Over the 18 months running up to the middle of 2015 an estimated $18 billion of new capital has entered the reinsurance market through investments in insurance-linked securities (ILS) funds, sidecars, hedge fund backed reinsurers and collateralized vehicles.
According to reinsurance broker Guy Carpenter, the “growing embeddedness” of this capital in the reinsurance market, where it is increasingly seen as a permanent fixture, has increased confidence among ceding companies to take advantage of it to buy additional limit and restructure programs.
In the latest renewal report from the broker, Guy Carpenter highlights the continued growth of ILS and alternative capital as a positive effect on the reinsurance industry, enabling ceding companies to leverage its low-cost and efficiencies for growth.
As alternative capital continues to flow in, Guy Carpenter estimates its growth at 22%, compounding since 2008, and an accelerated 34% over the period of 2012 to 2014 when new capital inflows to ILS were at their highest.
The growth of alternative and ILS capital within reinsurance markets - Source: Guy Carpenter from GC Securities research
As well as providing opportunities for cedents, the growth of alternative capital has added pressure on pricing, contributing to the challenging soft market environment that we see today.
“The increased fluidity of capital likely accelerated the development of the challenging market and has been the major catalyst of consolidation activity in the reinsurance sector,” the broker explains.
Reinsurance firms continue to juggle new capital inflows into the sector, alongside excess capacity and continued low levels of catastrophe losses. This comes at a time of increased regulatory and rating agency oversight, meaning reinsurers are adopting more sophisticated methods of managing capital.
At the same time, Guy Carpenter notes; “Investors seeking non-correlation and returns similar to or better than comparable debt instruments continue to be attracted to the (re)insurance industry.”
The broker highlights that one of the effects of the growing pool of ILS and alternative capital is further changes to sector capital and an increase in the fluidity of this capital.
“The ongoing entry of new capital has led to changes in the sector’s capital structure, further spurring innovation,” Guy Carpenter explains.
Stimulating this environment where capital is becoming increasingly fluid or mobile in reinsurance, has been the rapid entry of around $18 billion of alternative capital over a short 18 month period from 2014 through to the middle of this year, Guy Carpenter notes.
“Approximately 18 billion of new capital has entered the market through investments in insurance-linked securities (ILs) funds such as pension and sovereign wealth funds; sidecars; hedge fund-backed reinsurance companies and collateralized reinsurance vehicles,” the broker said.
This rapidly growing alternative and efficient capital is increasingly being seen as permanent by ceding companies, enabling them to now approach the reinsurance market more open to new forms of capital and new fund-based collateralized providers.
One of the effects of this is that ceding companies are now looking to use reinsurance capital to be expansive, to find growth in existing lines and geographies, or to expand their businesses.
Guy Carpenter explains; “The influx of new capital and the growing embeddedness of this capital in the reinsurance space have spurred confidence in the market environment allowing many companies to make changes that require additional limit purchased such as geographic expansion or line of business growth.”
At recent reinsurance renewals the broker notes that its observation that; “Buyers were purchasing more catastrophe limit to take advantage of lower costs, continued to be borne out and even accelerated. The increased demand for reinsurance and expansion of tailored coverage persisted through the April, June and July renewals.”
At the same time as reinsurance demand continues to be stimulated, both by the availability, cost and fluidity of capital, plus the pressure to shift strategies to lines and regions where profitability is higher, the broker is also seeing innovation in terms of new products and improvements to terms and conditions.
“Clients continue to evaluate the effectiveness of their reinsurance purchasing to determine if there are more cost effective and efficient means to reinsure risk. In many cases this may include consolidation in purchasing within or across lines of business, inclusion of new lines, modification of coverage definitions and evaluation of multi-year contract terms,” Guy Carpenter explains.
And importantly, the broker says; “Capacity affords us the opportunity to develop new solutions for new risks and consequently, drive growth, enabling the industry to provide cover for risks that are currently uninsured.”
The key factor that has turned on this ability to innovate, is perhaps the growing realisation that alternative capital and the investors providing insurance-linked securities (ILS) capacity, are here to stay and that the capital is becoming viewed as permanent.
Along side the view of permanence of capital there may also be an increasing realisation that with capital more fluid and mobile, the pool may not deteriorate even if some capital providers do exit and enter the reinsurance sector. This is the “embeddedness” of alternative and ILS capital that Guy Carpenter speaks about in the report.
The next step to put this capital to work, notes Guy Carpenter, is to seek to increase demand even more significantly by targeting coverages that don’t yet fully exist in the insurance and reinsurance space.
In its work with rating agency A.M. Best, Guy Carpenter says; “Our current estimate of total capital dedicated to reinsurance is approximately usd 400 billion of which the convergence capital, including catastrophe bonds, ILWs, collateralized reinsurance and sidecars is usd 66 billion.”
That 16.5% share of global reinsurance capital is significant. At that percentage it becomes difficult to see how ceding companies can continue down a traditional only reinsurance capital route, which further explains the rise of fronting relationships for ILS players as they seek to access new cedents.
Interestingly Guy Carpenter notes that in its latest calculation work with A.M. Best, looking at the size of reinsurance capital, it was noted that more capital is shifting into primary insurance business, something that we’re beginning to see with ILS capital as well now.
Alternative capital is also directly supporting competition in reinsurance, Guy Carpenter’s report explains, with the sustained and substantial inflows disrupting the status quo. The high levels of inflow have resulted in rate pressure, mostly felt with the short-tail reinsurance landscape. This softening then trickled down to specialty classes as well.
Highlighting just how disruptive the rapid inflow of alternative and ILS capital has been, Guy Carpenter said; “This inflow of capital drove declines in pricing, challenged (re)insurers and impacted the wave of M&a deals. It is likely that the increased fluidity of capital simply accelerated the development of the challenging market and the onset of consolidation activity.”
At the same time we’re now also seeing new types of investors seeking to enter the reinsurance market at the acquisition level as well, the broker notes highlighting EXOR’s bid for PartnerRe. The diversification a reinsurance operation can offer these investors can enable them to operate an efficient business model with “a lower requirement for underwriting return than normally assumed in markets.”
In mature markets there remains a concern that “the influx of alternative capital is permanent, making the current soft market the new status quo,” Guy Carpenter notes.
The challenge now is to put this capital to work meaningfully. If the insurance and reinsurance market can harness this fluid and increasingly embedded alternative and ILS capital to grow, create new opportunities and to innovate new products for currently unprotected risks, some of the pressure on incumbents may be alleviated.
The rapid growth of alternative capital has truly changed the reinsurance landscape and that change is expected to persist and continue to evolve the market. The opportunities that presents will be great, but the challenges for incumbent companies that find it harder to adapt may be greater.
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