ILS complementary, but should move down the reinsurance tower: Demetre

In recent times alternative, or third-party reinsurance capital growth has outpaced that of the traditional market, a trend underlined by cedants increasingly viewing it as a source of capacity that complements their traditional reinsurance coverage, and promotes innovation.

The varied structures, features, low correlation and diversifying benefits of the insurance-linked securities (ILS) market has seen it increasingly contribute a larger of share of the overall reinsurance pie, with more and more insurers and reinsurers utilising ILS to supplement their programmes and increase efficiency.

During a recent panel discussion at the SIFMA IRLS 2016 conference in New York, re/insurance and ILS market participants highlighted how the asset class and traditional reinsurance complement each other, but also noted the need for continued innovation to help the securitised ILS product move down the risk tower.

“Largely they (ILS) are complementary,” and “there is some competition which is breeding some pretty healthy innovation on both parts,” said Mike Demetre, Senior Vice President (SVP) and Chief Risk Officer (CRO) at Allstate.

“When we talk about a complementary offering, I like the fact that I can have traditional reinsurance in a securitised market that doesn’t have basis risk at the friction point.

“So to be able to have innovation in both spaces, where securitised markets take on some of the attributes of traditional reinsurance, and vice versa, just makes it more complementary for me as a buyer,” said Demetre.

Catastrophe bonds and collateralized reinsurance transactions are two of the more dominant features of the ILS market, with the former being used by an increasing number of re/insurers to sit, typically, at the upper end of their reinsurance towers to cover peak exposures.

Collateralized reinsurance placements are a rapidly expanding part of the market, and while it’s utilised at various risk levels within a reinsurance programme, in order for the securitised forms of alternative reinsurance capital to move further down the tower greater innovation is needed, explains Demetre.

“I need more innovation to put it further down the tower,” advised Demetre.

Adding; “I need two limits on a risk profile, such that a 1-in-80, 1-in-100 I need to have two limits available on any given year, and securitised hasn’t figured out a way to do that.”

Underlining that while the influx of alternative reinsurance capital and the response from primary insurers and traditional reinsurers has driven innovation in the space, more can be done in order to move ILS further down the reinsurance tower and expand its reach and influence further still.

Fellow panelist Ben Rubin, Executive Vice President (EVP) at Axis Re U.S. shared the view of Demetre that the glut of alternative reinsurance capital is complementary, stating that at Axis Re they often discuss the role of the reinsurer as the “arbiter of where risk meets capital.”

“So what that means in actuality is over time these companies that will be successful will be able to create distinct portfolios of risk, and those portfolios will have varying degrees of volatility, of duration, of investor components, so when you put all of those together, really alternative capital is key to our ability to become a reinsurer, and more importantly serve our clients,” continued Rubin.

As highlighted by Demetre the structures, skills and experience of the traditional reinsurance and ILS markets can be beneficial to each other, and when properly utilised together can ensure optimal portfolio performance, something of increased importance during the current softening landscape.

Expectations throughout the risk transfer industry suggest the continued rise of alternative reinsurance capital in 2016, with many predicting it to again grow its share of the overall reinsurance market size by the end of the year.

It’s natural for sponsors to call for cat bonds and ILS capacity to try to move further down the risk tower. For them, it would help to place their reinsurers under further competitive pressure, while enabling an even broader diversification of risk capital sources right through their reinsurance programs.

But in order for the market to really grow it’s likely that innovative solutions that utilise aspects of both the ILS and traditional reinsurance world will need to continue to move alternative reinsurance capital further down the tower, something that could lead to increased portfolio efficiency, diversification and profit for firms.