Reinsurance pricing won’t improve until alternative capital retreats: Peel Hunt

Alternative, or non-traditional reinsurance capital has continued down its impressive growth path in 2017, but until some of this capacity retreats from the global reinsurance sector the industry is unlikely to see any improvement in the rating environment, according to Peel Hunt analysts.

Since the insurance-linked securities (ILS) space really started to expand and cement its place in the global risk transfer industry as an efficient, willing and able source of capacity, discussions about its permanence post-event and ability to deal with a major catastrophe loss year has occurred, on numerous occasions.

In light of the devastation caused by hurricane Harvey, the impact hurricane Irma has already had on some parts of the Caribbean as it maintains its track towards the state of Florida, U.S., projected to make landfall this weekend, Peel Hunt has again raised the question of how the alternative market might react to a major loss year.

It’s important to remember, and as highlighted by a number of ILS industry experts over the years, while ILS players focused on Florida might well be untested against a major loss, so are many of the primary insurers in the region and the reinsurance firms, due to the lack of landfalling hurricanes in the region over the last eleven years or so.

“Some Alternative funds have significant exposure to the Florida market and may see a major loss of principle. We would need to see Alternative capital retreat subsequent to an event in order for the rating environment to improve, we believe,” said Peel Hunt, in a recent Lloyd’s insurers industry note.

The abundance of both traditional and alternative reinsurance capital in the sector is contributing to the persistent rate declines, and also expected to result in a flattening of the market cycle post-event as capital will easily flow back into the market, ultimately limiting any price upticks.

ILS has now become an important and influential element of the global insurance and reinsurance landscape, and the maturity and sophistication of the investor base most likely understands the associated risks and clearly still finds the low-correlation and diversification benefits as attractive, underlined by persistent market expansion.

It perhaps isn’t too surprising that some market analysts and observers continue to question the permanence of third-party reinsurance capital post-event, but, post-event arrangements, as seen with Stone Ridge Asset Management, among other ILS fund managers, supports ILS longevity and both fund and investor sophistication.

Post-event arrangements, such as the Stone Ridge Post-Event ILS Fund, enable investors that already participate in the fund to benefit from any increase in reinsurance pricing following a catastrophe.

So instead of pulling-back or exiting the natural catastrophe re/insurance space post-event, third-party investors are provided with continuity and are actually able to increase their market participation if they wish, in order to take advantage of any market dislocation and need for capacity.

Furthermore, after a major loss primary insurers and traditional reinsurers might need to purchase more cover, including retrocessional reinsurance, and it’s likely that those that can provide capital the fastest and the most easily will be ILS fund managers and some of the biggest reinsurers, while smaller firms might not be able to react so quickly.

In this way the ILS market could become a provider of continuity for those hit hardest by hurricanes, such as Irma, hence offering more incentive to stay in the market than to retreat.

The building up of post-event ILS capital will likely make the flattening of the market cycle even more likely to occur, as the overall volume of risk capital outside the market waiting to enter increases, with the Stone Ridge Post-Event fund alone having $2 billion of commitments, as at January 5^th, 2017.

Post-event funds can also enable the investors within that fund to capitalise on any pricing movements post-event, no matter how short-lived they might be when compared with previous insurance and reinsurance market cycles.

But more importantly they offer the cedents and clients a way to access reinsurance capacity even after the worst has occurred, providing certainty and capital they will need after their reinsurance and catastrophe buffers are eroded.

The price cycle certainly would revert to old patterns if ILS capacity exited the market, however it seems more likely to us that the capital markets could become the key capital source that enables the re/insurance industry to keep operating even after a devastating event, with even the traditional re/insurers pushed to use increasing quantities of alternative capacity as it’s much quicker to mobilise than their equity sources.