A trend which we’ve been writing about for a number of years here on Artemis, is the increasing number of reinsurers getting involved in the management of third-party investor capital in insurance, reinsurance and catastrophe-linked investment funds. The fully-collateralized reinsurance space has been on the up in recent years, but two of the world’s largest brokers see fund management as an area that will increasingly see reinsurers getting involved.
Reinsurers are clearly involved in providing fully-collateralized reinsurance underwriting operations and opportunities to invest in reinsurance or catastrophe risk already, via special purpose vehicles like sidecars and instruments such as catastrophe bonds and industry-loss warranties (ILWs). These sidecar vehicles are typically becoming more like funds (including more third-party capital) now as reinsurers find raising fund capital for deployment as collateralized underwriting capacity an attractive option in the current financial market climate.
Investor interest in reinsurance and catastrophe risk as an asset class has never been higher and while reinsurer equity remains attractive it is fund based operations which are receiving significant attention right now. Pension funds, private equity investors, endowment funds and even sovereign wealth funds are all large sources of capital which have been exploring the reinsurance-linked and ILS investment space in recent months.
For reinsurers this fund management approach gives them access to new, flexible capital sources which, with some effort, can be raised as and when required, such as just in time for the reinsurance renewals, depending on the state of the investor and capital market. This capital from third-party investors sits in a fund structure and is used to collateralize the underwriting of reinsurance, largely catastrophe, risk.
The reinsurer receives the underwriting premiums, as in traditional reinsurance business, and this can additionally be put to work in underwriting, invested in a hedge fund reinsurer type strategy, used to pay returns to investors or placed in trust to earn any interest available. Typically investors can receive anywhere from 5% to 20% by investing in these types of reinsurance-linked funds depending on the loss experience. The manager of the fund, increasingly a reinsurance firm or reinsurer backed entity, charges management fee’s and takes a cut of the premiums above the return paid to investors. This is a typical strategy, but certainly not the only reinsurer managed fund strategy, which is commonly employed and one we’re likely to see a lot more of.
Reinsurance broker Aon Benfield is bullish on this strategy and the prospects for more reinsurers adopting it in the coming year. The broker said in their recent Reinsurance Market Outlook report that they expect further work as reinsurers transition towards managing more non-equity sources of capital to improve the value proposition of their offering to reinsurance buyers. Aon Benfield have already noticed larger buyers of reinsurance accessing lower cost, non-equity capital sources as a way to reduce the weighted average cost of underwriting capital.
This focus on cost of capital, driven by excess capacity and reduced demand for reinsurance cover, will lead to consolidation and the launch of more reinsurer backed fund management businesses, said Aon Benfield. Showing just how strongly it believes that this strategy will become more prevalent in the future, Aon Benfield said that in five years time more than half of the world’s top reinsurers will manage insurance-linked funds for investors.
That’s a fascinating thought and if the third-party capital and insurance-linked fund management strategy really does become that popular then it will bring about changes in the reinsurance market as a whole. How the growth of fund managed reinsurer capital would affect their equity capital is at this time not clear, but we could see reinsurers adjusting their operational and share structure to accomodate capital from much more flexible third-party sources. It will be a fascinating shift in the reinsurance market to continue to watch, as it has been to date.
On the flip side of reinsurers managing and deploying investor capital in ILS and reinsurance-linked funds, Aon Benfield’s report suggests they will also continue to benefit from third-party investor capital as a source of retrocessional reinsurance cover. This capital can be better matched to reinsurers own tail-risk needs and will likely be put to good use supporting retro needs. Investors will likely continue to appreciate and find attractive the diversification provided by an investment in reinsurance and catastrophe risk for the forseeable economic future.
Aon Benfield expect that record reinsurer capital at the end of 2012 and the continuing interest from investors in structures such as catastrophe bonds and collateralized reinsurance facilities will keep reinsurance supply strong, likely in excess of demand, at the next renewals of April, June and July.
Another reinsurance broker, Guy Carpenter, recently acknowledged the influence that capital markets capacity, including that from reinsurer managed funds, is having on the market and said they expect that influence to expand strongly.
During a press briefing held yesterday in London, Nick Frankland, CEO EMEA of Guy Carpenter, commented; “In the last 12 months we have seen additional sources of capital entering the market and tending towards existing major players rather than being used to set up independent companies or dedicated structures. Existing players are finding it much easier to access these additional sources of capital. It is our expectation that in future we will see a larger number of reinsurers acting as (quasi) fund managers. This is how capital will enter the market – to proven entities within the industry. We must remember that our industry remains a very attractive market in which to invest money.”
So these two global reinsurance brokers both agree that we are going to see a continued move towards third-party capital management by leading reinsurers over the next few years. It’s also widely expected that new entrants to the market will adopt a fund or other collateralized structure to take advantage of investor appetite for reinsurance and catastrophe risk. On top of that there are also efforts to make it easier for hedge funds to get involved in reinsurance and a growing catastrophe bond and ILS market to consider. Put together, these various strategies, which we are going to see more of if the brokers are right, will mean a significant and continuing shift away from the traditional reinsurer model towards a complementary and growing third-party investor backed collateralized reinsurance and retro market.
Should be an interesting year ahead for us all!