Third-party capital providers to play growing role in catastrophe reinsurance market

The latest report on the insurance-linked securities and catastrophe bond market in the second-quarter to emerge comes from Willis Capital Markets & Advisory (WCMA), the capital market divison of global broker Willis. The report looks back at issuance in Q2 2012, comments on specific deals and gives some insight into the secondary market. In the report, WCMA conclude that going forwards the catastrophe reinsurance market is going to see continuing and growing involvement of third-party capital providers.

Third party capital comes in many forms. It can be backed by companies already involved in the reinsurance space, hedge funds, dedicated investment vehicles (often in the form of sidecars) accepting inflows of capital from any interested parties and dedicated investment funds such as ILS funds and collateralized reinsurance writers. The influence of this type of capital on the wider catastrophe reinsurance market has often been limited as the capital has tended to be speculative, dipping into the sector to be put to work when rates are attractive and then pulling out when conditions are less conducive to making a good return on reinsurance. The trend being seen in the last twelve months seems to be moving towards third-party capital becoming a more permanent, and growing, feature within the reinsurance market.

WCMA believe that we could be seeing the early stages of a strategic shift in the catastrophe reinsurance market as third-party capital providers look set to take on increasing amounts of peak catastrophe risk in the future. They say that private unlisted catastrophe reinsurance vehicles, such as sidecars, along with a growing number of specialist catastrophe risk funds will take an increasing share of the catastrophe risk market in collateralized form over time.

WCMA note that these types of private unlisted vehicles, or fund structures, are attractive to reinsurers as they allow them to earn profits from capital relationships, still using all of their underwriting skills and resources but without stressing their capital requirements or introducing volatility. This makes the sidecar model so attractive, but also reinsurer involvement in external catastrophe risk funds or ILS funds. It’s also an attractive model as the capital can be agile and an established vehicle can be expanded quickly as investor appetite and reinsurance market rate conditions allow or dictate.

On the ILS and catastrophe bond market the report suggests a positive outlook for the sector and WCMA say that the market is in a good place for continuing success. Bill Dubinsky, Head of ILS at WCMA, said; “The current market outlook is very encouraging. Reduced risk spreads as a result of strong investor demand and available capital should stimulate increased issuance from sponsors in the future. In the absence of a significant catastrophe, we would expect the total issuance for this year to be in the $5.5 billion to $6 billion range.” The report also notes that any significant catastrophe events could help to stimulate further issuance in the coming quarters.

We’ve written about this trend a number of times in recent weeks, and WCMA aren’t the only people predicting growth in the third-party capital backed reinsurance space.

The LGT ILS team recently forecast that capital market participation in reinsurance would grow faster than the traditional reinsurance market. That truly would be a shift in the global reinsurance markets make-up and suggests a much more influential role for this type of investor-backed reinsurance capacity on pricing and availability of reinsurance in the future.

We’ve already begun to see capital market backed inflows of capacity having a marked influence on pricing and helping to make catastrophe bonds more competitive with traditional forms of cover.We’ve also written about the pressure traditional reinsurers in Bermuda have been feeling as capital markets capacity helped to subdue rate rises. This is all leading to more meaningful pressure on pricing from alternative capacity providers including ILS and a decoupling of pricing has been noticed and may well continue.

Expect these sorts of influences and trends to continue if the predictions for more third-party capital in the reinsurance space come true.

You can access the full report from Willis Capital Markets & Advisory here.