Rationality & “flight to quality” seen in alternative reinsurance capital: Peel Hunt

The alternative reinsurance capital market showed evidence of increasing rationality at the key January 1st 2019 renewals, according to analysts at Peel Hunt, with a “flight to quality” also noted as being underway in some corners of the ILS fund market.

The analysts met with underwriters in London and at Lloyd’s recently to explore the dynamics of the reinsurance renewal and discuss market forces.

While the ILS market continues to absorb the losses from two consecutive years of major catastrophe industry loss impacts, Peel Hunt said that this became evident at the renewal in the form of less alternative capacity being made available for retrocession renewals.

In some cases the reduction in retrocession capacity provided by ILS players has resulted in reinsurers retaining their lower layer retro risks.

We understand that many reinsurers will revisit covering these layers as the mid-year approaches, wanting to secure their retrocessional coverage in time for the U.S. wind season.

That could lead to some availability of retro investment opportunities over the coming months, as well perhaps as some retro catastrophe bond issuance in the second-quarter of the year, we are told.

Analysts also heard of a “flight to quality” in ILS and alternative reinsurance capital, as some investors look to shift their allegiances to the larger, better established ILS funds over newer vehicles that may have taken heavier losses over the last two years.

This kind of shake-out in investor allocations to ILS and collateralised reinsurance vehicles was always going to happen in the wake of major losses.

However, we understand the redemptions to not be particularly significant compared to the size of the market, so far.

But the upshot of this is that alternative reinsurance capital did not grow at the renewals, in fact if you’re counting the amount of alternative and ILS capital actually available for underwriting and investment purposes (therefore not trapped or lost) then the amount of alternative capital available has shrunk.

Naturally this has an effect on the market and helped to ensure that rates did rise in the loss affected regions of the world at the reinsurance renewals.

Whether that continues through coming quarters of the year, with the April and June renewals looking most important to the market now, will depend on how quickly the losses can be dealt with by ILS fund managers.

If the losses can be dealt with relatively expediently and trapped collateral positions be closed down, it may help some fund managers to return to capital raising in advance of the mid-year renewal.

At the same time there are a number of initiatives that promise to bring new capital to market currently, while other initiatives promise to help increase the margins available to reinsurance underwriters, which could all help to promote and keep the ILS asset class attractive.

The increased rationality, in terms of rates and the pricing that players are willing to deploy capacity at, is needed on both alternative and traditional sides of the market.

The January renewals have provided further evidence of the appetite of major traditional reinsurance firms to soak up business from some peril regions at rock-bottom price levels, often at levels the ILS market cannot compete due to players less diversified and generally smaller portfolios.

Here the traditional market contradicts itself, in calling for rational rates from ILS players but then  undercutting them in regions such as Europe.

The power of diversification is a wonderful thing and discounting to dominate markets is one way to approach business.

But at some point major catastrophes will strike these regions and when the reinsurers decided its time for payback the ceding companies in some of these currently diversifying zones may find their rates spike considerably, which is not as healthy for the local or global market as charging risk commensurate rates all of the time, we’d venture.

Peel Hunt’s analysts note that risk-adjusted returns have now slipped below cost-of-capital across much of the reinsurance industry, making capital efficiency key.

That leads the analysts to conclude, “Either the supply/demand imbalance improves or actors need to become more rational. This would suggest that there is little room for rates to decline from here and further (gradual) repricing of property Catastrophe risks in Japan and the US is warranted.”

It would be nice to think that rationality could apply globally. But it’s likely the heavy discounting of rates in regions such as Europe and Asia Pacific (ex-Japan) will continue, until someone loses a lot of money through a major catastrophe in a peril zone that was considered a valuable diversifier.