European reinsurers using more ILS & third-party capital: A.M. Best

With the low rate environment set to continue in the global reinsurance space, amplified by a lack of major catastrophes and an abundance of capacity, Europe’s reinsurers are increasingly turning to insurance-linked securities (ILS) and alternative capital, according to A.M. Best.

Ratings agency A.M. Best recently published a special report, titled “European Reinsurers Post Strong Performance but Growth Limited,” highlighting European reinsurers burgeoning use of third-party reinsurance and ILS capital.

“There has been an active use of alternative capital markets for balance sheet protection through Industry Loss Warranties (ILWs), risk swap and CAT bonds. Alternative capital is a competitor but also represented a partner in many cases,” notes the report.

Larger reinsurance companies, like Munich Re and Hannover Re leverage a broad scope of financial market tools as a means of transferring risk to the capital markets, explained A.M. Best.

With the low yield environment predicted to remain in the reinsurance market throughout 2015, traditional and alternative capital sources will likely continue to find the space attractive to operate in.

Solidifying this, and a signal that third-party capital from insurance-linked securities (ILS) and other risk transfer mechanisms is perhaps more permanent a feature than some had predicted, A.M. Best notes an expanding investor base.

“Furthermore, alternative capital is increasingly provided by pension funds rather than opportunistic investors, which may be less likely to reallocate their investments given that insurance-linked securities represent only a relatively small proportion of their substantial asset portfolios,” added the ratings agency.

The burgeoning volume of capital from pension funds and alike in the international re/insurance sector is something we touched on here at Artemis a couple of months ago, when covering Beazley’s 9% scale back of its reinsurance business.

Something Beazley’s Chief Executive Officer (CEO) attributed to “a large influx of capital from pension funds that drove down premium rates.”

Although the consistent competition and flooded market are sure to impact firms in different ways, driven by varying methods individual companies adopt to navigate current trends, if used innovatively and sensibly the benefits of alternative capital are apparent.

“Some of the larger reinsurers are using backing from alternative capital providers for themselves, or to offer solutions for their clients,” said A.M. Best.

This has helped to stimulate the continued growth of alternative and ILS capital in the sector, with collateralized reinsurance and catastrophe bonds providing an increasingly mainstream source of risk capacity.

And Catherine Thomas, director, analytics for A.M. Best, noted; “Reinsurers are seeking opportunities for expansion into emerging markets and new lines of business.”

This is clearly evident with the wave of merger and acquisition (M&A) activity currently happening in the global re/insurance space, as firms look to scale up in a bid to remain relevant in tough conditions.

But for the larger firms, where perhaps a merger or takeover isn’t appropriate or necessary, opportunities to offer innovative, profitable re/insurance products to an expanding client and investor base exists within the abundance of alternative and ILS capital.

And with a prediction from Aon Benfield that the volume of alternative capital in the space could reach $150 billion by the year 2018, the need to embrace and utilise the bulk of third-party capital has never been more apparent.

As well as dedicated reinsurers turning to the ILS and cat bond sector for diversified risk transfer solutions, A.M. Best notes that “individual London market participants are embarking upon partnerships with third-party capital to expand their line sizes.”

Notably, “Amlin, Beazley, Catlin and Hiscox have provided specialist expertise to third-party capital providers, managing special purpose syndicates and ILS funds,” states the report.

Examining whether the influx of alternative capital will slow down or halter altogether, the ratings agency warned; “Traditional and alternative capacity remains plentiful and a single large catastrophe is not expected to have a significant impact on current market conditions.”

Although; “Major losses combined with a sustained recovery in interest rates could reduce the sector’s attractiveness to alternative capital.”