Reinsurers increasingly see ILS capital as an opportunity: Xuber report

While the glut of third-party reinsurance capital continues to exacerbate the softening re/insurance marketplace, industry leaders and executives increasingly view ILS features and capacity as an opportunity, according to Xuber’s latest Global Reinsurance Survey.

The international insurance and reinsurance market began 2016 with a series of headwinds that have persisted for some time, epitomised by further rate reductions at 1/1, April and June renewals, and a supply/demand imbalance that’s exacerbated by the rise of alternative reinsurance capital.

As a result, and somewhat unsurprisingly, industry leaders and executives that participated in Xuber’s latest reinsurance market survey view the softening landscape as the biggest challenge facing the sector.

“With investment returns so low worldwide, there is an attraction to the re/insurance markets, via ILS funds, and this surplus of capital is squeezing down rates,” said one survey respondent.

Other main concerns include regulation, maintaining underwriting discipline, boosting returns in the current low interest rate environment, and competition from third-party reinsurance capital. The latter, while the fifth top concern for reinsurers in the softening landscape, is viewed as less of a concern than last year, according to Xuber’s 2016 Global Reinsurance Survey.

Furthermore, the recent growth, maturity, and sophistication of the insurance-linked securities (ILS) market and its investors have also resulted in the presence of third-party capital being viewed as a top opportunity for reinsurers.

The large growth of the collateralised reinsurance, and catastrophe bond market in 2015, and during the first-quarter of this year, suggests that ILS will continue to grow its share of the overall reinsurance market. Cat bond issuance in Q1 2016 broke records, with outstanding capital at the end of March of more than $26 billion.

As the asset class has matured and become more widely accepted in global insurance and reinsurance industries, so too has its utilisation by international re/insurance companies, who increasingly view ILS as an opportunity.

“Competition from third-party capital is not the correct phrase: it is the opportunity to utilise third-party capital. In other words, you can go out and say ‘if you want to get into the business, that’s great as you can have some of my business and pay me for the privilege of doing so,” said one respondent.

49% of respondents’ placed competition from third-party, or alternative reinsurance capital among their top five concerns, compared with 66% in last year’s survey, explains Xuber. While 46% of respondents’ put competition from third-party as an opportunity.

The survey results reveal that industry leaders and executives view diversification of business portfolio as the top opportunity, overall, with 75% of respondents putting this in their top five.

The use of ILS capital that’s available from a growing base of capital markets investors is a valuable source of diversified capacity, underlined by efficient, and sophisticated features that supplement re/insurance business operations.

The ILS market is increasingly looking to access new perils and regions across the globe, and as more industry players look to work with alternative capital alongside their own balance sheets, its influence and growth is likely to persist.

“ILS is now seen as a more mainstream financial instrument, and growing numbers of reinsurers have adopted the new reality by embracing this, hence our survey has identified this as an opportunity. Traditional reinsurers realise they have the deep understanding of catastrophe risk that the capital markets do not, and they are using this knowledge to take capital from third parties and invest it for them,” said Xuber.

In light of this, it’s worth remembering that ILS investors are increasingly willing and demanding to understand the underlying risks of their investments in ILS. A desire to optimise risk portfolios, increase diversification and efficiency via investing in a largely uncorrelated asset class has driven heightened market sophistication.

A trend, that’s resulted in certain ILS players noting a desire to get closer to the original source of risk.

One way to alleviate some of the pressures of the softening landscape is to remove some of the excess capacity and look to deploy it in underserved, underinsured regions of the world. Something the features and mechanisms of the ILS sector can assist with on all fronts.

A challenge and opportunity for the entire risk transfer landscape is to close the global protection gap (difference between economic and insured losses post-event) and improve disaster resilience worldwide. And entering underserved regions with the capacity and tools of the ILS and re/insurance sector is an opportunity that will require innovation and cooperation.

When ILS really started to expand its share of the reinsurance market questions were raised surrounding its longevity post-event, and although the general view is that it’s here to stay, one survey respondent did stress that capital markets investors remain untested.

“The market would be well-served by a catastrophic loss that severely affects the investors in alternative capital. So far, these investors have been lucky. But what the market needs from this capital is that it is fully committed to the market for the long-term and such a cat event would likely cause an exit for short-term oriented players,” said an executive.

Only time will tell how the ILS market reacts when the next significant loss event, or series of major events disrupts current market trends, but as with any market when a large loss occurs, it’s possible some will leave. Although this capital could be quickly replenished via those sat on the sidelines, waiting for returns to rise before entering the space.

Adapting to the presence of ILS capital is challenge for re/insurers, and will become more so as the asset class broadens it reach. But as survey respondents highlighted, the opportunity to utilise efficient, diversifying, and innovative features is one that market players are increasingly embracing, ultimately supporting further convergence of the industry.

Finally, it’s encouraging that the percentage of executives responding to the survey who view ILS and third-party capital as a concern has dropped. This shows that ILS is both becoming increasingly mainstream, and also that executives are now able to recognise the benefits of embracing the capital markets and bringing it into their businesses, either in the form of reinsurance or to manage and partner with ILS investors and capital providers.

As comfort grows, this concern drops, and as a result the volume of capital market capacity making its way into insurance and reinsurance markets through direct, ILS style structures will likely see continued growth.

You can download a copy of the survey results from Xuber here.

Also read our piece on last year’s survey:

– Soft market, third-party capital top reinsurance survey concerns: Xuber.