2021 renewals to be “decisive” for alternative capital, says Fitch

The reinsurance renewals in 2021 are set to be “decisive” for the alternative reinsurance capital and insurance-linked securities (ILS) market, in determining whether returns can sustain higher levels to encourage greater investor participation, Fitch Ratings suggested in a new report.

Fitch has remained negative on the reinsurance sector overall, highlighting the challenges posed by the Covid-19 pandemic and economic environment.

But reinsurance carriers in general remain well-capitalised and with rates improving there is now a chance for better profitability as well.

Brian Schneider, Senior Director at Fitch Ratings said, “Fitch expects the favourable price environment for reinsurers to continue into 2021, leading to a better underlying technical profitability of the sector.

“However, mounting losses caused by the coronavirus pandemic and the increasingly low-interest-rate environment will weigh negatively on the sector’s financial performance in 2020 and 2021.”

Reinsurance as a whole has entered a hard market, with terms and conditions also seen to be improving.

Capital levels remain high for the traditional sector, despite the impact of the pandemic, but alternative capital has shrunk slightly as certain structures failed to be fully replaced by new issues and investors have become increasingly cautious and demanding of higher investment returns.

While the reinsurance market is hardening and this promises better returns for ILS funds and their investors, as has already been evidenced in recent months, the 2021 renewals and the ability of the overall reinsurance market to sustain rate gains made this year could be key to sustaining investor appetite for ILS, Fitch suggests.

Fitch notes “structural challenges” for alternative capital and ILS, saying that, “Investors are seeking higher returns given the higher-than-expected losses in the past couple of years and the longer-than-expected claims settlement times that are leading to trapped capital.”

As a result, the rating agency believes that, “The 2021 renewals will be decisive in determining whether higher expected returns are sufficient to overcome these structural challenges, or whether the market position of the alternative capital market will continue to erode.”

On the other hand, the rating agency also notes that we haven’t seen a wave of new reinsurer start-ups and part of the reason for this is the ease with which alternative capital structures can channel new capital into the reinsurance market.

“Alternative capital can move more fluidly into the reinsurance market through securitisations and other structures, which traditional reinsurers also participate in through sidecars and other unique platforms,” Fitch said.

While Fitch strikes a cautious tone on the future for ILS capital, others are more positive right now.

Yesterday, Aon said that ILS capital could return to growth this year thanks to new inflows and more expected flows through the end of the year.

In addition, Swiss Re’s Head of Alternative Capital Partners noted the beginning of an influx of ILS capital in a recent interview with us.

But Fitch is correct that the upcoming renewals and those later in 2021 could be critical for ILS. The sector does need to hold onto its returns, to ensure loss costs are compensated for and investors are earning appropriate returns for the risks they bear.