Alternative capital growth driven by collateralised reinsurance: Swiss Re

Global reinsurer Swiss Re said at a media and investors briefing today that it believes the recent growth in alternative capital in the reinsurance market has largely been driven by collateralized reinsurance, above inflows into other instruments such as catastrophe bonds, insurance-linked securities and industry loss warranties.

Speaking at the event held in Monte Carlo today at  annual reinsurance Rendezvous, senior Swiss Re executives outlined the reinsurers thinking on alternative reinsurance capital, clearly the hottest topic at this years reinsurance event, as well as outlining their response to it.

In terms of the amount of capital provided by alternative sources, such as institutional entities like pension funds, hedge funds and other investors, Swiss Re said that as a percentage of the U.S. reinsurance market it is only now back at a similar high point seen in 2007.

Swiss Re explained that it has seen alternative capital take a bigger role in reinsurance before and learned from it the first time round, putting it in a position where it knows how to deal with it and also leverage it to support its own capital and risk transfer needs.

Swiss Re has seen the inflows of capital coming into the reinsurance market from alternative and third-party sources. It believes that these inflows may be sticky but waits for a real test before it will commit to that. However Swiss Re sees alternative capital as perhaps a little stuck in property catastrophe risk and while it expects it to expand it doesn’t see this as a direct threat.

Most of the growth in alternative capital is coming into the market in the form of collateralized reinsurance, according to Swiss Re. In this area alternative capital directly competes with traditional reinsurance, but in a limited area of the market currently.

The chart below shows the split of different reinsurance products which utilise alternative capital showing that collateralized reinsurance now outstrips catastrophe bonds and ILS, in Swiss Re’s opinion.

The alternative reinsurance capital product split

This growth of collateralized reinsurance capacity has helped to take alternative capital to approximately 22% of the U.S. catastrophe reinsurance market. This is now back to the highs seen in 2007, although in real dollar terms the alternative reinsurance capital market is much larger than in 2007 as back then it was largely ILS based.

This chart showing the growth of the alternative reinsurance capital market clearly shows the impressive rate of growth of collateralized reinsurance over the last two years as it became the dominant form of protection using alternative capital, in Swiss Re’s view.

The size of the alternative reinsurance capital market

This final chart below shows an interesting insight into catastrophe bond spreads and pricing. Spreads have fluctuated, in some cases wildly, over the last few years. This has been caused by demand supply dynamics and other events impacting secondary market price expectations.

This chart shows that since April of 2013 catastrophe bond spreads appear to have stabilised, roughly around the 6% mark which is almost half where they were in 2009. Swiss Re said that it believes that this is evidence of cat bonds having hit a low pricing point and it suggested that this stability may remain as capital continues to comes into the market, unless we see large catastrophe events creating losses.

Catastrophe bond spreads stabilise

Despite the influx of alternative capital over the course of this year and the resulting impact on rates and pricing, Swiss Re believes that it will see a successful renewal in January and believes that rates will remain attractive. Natural catastrophe reinsurance rates are expected to drop further, the reinsurer said, but other opportunities within its broad book of business would compensate for that.

“We take the inflow of alternative capital seriously, but we are not alarmed by it. Swiss Re can take advantage of its capital markets expertise and – at the same time – compete successfully as a full service provider,” commented Swiss Re’s Group Chief Underwriting Officer Matthias Weber. “Smaller, less diversified reinsurers, however, will be under significant pressure,” Weber added.

Swiss Re expects its opportunities will grow, with a forecast that demand for catastrophe reinsurance will double in emerging markets and at the same time increase in size by 50% in mature markets by 2020. Swiss Re believes it is well positioned to continue to take a large share of this business.

“Especially in today’s connected world, risk transfer is getting more complex. Being able to deliver tailor-made solutions to your clients for very different and challenging scenarios will be a key differentiator to succeed in the market,” said Christian Mumenthaler, CEO Reinsurance at Swiss Re. “We provide a truly global client service model with in-depth expertise and risk knowledge transfer.”

Swiss Re also sees opportunity in other lines of business such as liability, where rates are still hardening in some regions. So despite price softening in core catastrophe lines of business Swiss Re is not afraid of this leading to any structural change in the reinsurance market.

Looking further ahead Swiss Re believes that ILS pricing is as low as it can go and wider catastrophe reinsurance pricing will stabilise in 2014. It sees the threat from alternative capital as largely contained to smaller and less diverse reinsurers, saying that its business model was not at risk from ILS.

The reaction of traditional reinsurers to the focus on alternative capital and ILS at Monte Carlo has been fascinating to watch. Some reinsurers have ignored suggestions that the reinsurance business model could be fundamentally changed by this trend over the next ten or twenty years, an opinion held by a number of people we have spoken to.

Swiss Re is one of the oldest reinsurers, celebrating 150 years of business in 2013. The long relationships it has with its clients will be a difficult bond for alternative capital to break down and this could be one of the more interesting changes in the markets dynamic to develop in coming years. If alternative reinsurance capital continues to grow rapidly it will begin to pressure these relationships and even the most loyal clients may begin to look outside of their typical panels of reinsurers.

It may take a major loss event or test of some description for alternative capital to really prove its staying power before we begin to see the very large global reinsurers like Swiss Re begin to discuss potential structural change. It’s likely that any changes to the reinsurer business model will become evident in property catastrophe specialists first, just the group of companies that are right now positioning themselves to embrace alternative capital with their asset management and capital markets units.

Swiss Re said that it uses alternative capital itself for retrocession, to assist its clients and that it will continue to do so. If the current trend continues and reinsurance grows further as an asset class, Swiss Re may one day find itself having to look more seriously at whether it begins to more broadly utilise third-party capital within its own business and even begin to manage it.

More reading:

There are so many reports and commentaries coming out on alternative reinsurance capital and ILS in the run up to and at the Monte Carlo Rendezvous event that we felt it worth highlighting some other reading on the topic, all from the last week or so, which you can find below (most recent first):

– Alternative capital may squeeze out equity capital in reinsurance: Willis Re

– Lloyd’s Nelson: Alternative capital can help insurance grow to $2tn by 2025

– Insurance-linked securities market calling for innovators: PwC

– Catastrophe bond market may hit $23 billion by end of 2016: GC Securities

– Alternative capital as significant to reinsurance as emergence of Bermuda: S&P

– Demand for alternative reinsurance instruments and ILS to continue: Fitch

– Alternative capital the biggest challenge for traditional reinsurers: Moody’s

– Lloyd’s Nelson warns on ‘systemic’ risk of alternative reinsurance capital

– Broker facilities an opportunity for third-party capital to expand reach?

– Opportunity for reinsurers to learn from ILS: Aon Benfield CEO

– Capital markets investors boost global reinsurer capital to $510 billion (including a useful list of links to many alternative reinsurance capital initiatives that we have covered previously)

– Strong capital inflows bring ILS & cat bond market to new high: Aon Benfield

– Alternative capital a disruptive force in reinsurance: Goldman Sachs