Collateralized reinsurance capacity is disrupting the traditional market

It’s earnings season in the insurance and reinsurance markets and many companies have been holding half-year earnings calls during which their senior executives answer questions from analysts on company performance and the market itself. That means it’s a good time to see what reinsurance company execs are saying about the collateralized and capital market backed reinsurance alternatives and how they are impacting, or otherwise, the traditional reinsurance marketplace.

First off we thought we’d look at what Bermuda reinsurer PartnerRe had to say. PartnerRe are active in collateralized markets as an investor in catastrophe bonds and insurance-linked securities but tend to underwrite on a more traditional basis. Costas Miranthis, President and CEO of PartnerRe, said regarding the June/July reinsurance renewals; “Capacity was plentiful and there was no market dislocation. On the margin, I believe collateralized capacity did have an impact in moderating price increases. Where we go from here will to a large extent depend on what happens in the remainder of the year.”

So PartnerRe join the ranks of reinsurers who believe that collateralized capacity had some impact on the renewals season either directly on rates, due to the increased available capacity, or on margins of business they managed to underwrite. This is evidence of the disruptive effect that collateralized capacity, be that from reinsurance or ILS and cat bonds, can have on the traditional market.

Next we looked at another Bermudian reinsurer, RenaissanceRe. RenRe see themselves as in a unique position to actually take advantage of the collateralized markets due to their sidecar entities. Kevin O’Donnell, EVP and Global Chief Underwriting Officer, said; “There has been a lot of discussion about the collateralized markets, and I think we’re uniquely position where we can sell across the spectrum of products that people want to buy. So, we have partner balance sheets, we have the ability to provide collateralized products, and the ability to provide traditional reinsurance on rated balance sheets. So, from a competition standpoint, I think we’re uniquely well positioned.”

RenRe do see the competitive nature of collateralized capacity but believe that their operational setup allows them to work with collateralized capacity and still manage the basis risk between reinsurance and collateralized products, so as well as recognising that there is a degree of competition they also believe that collateralized capacity presents an opportunity.

Kevin O’Donnell continued to say that he see’s collateralized markets now playing across the distribution of reinsurance, where as it used to be constrained to the higher end of reinsurance, he said; “As different funds formed with different strategies, they participate at different levels within the reinsurance tower.” He stressed that he doesn’t see it as just competition as it creates some opportunity for them to buy from the collateralized markets to manage their basis risk.

This is quite interesting as these comments suggest RenRe see’s collateralized capacity as a more permanent feature of the market providing both competition in some areas of the market but also a useful service and source of retrocessional capacity for reinsurers. Perhaps what we are seeing is a healthy disruption of the market which could result in a new insurance-reinsurance-retro market chain with collateralized capacity playing a part at various places within the chain.

Finally we looked at what Bermuda reinsurance group Validus had to say in their earnings call. Validus are a large reinsurer, with reported capital and surplus of $3.3 billion, and have just become the 20th foreign reinsurance company to be admitted to offer reinsurance in Florida while posting a reduced level of capital, which will open new avenues for their business.

Ed Noonan, Validus’ Chairman and CEO, said that “The catastrophe reinsurance market saw a significant amount of new capacity enter through collateralized companies backed by institutional investors”, referring to the second quarter of the year. In some cases, he said; “This was disruptive as these companies occasionally deploy capital at attachment points and in concentrations that we would not expect.”

We’ve reported recently that others in the market foresee collateralized capacity becoming a more permanent feature of the reinsurance market and this seems destined to be the future for reinsurance where capital market backed capacity, in whatever structural form, provides an ever more competitive and disruptive complement to the traditional reinsurance market. Collateralized players look destined to be able to compete ever more closely on certain attachment points and layers of reinsurance business, by matching risk to their desired return profile.

Ed Noonan of Validus agree’s and he commented in the earnings call; “We believe this will be an ongoing factor in the market, particularly for retrocession, national and global accounts in the Florida market. However in general, we find this capacity to be more complementary than competitive to us in the marketplace.”

Of course Validus themselves are also offering collateralized capacity through their AlphaCat 2012 vehicle, which launched earlier this year, and the PaCRe venture. Ed Noonan see’s this as a permanent feature of their business model; “We have believed since our founding that catastrophe risk would be an attractive asset class for institutional investors.” Validus see investor backed reinsurance capacity as generally complementary due to the returns it seeks depending on the types of investors involved. Hedge funds tend to opt for higher returns where as pension funds and similar investors opt for a lower, more stable return profile. Validus believes this complements their business model as they can play in all areas; traditional, higher rate and more stable collateralized programs.

These comments from Validus are particularly interesting as they provide further evidence of the way collateralized investor backed reinsurance capacity is impacting the market. Traditional reinsurance players are finding that collateralized capacity is able to accept risk on different terms to the way they have traditionally done business. This is putting collateralized reinsurance in direct competition with traditional reinsurance during renewals, exactly as we have witnessed in recent months where catastrophe bond and insurance-linked security (ILS) capacity has done the same.

This is definitely providing a disruptive element within the reinsurance market right now and it will be interesting to see how collateralized reinsurance and risk transfer capacity plays a role at the end of the year. It is likely that we will see it playing a growing role, creating further disruption, and playing a competitive role versus some traditional reinsurance players who are not geared up operationally to take advantage of it.