The trend for reinsurers to launch vehicles providing alternative forms of reinsurance capital continues apace, with sidecars, catastrophe funds, insurance-linked security funds and collateralized reinsurance vehicles, being backed by some of the largest traditional reinsurance firms this year. With more of this activity on the horizon from other stalwarts of the traditional reinsurance sector it’s timely, and encouraging, to read quotes which suggest that this trend could change the sector for the better.
This recent article in the Bermuda Royal Gazette discusses comments made by participants in a panel session at the annual Bermuda (Re) insurance Conference, sponsored by PwC and Standard & Poors, which was held on the island earlier this week. It contains some really good quotes which drive home the reason reinsurers are looking closely at the alternative reinsurance capital space, how they can leverage investor capital within their underwriting and why some are deciding to get involved.
The comments from panel members suggest that reinsurers initially saw the alternative capital players as a threat and blamed them for keeping rates down. That’s a sentiment that was prevalent earlier this year and one we still hear occasionally from some traditional reinsurers with the January renewals fast approaching. Frank Majors of Nephila Capital, an ILS and reinsurance asset manager with around $7 billion under management, said that he believes some are realising that they better join in and get involved with the growing sector.
Majors said that reinsurers should not think about the rate environment, saying that it rates are volatile and reinsurers are essentially just along for the ride. He commented; “What the rate environment is shouldn’t matter, it should be your return on equity.” This is a very important point and Majors has hit on something that some innovative reinsurers are beginning to move away from, a reliance on high rates, and are instead finding new ways to profit even in lower rate environments.
Majors explained to the audience that insurance-linked securities, if utilised in the right way, could result in a change to the reinsurance landscape, likely for the better and this could help companies trade at higher book values.
The Gazette article has a great quote from Majors which explains this well:
“If they (reinsurers) can isolate and outsource the pure cat risk then they can hold less capital. They can hold capital that commensurates with the risk that they are keeping. So you’ll see smaller companies that are valued for their expertise. If reinsurers held less capital and the capital is appropriate to the risk they maintain, then they can trade at much higher multiples. You get paid for expertise.”
“The occurrence or nonoccurrence of a cat is a commodity risk. Underwriting expertise is a value ad. Get rid of the commodity risk as cheaply as possible, highlight the value ad, hold less capital, and you’ll see higher multiples and higher returns on equity.”
Majors also said that the alternative capital players can bring lower cost to capital where reinsurers hold onto the residual risk but the alternative markets take on the risk of occurrence or non-occurrence of catastrophe events in its cleanest form.
Finally the panel said that the alternative reinsurance capital should be seen as complementary not competitive with traditional reinsurance cover and should be seen as a way to help grow the market.
A lot of this comes down to understanding where risk can most efficiently be transferred to and where capital can most efficiently be put to work. That does require reinsurers to learn to operate with an asset management type approach. There’s a learning process for re/insurers to enable them to intelligently transfer risk to the most efficient form of capital prepared to bear it. Similarly brokers need to understand all the options and markets now available to them. Understanding this new paradigm will allow the reinsurers to deploy their traditional reinsurance capital where it can be most effective, while the alternative capital providers can assume risk where it is most appropriate for them to do so.
This complementary spreading of risk across multiple forms and sources of capital will mean a change in the reinsurance landscape. It’s beginning to happen in some of the largest reinsurance programmes and how they are placed. It will mean more business opportunities, more innovation, a more global outlook on risk transfer, perhaps more profitability for re/insurers and more choice for cedents; all of which are positive for the sector. We expect the topic will become more widely understood in 2013 and even smaller insurers and reinsurers will look seriously at alternative sources of reinsurance capital. This will require a change in the mind-set of some reinsurance industry participants and will continue (perhaps accelerate) the transition the market has already seen thanks to capital markets convergence over the last decade.