someway, albeit minimal in the current environment, to limiting the depths of declines in pricing that’s predicted at the upcoming January 1^st, 2016 renewals.

But it also shows increased discipline and sophistication from ILS investors, as they look to maintain desirable levels of return from their reinsurance linked investments, and resist writing business for the sake it.

Looking forward, Hilti says, “there is still a lot of quality and a lot of new ways” that the ILS and re/insurance markets can grow together, but underlines that how the alternative capital reacts to a large loss will also determine the long-term success of the convergence market.

“I think short-term it’s always return, I think that is important. I think long-term; success factor for the investor base will be that there are no negative surprises.

“I think this is something that we only will see eventually when there are very extreme events, so from that perspective I think that is an important success factor,” said Hilti.