Portability, efficiency of capital in reinsurance greater than ever before

Capital in the international reinsurance industry is more portable and efficient than ever before, thanks to growing interest from investors to access the sector via ILS and other means, according to speakers at a Standard & Poor’s event in London this week.

Discussing the trends that have affected the reinsurance industry in recent years and which have now pushed major reinsurers to look to mergers and acquisitions in a search for the necessary scale, diversification and relevance to be competitive.

“Alternative capital continues to flow into the market quite freely,” Dennis Sugrue, Director and Reinsurance Sector Specialist at Standard & Poor’s explained.

“At the same time we are seeing a change in demand dynamics. Last year we were talking about a lot of the large global cedents who were changing the way they were buying reinsurance. We’re continuing to see that with some of the big, global multi-liners, but even some of the smaller buyers are starting to a take a more centralised approach, so this is starting to spread down the ranks,” Sugrue commented.

Pressure remains on reinsurers to adapt to this environment, of more capital, centralised buying and smaller players are especially squeezed. This is forcing a spill-over of pressure into many lines, as players look to new areas to deploy their capacity.

The effect is that this pressure is ramping up the expectation for M&A, which S&P expect to continue with more deals likely to come to market, Sugrue said.

Sugrue discussed the M&A trend with Robert Thomson, Managing Director of the European Financial Institutions Group at investment bank J.P. Morgan, and the changing capital dynamics in the reinsurance market were cited as a key driver.

“There is a large amount of capacity in the sector, which is having its impact,” Thomson began, saying that the combination of excess capacity among the traditional reinsurance incumbents and the addition of alternative capital was helping to ramp up the competitive pressures.

Thomson continued; “We’ve seen the portability of capital increase dramatically, whether it is pension funds or hedge funds, the ability to come into the sector without the need to form a new company just put capital to work, is greater than it’s ever been before.”

This is a key point, aligned with much of Artemis’ previous writing on the new mobility in capital flows which allows money to move quickly in and out of markets. This has driven interest in reinsurance among institutional investors, to a degree, as many do not want to have an investment in the operating company, but purely to be able to attach their capital to the risk.

“In addition, there is the pressure on costs and the pressure around distribution as well I would say,” Thomson continued, explaining other forces that have pushed reinsurers to look to M&A. “Pressure from brokers, to be more meaningful to them, has increased significantly over recent years.”

“I think also efficiency in the use of capital,” Thomson explained, adding that some of the reinsurance M&A deals we have seen so far make sense as they involve a well-capitalised player coming together with an efficient player.

Conversely, other deals are “more like a rights issue”, where one company is buying another to gain access to a complementary, or diversifying, set of business.

Thomson discussed growth, saying that it’s hard to come by in developed markets which is pushing some re/insurers to look to regions such as Africa. He said to expect more interest from capital coming from regions such as Asia, who are also looking to enter the developed markets at this time.

Thomson said he does expect there to be more M&A transactions in reinsurance, with the consolidation around the middle-tier companies likely to drive an ongoing trend of deals.

With capital more portable and mobile than ever before, while the global investment environment remains depressed, interest in reinsurance is likely to continue. This should drive more M&A transactions and also more capital flowing into direct ways to access the risk, including insurance-linked securities (ILS).

And while capital continues to enter the sector the pressure on incumbents will continue. Thomson said that he can’t foresee enough capital leaving the space to relieve the pressure, meaning that companies need to learn to adapt to it and find ways to put it to work.