Alternative capital vehicles provide “competitive advantage” – Moody’s

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Alternative capital vehicles operated by traditional reinsurance firms are increasingly an area of competitive advantage for the sector, according to rating agency Moody’s Investors Service, something that may accelerate the shift towards re/insurer managed ILS assets.

moodys-logoMoody’s maintained its stable outlook on the global reinsurance sector today, citing strong balance-sheets, rising profits and benefits driven by sector consolidation as three key areas of rating consideration.

“Good risk management and underwriting discipline mean reinsurers’ balance sheets remain strong, while modest price hikes following the severe natural catastrophe events in 2017 and higher interest rates will bolster profits,” James Eck, Vice President — Senior Credit Officer at Moody’s said.

He went on to explain that “Both factors underpin the continued stable outlook on the sector into 2019,” adding that “Recent M&A, diversification initiatives and corporate strategy shifts have also improved reinsurers’ overall credit profiles.”

Moody’s also highlights some increased reinsurance demand, another area that is positive for reinsurance firms going forwards, which the rating agency says could serve to add some balance between supply and demand.

However the firm said that pricing power is likely to evaporate, explaining that “weak pricing power during the mid-year reinsurance renewals suggests it may be harder to maintain pricing gains moving into the key January 2019 renewals.”

But pressure is going to remain and particularly on smaller reinsurers, as well as those that fail to find new M&A partners.

However, for some reinsurers, there may be a differentiator available that could help them in their quest to sustain their businesses through the new reinsurance market normal, alternative capital.

Moody’s notes that, “For reinsurers with strong risk modeling capabilities and marketable underwriting skills, managing alternative capital vehicles will provide a distinct competitive advantage in the years ahead.”

Adding that these reinsurers can, “Manage alternative reinsurance capital investments for third parties, trading volatile underwriting income for a more stable stream of management fee income and profit-sharing arrangements.”

Providing their underwriting and analytical platforms to third-party institutional investors, by running alternative capital vehicles alongside their own balance-sheets, has been a part of the reinsurer strategy for the last decade or more.

But now it’s an accepted source of differentiation and additional revenues, making it an area that reinsurers can find some solace in at a time when their own returns-on-capital continue to wane.

“While alternative capital has strained reinsurance pricing and profitability for years, it has also enabled reinsurers to lower their total cost of capital, helping them manage peak risk exposures and improve risk-adjusted returns,” Moody’s said.

So finally more of the reinsurance sector is leveraging ILS and alternative capital for more than just a cheap hedge, realising that the efficiency of capital markets structuring and institutional capital can actually help them to add revenues to a business model that requires sustenance at this time.

Moody’s notes that alternative capital is helping reinsurers to enhance their competitive position, helping them to provide larger line sizes and underwrite risks that may not fit within the risk-return parameters of their own rated balance-sheets.

“Reinsurers that can offer risk transfer solutions to clients across both rated balance sheets and more flexible alternative capital platforms will have a distinct competitive advantage in the years ahead,” the rating agency reiterated.

Before going on to highlight that after the recent announcement of Markel’s acquisition of Nephila Capital, Moody’s now believes that as much as 40% of alternative and ILS capital is now managed by reinsurers through their affiliated sidecars, collaterized reinsurance vehicles and managed ILS funds.

This is significant, as the shift from independently managed ILS assets to reinsurer managed ILS assets has been accelerating in the last year, helped by acquisitions.

How this plays out and whether re/insurers can truly use this to assist their competitive advantage, or whether questions of interests emerge for some, remains to be seen.

But it is clear that re/insurers now recognise the importance of having their own alternative capital management activities and as a result this shift towards re/insurer managed ILS assets may continue to accelerate over quarters to come.

Also read:

New reinsurance normal wins out, optimism diminished: A.M. Best.

Reinsurers need to offer more than just capacity, ILS can help: S&P.

Fitch ups reinsurance outlook to stable, but lower returns expected.

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