Alternative capital improves the reinsurance value proposition: Aon Benfield

Global reinsurance capital rose to another high by the end of 2014 and the addition of a growing pool of third-party investor sourced alternative capital means that the value proposition of reinsurance has never been higher, according to broker Aon Benfield.

In its latest Reinsurance Market Outlook report, Aon Benfield the reinsurance arm of Aon plc, acknowledges that the growing influence of alternative and insurance-linked securities (ILS) capacity is a positive for reinsurers as they increasingly incorporate it into their client value propositions.

“The quality of the financial security for the reinsurance market has never been higher,” the report explains. The price of traditional reinsurance capacity, especially property catastrophe capacity, has dropped as alternative capital disrupted the status-quo, growing in influence to become a price maker rather than a price taker.

As a result reinsurance capacity has never been as efficient, mobile, cheap and abundantly available for insurance companies seeking protection, or indeed reinsurers seeking retrocessional capacity. Prices may have been lower in the past but capital efficiency and mobility were certainly not as apparent.

Aon Benfield believes that due to the influence of alternative capital on the reinsurance market, it is likely that the value proposition of reinsurance, the combination of quality and price, has never been higher.

Alternative capital’s journey into reinsurance is nearing a point where it is becoming simply a mainstream option for coverage for cedents and for the reinsurers themselves it is becoming a more efficient business model which through adoption enables them to improve their own client value proposition.

“Traditional reinsurers have reached the end of a 15 year journey featuring chronological stages of alternative capital’s insignificance, competition and finally disruption,” Aon Benfield’s report explains. “As disruption reigned over the last three renewal cycles, leading traditional reinsurers made material progress to incorporate the value of alternative capital – lower cost underwriting capital – into their client value propositions.”

Increasingly we are seeing large reinsurers incorporating this lower-cost, more efficient, third-party investor sourced reinsurance capital into their underwriting and Aon Benfield believes we have reached the point where this is now improving their offering to clients.

At first, alternative capital perhaps did not have the price competitiveness of traditional reinsurance, so the use of ILS structures was valued due to the diversification of risk capital sourcing properties. Now, with ILS issuance cheaper and collateralized reinsurance structures much easier to establish, the true efficiency of lower-cost capital can come to the fore.

In 2014 (to the end of Q3), global reinsurer capital has risen again to a new record level at $575 billion, while at the same time the amount of alternative capital in reinsurance has grown further to $62 billion. The figures represent 6% growth for total reinsurer capital but 25% for alternative capital over the course of the year. More on alternative capital’s growth can be found here.

The growth of reinsurer capital year-on-year

The penetration of alternative capital into reinsurance has, of course, been most evident in property catastrophe reinsurance where it represents as much as 40% to 50% of the total market. Aon Benfield notes that the ILS market is now turning its efforts to new lines of business and penetration overall is likely to grow from the 12% of total reinsurer capital it represents today.

Encouragingly for both traditional and alternative sides of the market, Aon Benfield reports that demand for property catastrophe reinsurance grew at a higher rate in 2014 and at the January 2015 renewals. However, this demand growth was not as fast as the growth of supply, so the market remains imbalanced.

At the January renewals growing demand for multi-year covers, aggregate protection, underlying and overlying capacity covers were most notable, Aon Benfield says. Further movement on terms and conditions for cedents was also noticed, with Aon Benfield saying “material progress” was made.

Casualty reinsurance demand has also improved, Aon Benfield notes, adding that these featured highly customised structures and terms and conditions. As a result counterpart selection is considered highly important in casualty reinsurance by both reinsurers and cedents.

Aon Benfield expects these trends will continue into the other renewals in 2015, at April, June and July. Insurers have the “widest selection” of “high quality offers of accretive underwriting capital” that the broker can recall. More choice, more efficiency and it seems that those that have leveraged this lower-cost capital are the companies that have made the best progress at the renewals.

Insurers capital grew at the same rate as reinsurers, 6%, reaching $4.2 trillion at the end of Q3 2014. Some cedents have modified their structures as a result of the continued downward slide in reinsurance pricing as well as new capacity offering alternatives. However, overall demand for reinsurance remained “relatively stable” but with some non-peak regions looking for additional capacity of up to 5% extra at the January renewal.

The report notes that there will be “more to come” in terms of growth and consolidation in the reinsurance market in 2015, suggesting that the M&A trend that began towards the end of the year may be only the tip of an M&A iceberg as reinsurers evaluate their options in the wake of the January 2015 renewal cycle.

The report notes that any M&A activity seems to have been driven by a desire for scale, growth and diversification. Supplementing that increasingly will be a desire to offload books of business which do not meet their cost-of-capital, which could explain some large portfolio transfer type transactions in recent months. It will be interesting to see what role alternative capital will play here, with its lower cost-of-capital perhaps meaning it can take on and profit from some books of business that a traditional re/insurer cannot.

Aon Benfield Securities says that it; “Expects strategic investors to pursue consolidation in a focused “bolt-on” approach expanding into new geographies or products via acquisitions of underwriting teams or specialty units. Over the medium to longer-term, however, we expect the need to grow and improve returns via traditional whole-company M&A will intensify.”

The report from Aon Benfield leaves the impression that alternative reinsurance capital and ILS is coming of age, with the traditional reinsurance business model now fully-embracing its efficiencies and finding ways to benefit from it. The report suggests that Aon Benfield believes that the reinsurers that have learned to leverage and use alternative capital or ILS, to increase their efficiency and lower their cost-of-capital, are the ones that have found an edge at the January renewals over those still with their heads in the sand.

The report shows the meaningful role that ILS and alternative capital plays in the global reinsurance market, a role that is expected to grow and become increasingly important in 2015.

Also read:

– At $62B alternative capital now 40%-50% of catastrophe reinsurance.

You can download the full report in PDF format here.