Still early days for primary insurers establishing own sidecars

The trend of primary insurance carriers establishing their own collateralised reinsurance sidecar type vehicles, as a way to more efficiently access, and control their access to, alternative sources of reinsurance capital is still in its infancy, according to Standard & Poor’s.

Speaking during a webinar at the end of last week, Taoufik Gharib a senior director and lead analyst from Standard & Poor’s Global Ratings explained some of the trends being seen in alternative capital, one of which is the recent emergence of more primary insurers directly accessing the capital markets through their own structures.

Of course primary insurers have been utilising alternative capital and collateralised sources of reinsurance for years, through catastrophe bond issues, private ILS and capital markets backed reinsurance deals.

But over the last few years a number of innovative primary players have launched their own vehicles, either through an initiative of their own or in partnership with a cornerstone ILS investor, in order to gain greater control over their reinsurance spend.

It’s a trend that we suspect will accelerate over the coming years, as primary insurers seek to wrestle greater control of their access to reinsurance capital back from the traditional market, take advantage of ILS investor appetite and benefit from removing portions of their program from the traditional renewal cycle.

The most recent example of this trend comes from one of the largest primary insurers, Liberty Mutual, which launched a collateralised reinsurance sidecar named Limestone Re at the end of 2016.

Rating agency S&P recently said that primary underwriters could take a leaf out of reinsurers to increasingly sponsor such sidecar type vehicles, adding another element of competition for reinsurance firms to deal with.

However, speaking during the S&P Global Ratings webinar on Friday, Gharib said that this trend is still in its early stages and so the impact on reinsurers is not yet meaningful.

“We have noticed some of the primary companies establishing their own sidecars. It seems the trend is in its early stages, at this point it doesn’t impact significantly the reinsurance market,” Gharib explained.

Continuing, “In terms of the direct impact it’s not material at this point, so we don’t see an impact on reinsurance ratings.”

This trend, alongside others that see primary insurers leveraging alternative sources of reinsurance capital to make their use of reinsurance more efficient, such as Chubb’s internal reinsurer ABR Re and other similar initiatives, are also helping primary underwriters extract more profit out of the business they wrote in the first place.

By shortening the value chain to bring sources of reinsurance capital directly into their business models, primary writers benefit in a number of ways.

They can leverage lower-cost capital for a portion of their reinsurance cover, saving on reinsurance costs, and they can extract some fee income through the management of the vehicle and the investors capital, thus making another element of profit from business that previously would just have been ceded to reinsurers.

Essentially, this is primary companies seeking to retain more of the value they created in underwriting the risk in the first place, and by doing so with a third-party capitalised sidecar-like structure the benefits can be maximised.

If this trend accelerates and more primary companies look to how to manage their own internal reinsurance vehicles, backed by third-party capital, it could become a more meaningful hit to reinsurers as it will take an increasing chunk of business out of the renewal marketplace.

It’s a positive trend for ILS investors as well, providing an opportunity for ILS fund managers to partner directly with primary insurers, or for institutional investors to directly capitalise these vehicles. That means access to risk without the competition seen at renewals, which for ILS investors could also mean a better rate of return on the insurance business they collateralise as reinsurance.

Gharib concluded that while reinsurance has faced pressures from third-party and alternative capital, it has also learned to harness it as well.

“Alternative capital continues to come to the reinsurance market and players have built their own sidecars through which they harness some of the alternative capital to enhance earnings, but also to cede some of their cat risk, especially in peak zones.

“Reinsurance has been under pressure from alternative capital but it has coped with the pressure of managing the flow of third-party capital coming in,” he explained.

But he cautioned that this trend of primary companies more directly leveraging third-party capital through their own ILS structures could just be in its early stages, which suggests further expansion to other players may be likely.