Expect to see more innovative ILS structures in 2017: BNY Mellon

Investment management and investments services banking group BNY Mellon recently explored the prospects for global reinsurers in 2017, and the impact market dynamics could have on the insurance-linked securities (ILS) space in the coming months.

In an interview with Artemis, Harold Fudali, head of US corporate and insurance sales and relationship management at BNY Mellon Corporate Trust, highlighted the financial and political headwinds engrossing both the traditional and alternative reinsurance sectors, providing some valuable insight into what might influence the space over the next 12 months.

To begin, with Fudali told Artemis that over the past year, the global reinsurance sector has seen many challenges to business growth, including balance-sheet pressures exacerbated by financial market volatility, and mounting regulatory demands which have been exhausting compliance costs and resources.

Over the next year, Fudali foresees ongoing change and evolution to the sector’s competitive landscape, fuelled by recent financial and political headwinds, which have the potential to create more uncertainty and growth challenges for the sector.

The rest of the interview with Fudali of BNY Mellon, follows:

You mentioned financial headwinds that are expected to continue driving the evolution of the industry, could you explain what impact such headwinds might have on the profitability and investment performance of the sector?

The sector trend toward declining Return-On-Equity (ROE) has challenged many traditional reinsurers to improve on delivering shareholder value. Firms may continue to diversify into new lines of risks to raise price margins [i.e. cyber], focus on their largest or most profitable relationships to manage costs, and continue to pursue consolidation opportunities to achieve operational and growth objectives.

A prolonged low interest rate environment has put pressure on investment portfolio performance, creating a challenge for traditional reinsurers to match assets and liabilities. This has pushed many firms to chase yield down the credit spectrum toward illiquid assets, including insurance linked securities. A first or second rise in interest rates may not necessarily push investors to return to more traditional assets, but a third or fourth rise in rates may have the potential to slow illiquid market growth.

Sticking with financial headwinds, how might a continuation of recent trends impact borrowing in the space?

The influx of cheaper reinsurance capital from alternative third party sources, in what has been a relatively benign catastrophe loss environment, has served to prolong a soft reinsurance market cycle. With property reinsurance prices now 30% lower than five years ago, according to Willis Re, traditional reinsurers will only continue to be pressured for growth, as alternative reinsurance capital is here to stay. In 2016, total market stood at $75B and has the potential to be on track to reach $150B by 2020, according to Goldman Sachs and Artemis data. In 2017, we expect to see more innovative alternative capital structures that serve to broaden reinsurance coverage, further reduce capital costs and enhance market access for new sponsors. Finally, the disparity in global interest rate environments (e.g. US vs. EU) could widen the cost gap for capital market borrowers in 2017.

Technological advances and the need for efficiency across the sector continues to drive the creation of new business models, do you anticipate any financial headwinds impacting this?

Regarding new style participants, insurtech is changing the competitive landscape through more innovative distribution and cost models. While it is increasingly attracting direct and indirect funding from traditional and non-traditional participants, a lack of transparency to assess the return on investment may create access barriers for many.

As you mentioned earlier, political headwinds are combining with financial market challenges, ultimately intensifying uncertainty. What impact might ongoing political headwinds have on regulatory oversight and market operations, in the coming months?

The evolving regulatory landscape creates a significant cost and resource challenge for the sector, as a well as the potential for competitive disparity across jurisdictions. For instance, in the US, a Trump presidency could bring unknown regulatory changes such as the potential repeal of Obamacare (which will depend on how much is cut) but if cut, could free-up government spending yet leave the insurance and reinsurance sector and consumers to cover rising medical costs. The potential repeal or modification of provisions in the Dodd Frank Act where the possibility of rising protectionist values could impact the current Credit For Reinsurance Collateral Reform and maybe cause a re-instatement of full collateral requirements on non-admitted reinsurers to protect US cedants. While the US and EU have recently negotiated a covered agreement that recognizes each other’s insurance and reinsurance oversight regime, the final agreement must still be passed by each government’s legislative process. Furthermore, a potential US administration regressive stance on climate change could also cause significant impact to this sector, as they are concerned with managing the fall-out from environmental and catastrophe risks.

A rising global populist repudiation theme has the potential to influence how the sector may operate (or may be regulated) in certain locations, like in the EU. With Brexit negotiations about to get underway, and the potential for anti-EU forces influencing other national elections in the Netherlands, France and Germany as they go to polls in 2017, there is significant potential that this uncertainty may delay business decisions for the sector

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