Alternative capital forced reinsurers to adapt, further evolution needed

The persistent inflow of alternative reinsurance capital in the overall market has created a competitive environment that forced traditional players to adapt to survive, but it’s important for market players to continue the path of evolution, particularly in emerging risks and markets.

Benign loss activity, a supply demand imbalance underlined by ample capacity and heightened competition from third-party backed capital, has driven widespread industry consolidation and change as reinsurers attempt to navigate challenging operating conditions.

But while the rise and expansion of the insurance-linked securities (ILS) market brings notable pressures and challenges to traditional reinsurance players, it has also forced firms to adapt their business and investment approaches to remain relevant to clients and the marketplace, a trend that has seen the global reshaping of the market.

“I think the alternative capacity has clearly pushed the traditional market to adapt, and I think we’ve done a good job of it. The lines are certainly starting to blur, or have blurred by this point, but I don’t necessarily think disintermediation is the future,” said Bryon Ehrhart, Chief Executive Officer (CEO) of reinsurer broker Aon Benfield Americas, and Chairman of Aon Securities Inc.

The more efficient reinsurance capital currently sitting in the marketplace has created a buyers market where primary insurers are benefiting from ample supply and increased reserves, leading to the retention of more risk and ultimately less reinsurance purchase.

Furthermore, primary players have increasingly centralised their reinsurance purchasing to realise cost efficiencies and better manage their investment portfolio exposures, all of which leads reinsurance entities, from brokers to underwriters, to increasingly search for ways to remain relevant to the client and drive up demand for their capacity.

“We, the industry, are doing our part to bring the demand side to our business,” explains Ehrhart.

An area where the glut of capacity, from both traditional and non-traditional sources, can be put to good use is through innovative solutions to improve disaster resilience and risk finance measures in emerging markets, like the Asia-Pacific, or with emerging, complex risks that impact all markets, mature and underdeveloped, like cyber.

Insurance and reinsurance experts speaking at the 2015 Bermuda Reinsurance Conference, sponsored by Standard & Poor’s (S&P) and PwC Bermuda, echoed this notion, highlighting that further evolution is required to adequately address, and fully capitalise on the opportunities this presents.

“There’s great opportunity out there, and we’ve got to get out there and find it,” said JLT Re Bermuda partner, Charles Withers-Clarke, continuing to stress that cyber could be one such opportunity, as there “are reinsurance solutions out there being offered. But they’re not adequate, really. There’s great opportunity out there.”

To meaningfully, and adequately protect such a complex, far-reaching and potentially costly, emerging threat like cyber, clearly advances in modelling and further education is required on a global scale.

But also, it’s unlikely that traditional insurance and reinsurance capacity alone will be sufficient to significantly address the exposure, again underlining that although alternative reinsurance capital comes with its challenges, it’s been essential in the recent evolution of the sector and is vital if the industry is serious about covering large, potentially crippling exposures like cyber.

And the same is true of emerging markets and the ability to protect their vulnerabilities to the increased severity and frequency of natural disasters, like parts of the Asia-Pacific and Latin America.

The expertise, structures, and capacity of the entire risk transfer landscape, ILS included, will surely be essential in the fight to improve global disaster resilience efforts, and ultimately lower the rising insured to economic loss protection gap post-event.

But as highlighted by Withers-Clarke, further adaption will be required to achieve this. “We really enjoy where we are with Asia-Pacific. We’re seeing good growth out of that, but it’s important for players in the industry to continue to evolve. Just having boots on the ground isn’t necessarily the answer.”

Evolution and change within the global reinsurance sector has seen the establishment of hybrid reinsurance models, either set-up as stand-alone companies or structured within an existing insurer or reinsurer.

And while this trend is widely predicted to continue, as is the continued growth of the ILS market, experts warned that its entry could slow in the coming months and could also find its way into more primary business lines.

“More capacity is good for our client, and more reinsurers is good for our clients. But clients prefer traditional paper. So we don’t think that growth is going to come along to the 40% that some people are predicting,” said Withers-Clarke.

Agreeing, Ehrhart added, “additional capacity may find other ways to participate, including the primary market.”

The message form the panellists points to further evolution for the reinsurance market going forward as it continues to navigate and find out how best to use the glut of alternative capital. While stressing that although third-party capital has driven competition up, and rates down, its pressures forced traditional players to adapt and evolve, which is a good thing.