Growing ILS market can benefit entire insurance value chain: Deloitte

by Artemis on February 5, 2016

The efficient capacity and capital market structures of the insurance-linked securities (ILS) market have the potential to benefit the entire insurance value chain, from end consumer through to investor, according to Deloitte.

Certain insurance and reinsurance market executives, analysts, and experts have stressed the importance and need to utilise the wealth of alternative capital flooding the sector, following industry-wide acceptance that it’s here to stay and will likely increase its influence on, and share of the overall reinsurance marketplace.

Deloitte has advised, in a new report that discusses the impact of ILS on the reinsurance industry, that traditional insurance and reinsurance entities should embrace the entry of ILS capacity and the structural change this has brought about, as “everyone – investor, insurer, reinsurer, regulator, and consumer – can benefit from a vibrant ILS market.”

For insurers, notes Deloitte, the growth of ILS has created an environment of cheaper, more efficient reinsurance capacity from a diversified source, something that Deloitte describes as close to the “Holy Grail,” for insurers. However, for the reinsurers it’s been perceived as not so beneficial, as it has resulted in reduced returns and ongoing margin pressures, although they too benefit from efficient retrocession.

Despite this, and perhaps heeding the advice of those that said it’s best to get on board with the influx of alternative capital and figure out how to best utilise it, rather than miss an opportunity and risk being left behind, on average half of cat bond transactions are sponsored by reinsurers, says Deloitte, referring to a report from the National Association of Insurance Commissioners (NAIC).

Deloitte notes that the reinsurers that have done this, used the ILS transaction “sometimes as the vehicle to transfer their own risk and other times to help a client externally transfer that client’s risk, thereby increasing profit without adding to the reinsurer’s own risk.”

Insurers and reinsurers have been looking at ways of utilising alternative reinsurance capacity more broadly across their businesses in recent times, in terms of underwriting and for reinsurance or retrocession purposes.

And with efficiency now being as important as ever with the market undergoing significant changes, some have successfully used ILS as a tool to extract more value from the re/insurance business premiums they underwrite, by retaining more of it utilising third-party capital vehicles.

“Both insurers and reinsurers need to continue to explore innovative responses to what is still in many ways a nascent market. The disruptive innovation that is ILS should be used to help transform and improve the reinsurance market, while rationalizing the traditional reinsurer model,” says Deloitte.

The final point here is an important one, as beyond simply leveraging the wealth of ILS capacity that’s out there, willing and waiting to be deployed, insurers and reinsurers have an opportunity to manage that capital and bring it in-house, incorporating it within their current business model to extract as much value as possible.

Deloitte highlights this point; “The goal should be for traditional reinsurers, insurers, and investors to create from the ILS market a new platform that, among other benefits, would allow investors an attractive asset class for diversification, insurers to hedge risks more efficiently, and reinsurers an avenue to avoid commoditization, exploit their expertise, and expand into new growth markets, either geographically or to cover new or different risks, such as cyber.”

The result of insurance and reinsurance companies using ILS capacity in a more meaningful way should translate to a broader, more affordable, and more efficient product range for the end insurance and reinsurance consumer.

Deloitte underlines that across the risk transfer landscape the biggest regulatory fear is a lack of capacity, and then concerns about pricing, both of which have the potential to filter down the value chain, resulting in a lack of options to the end consumer, or products that are just too expensive.

“Stability, efficient pricing, and capacity from the capital markets would help address these fears,” stresses Deloitte.

Insurers and reinsurers that fail to successfully leverage the flood of ILS capacity that’s currently in the space, including the wealth of capital that’s currently on the side-lines perhaps waiting for the next catastrophe event before looking to enter, risk missing out on the opportunities and increased efficiency.

Something that can be very dangerous at times of financial market turmoil and when the reinsurance landscape is highly competitive and returns remain pressured. As those that were brave enough to leverage alternative reinsurance capacity from the start, could end up too far ahead of those too slow, and unwilling to adapt to the changes the market continues to undergo.

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