ILS can increase efficiencies & reduce costs for reinsurers: Aon

Being able to successfully attract and deploy alternative reinsurance capital can provide reinsurers with some potentially invaluable cost reductions and broader market efficiencies, according to global reinsurance broker Aon Benfield.

The persistent inflow of sophisticated, and efficient third-party reinsurance capital is contributing to the evolution of the global reinsurance industry, which, has seen a host of companies look at adopting new, innovative, and more cost-efficient business models.

“A structural shift in the way capital is raised and deployed to mitigate insurance risk is underway,” says Aon, in its latest Aon Benfield Aggregate report (ABA).

Capital markets investors remain willing and able to assume insurance and reinsurance-linked risks, highlighted by the fact that alternative reinsurance capital continues to increase its share of the overall reinsurance market volume.

As a result of the consistency at which the insurance-linked securities (ILS) space has competed with, and supplemented the re/insurance space in recent times, traditional players now, for the most part, seek to work with the abundance of diversifying, third-party investor backed capital.

“Most ABA constituents are now moving strongly to incorporate alternative capital into their business models. Many are now actively involved in raising and managing third party capital. Others have invested in strategic partnerships with established independent specialist fund managers,” explains Aon.

Continuing to explain that those “that are successful in attracting and deploying third party capital will potentially be able to advance their client offering, reduce earnings volatility through fee income, lower their own risk transfer costs and manage their capital bases more effectively.”

In recent times the attractiveness of ILS investments has been aided by volatility in other alternative asset classes, and while expected returns in the cat bond market and other forms of ILS have declined, it remains an attractive, diversifying, and uncorrelated income stream for capital markets investors.

Reinsurers are able to benefit from their ability to leverage alternative capital and its features. Examples of this include the formation of a sidecar facility that can reduce catastrophe risk transfer costs, sponsoring a catastrophe bond and an increased use of efficient retrocessional cover, explains Aon.

“This has reduced the cost of their underwriting capital and allowed them to grow positions with key clients, while reducing many peak zone probable maximum losses (PMLs) relative to capital held,” says Aon.

Being diversified, able to produce relatively stable and acceptable returns, and being largely uncorrelated to the volatility of the broader financial markets at times of market stress, continues to drive new investors to the re/insurance industry via the ILS market.

In response to their growing presence in the marketplace, and in certain cases their willingness to get closer to the original source of the risk, traditional players have been forced to rethink their business models to incorporate alternative capital and to remain relevant to the changing industry.

“These dynamics are forcing many ABA constituents to rethink their business models in the pursuit of differentiation and relevance in the market. In the catastrophe reinsurance space, this increasingly means being able to offer larger line sizes, a full product suite including collateralized limits and enhanced claims service,” explains Aon.

While the excess capacity in the global reinsurance industry has created a buyers market where cedents can take advantage of more favourable rates and terms, it’s also meant that “most ABA companies” have been able to “drive down their own risk transfer costs.”

“Retrocession pricing has reduced and in some cases additional protection has been purchased, with consequent impact on disclosed modelled exposures,” advised Aon.

In its infancy, which wasn’t too long ago, discussions surrounding the inflow of alternative reinsurance capital were often negative, questioning its permanence and ability to play in the global re/insurance sector.

But it appears those days are long behind us, and while its presence, along with the excess and growing wealth of traditional capacity, can be seen to increase competition and contribute to recent rate declines, it can also provide value and reduce costs if leveraged in a sensible and prudent manner, and for the right risks.

The general view among the marketplace is that alternative reinsurance capital is here to stay, even post-event. So it’s likely wise for companies to start working with the ILS market sooner rather than later, to be able to enhance and build capital markets client relationships that could prove essential after the next large loss.