Third-party capital from insurance-linked investors can be expected to rush into the reinsurance market after the next major loss events, and while this won’t make the pricing cycle disappear altogether, it will reduce payback to reinsurers and temporary capacity shortages, according to WCMA.
For a number of years now the expectation that the reinsurance pricing cycle will never be the same again has increased, with the majority of the market now accepting this to be the case. When major losses do occur, there may be price spikes but likely on the basis of the view of risk changing, rather than purely recouping payback.
Willis Capital Markets & Advisory (WCMA) discusses this in its latest catastrophe bond and ILS market report, saying that the expected in rush of capital from ILS funds and their third-party investors will likely dampen any hoped-for price rises across the reinsurance market.
Bill Dubinsky, Head of Insurance-Linked Securities (ILS) at WCMA, explained that there is an expectation that losses are coming the way of both reinsurance firms and ILS fund players, with the climatic conditions aligning for a potentially more active U.S. wind season in 2016.
“With hurricane season now underway, combined with the expectation that 2016 will be a La Niña year, there is unshakeable sentiment among many involved in this year’s June and July 1 U.S. property catastrophe renewals that reinsurers and ILS investors will both take significant cat losses,” Dubinsky said.
But how the market reacts is less certain, although WCMA is convinced that the market will not suffer from capitalisation or capacity issues anymore, with plenty of capital ready and eager to move into the ILS market at the first sign of major events.
He continued; “What happens next if this comes to pass depends upon whom you ask, but we expect capital will rush into the market post the next event. The historic pricing cycle will not disappear altogether but temporary capacity shortages and payback will significantly reduce impact compared to the past.”
Dubinsky notes in the WCMA report that some might suggest that the market saw heavy losses in 2011 and 2012, but those events did not move the market significantly and even larger losses are possible and expected.
The question is though, how will the traditional reinsurance and ILS market both react after a $75 billion or greater catastrophe loss event?
Dubinsky explains some of the dynamics that may play out, when this larger loss occurs; “Traditional reinsurers expect a hard market and payback. Ceding companies expect to enjoy the benefits of multiyear capacity both from the traditional markets and the capital markets with little price movement as investors quickly replenish any lost capital.
“Capital markets investors expect to shine with ceding companies as a result of contract certainty and quick claims payments in contrast to coverage disputes with traditional reinsurers. Capital markets investors expect that possible reinsurer downgrades or insolvencies will show the value of collateral.
“In contrast, reinsurers hope that the value of reinstatements even at the princely rate of 1@100% will prove the value of a leveraged rated balance sheet.”
But what is clear, capital sources aside, a large loss will show up winners and losers on both sides, as underwriting discipline from the last few years suddenly becomes more apparent, as “superior underwriting is easier to identify when the wind blows.”
There is a question about where capital is most efficiently reloaded, whether that is into a new class of Bermudian (or other location) reinsurance firms, or whether ILS funds and collateralised reinsurance sidecars are the easier vehicles to reload and deploy capital quickly through.
“At the risk of talking our book,” Dubinsky says “We expect ILS capital to rush in. The pricing cycle will not disappear altogether but temporary capacity shortages and payback will have a significantly reduced impact relative to the past.”
However, a more uncertain or less well-modelled (and expected) loss event could have different effects. Dubinsky continued; “If we get a similar loss from an unexpected source such as a Texas earthquake the cycle could still return with a vengeance.”
But until we see this large loss, it is hard to say exactly how the capital will move into the market, what will be the most effective vehicle for mobilising underwriting capital quickly and whether it will be traditional or alternative side of the market that will prosper in the aftermath of a major catastrophe loss event.
Dubinsky commented; “What seems indisputable is that regardless of your view on all of these questions, it actually takes a loss to prove or disprove these pet theories. As a market, we spend a lot of time thinking about a continuation of the status quo in the absence of disruptive influences. If you buy into the thoroughly non-scientific and perhaps irrational views expressed over the last few months, disruption will soon deliver some answers to important questions.”
The rush of capital seems assured, especially if there is any chance of even slightly increased rates available for underwriting. The how’s and why’s, of who benefits most from this remains to be seen.
WCMA’s latest cat bond market report can be accessed here.
Artemis’ Q2 2016 Catastrophe Bond & ILS Market Report – A quiet quarter fails to keep up with investor demand
We’ve now published our Q2 2016 catastrophe bond & ILS market report.
This report reviews the catastrophe bond and insurance-linked securities (ILS) market at the end of the second-quarter of 2016, looking at the new risk capital issued and the composition of transactions completed during Q2 2016.
Q2 2016 issuance failed to hit $2 billion, with just $1.624 billion of new risk capital issued from 14 transactions. This is the first time since 2011 that Q2 issuance has failed to reach $2 billion.