Aon’s capital market & ILS activities offset some reinsurance pressure

It’s not just traditional reinsurance companies that can branch out to leverage returns from activities in the third-party reinsurance capital and insurance-linked securities (ILS) space, the same applies to reinsurance brokers.

Many reinsurers have set up third-party capital or ILS focused units, aiming to attract investors to let them manage their capital, sharing a portion of their underwritten risks to provide the investors with a return while benefiting from the management and commission fees.

With the pressure on reinsurance pricing not letting up, large insurance companies retaining more risk, buying less reinsurance in some cases, reinsurance programme consolidation with some moving back to fewer counterparties and prices generally on the decline, it’s important to get revenue from other areas of the market.

For the reinsurers looking to ILS and alternative capital, the hope is that these operations will boost their capacity, allowing them to write larger lines for clients, enable them to write new risks which their own balance sheet does not have the risk appetite to hold and earn fees for managing investors money.

For these reinsurers the question in the future will be whether the third-party capital operations can bring in sufficient income and profit to replace any lost reinsurance business, or decline in reinsurance profitability over the coming years.

For brokers, operating in the third-party capital and ILS space can be lucrative. In fact, the capital markets skills necessary for structuring, arranging, distributing and running an ILS or catastrophe bond book can actually be more profitable than the pure brokerage fee and commission on traditional reinsurance business.

Of course there is not as much business to go around, so you need to be one of the larger players for the capital markets to activity to really move the needle, or you need to be a specialist with a good pipeline of deals that your skills are most suited to.

Aon is a prime example of a broker making a good profit from the capital markets, catastrophe bonds and ILS.

Back in February we wrote that the alternative reinsurance capital and ILS work at Aon Benfield was contributing around 5% to 10% of its overall reinsurance broking and advisory income, a healthy contribution when you consider the, relatively, small Aon Benfield Securities team.

In the Aon plc quarterly report published today the contribution of the capital markets and ILS team at Aon Benfield Securities is mentioned, indirectly, once again. The reinsurance brokerage area at Aon Benfield has felt the pressure of the competition in th reinsurance market, unsurprisingly given its size and reach. In fact, organic revenue from reinsurance brokerage was actually down for the quarter by -4%, as the unfavourable market impact on treaty business as well as a drop in facultative placements was felt.

However, there were some positive areas of the reinsurance business which helped to offset some of the decline in organic reinsurance revenue growth. One of those areas worth a mention was, of course, the capital markets team at Aon Benfield Securities, with growth in the capital markets transactions and advisory business helping to ensure that the organic revenue figure was not worse.

The way this market is playing out right now, both brokers and underwriters are going to end up putting even more focus on their capital markets, ILS and third-party reinsurance capital activities. These activities can be profitable and perhaps for brokers there is less concern about cannibalising traditional business, as the ILS units of brokers can often make more per placement than the traditional side.

The importance of the capital markets units of both brokers and reinsurers are set to rise, which in turn will increase the availability, popularity and widen the understanding of ILS and capital markets backed reinsurance solutions.