What if alternative capital was indistinguishable from traditional reinsurance?

Costas Miranthis, President and CEO of Bermudian reinsurance firm PartnerRe, said that demand for traditional reinsurance capacity is not suffering in the face of increased competition from alternative capital, rather the key impact has been on pricing.

With capacity funded by capital market investors and collateralized reinsurance vehicles increasingly flowing into the space, Miranthis said that increasingly the alternative reinsurance capital is morphing into traditional capacity, but with new owners who have different return requirements.

This is an interesting statement from Miranthis. The capital markets involvement in reinsurance is often referred to as convergence, but what happens when alternative reinsurance capital becomes sufficiently similar to traditional reinsurance so as to be indistinguishable from it?

As capital sources converge a natural step is for new products to evolve which at times will blur the lines between types of capacity and where it is sourced. To many reinsurance buyers now, alternative capital is becoming part of the traditional reinsurance renewal cycle, just another product in the risk transfer toolbox allowing insurers and reinsurers to optimise their returns by laying off risk to capital sources with the appropriate risk appetite and cost of capital.

So as collateralized reinsurance products and instruments such as catastrophe bonds become increasingly indistinguishable from their traditional reinsurance counterparts, where and what are the differentiators? Often for buyers it comes down to the cost-of-capital and risk appetite, with the capital markets and ILS capacity providers offering lower cost capacity than large, traditional reinsurers in some cases.

That translates into pricing and this is where Miranthis feels the most pressure at PartnerRe. Miranthis said that his firm still sees plenty of demand for traditional reinsurance capacity, but that alternative capital in the reinsurance market is the key challenge that firms such as his are facing right now.

ILS, catastrophe bonds and alternative reinsurance capital were initially seen as a complement to traditional products, perhaps more suitable for taking high levels of reinsurance programs in well-modelled peak catastrophe zones. That has changed in the last couple of years and alternative capital is now in use across a much broader swathe of the reinsurance market, even stepping outside of catastrophe risk into areas once thought the sole domain of the traditional reinsurer.

However, Miranthis’ point was that while alternative capital is prevalent and is offering reinsurance cover at lower prices in some cases, PartnerRe is still seeing plenty of demand for traditional capacity, with some clients still preferring the traditional reinsurance relationship and product structure.

Miranthis said; “It’s not the product itself that’s different, but a lot of that goes through a transforming vehicle. So not a lot of our clients want to have all their cat exposure through a bond or through a single shot collateralized cover.”

The traditional product still has a draw for many reinsurance buyers, PartnerRe feels, but the market is not without challenges, one of which is certainly alternative capital.

Miranthis explained; “So there is demand for traditional reinsurance. Now, the challenge that we face, because there are a number of alternative products out there, it’s pricing, for pricing is the marginal capacity that makes the difference, and that’s why we see the cat reinsurance product as being challenged. It’s not because there isn’t demand for the traditional product. It’s because the alternative is influencing pricing on the margin.”

Miranthis went on to explain that as a large reinsurer PartnerRe has some luxury of being able to decline to underwrite business it does not feel is well priced, or that has too expansive terms. This allows PartnerRe to be a bit more choosy in the business it underwrites than perhaps some of its smaller competitors can be.

But here is the issue for reinsurers generally. Being picky about which reinsurance business you underwrite is fine while there remain opportunities that you are able to write on an acceptable cost of capital basis.

However, as lines blur between traditional and alternative, what happens if pricing expectations come down to a level where demand for reinsurance is increasingly based on price and value rather than on relationships? As alternative reinsurance capital becomes increasingly less distinguishable from traditional and structural features and terms become more similar, what happens if price increases further in importance as a selling point? What if the price advantage of the capital markets begins to seriously erode reinsurance firms core markets?

If alternative capital backed reinsurance becomes significantly indistinguishable from traditional reinsurance, in the buyers eyes, what do the traditional reinsurers have left to offer?

This is a serious question, not a flippant ending to a speculative article. If the current trends of lower reinsurance pricing, increasing volumes of capital market money in reinsurance and ever more flexible alternative reinsurance structures continue to accelerate, where do the reinsurers turn to next? If alternative capital was indistinguishable from traditional reinsurance, but still lower cost, what would the buyers choose?

The ILS market and those managing alternative or third-party reinsurance capital are continuing to work to level the playing field in terms of flexibility and structural features, bringing ever more buyers to alternative capital as a result. As these efforts continue the lines between types of capacity will eventually dissolve, leaving reinsurance purchase decisions to be based on trust, cost, value, and innovation, four areas that traditional reinsurers may now find themselves forced to compete on. Playing the relationship card alone may not cut it anymore.