AIG & AXA examples could lead more re/insurers to acquire ILS units

The example that will be set by major insurance firms AIG and AXA, in how they integrate newly acquired third-party reinsurance capital and ILS management units within their businesses, could stimulate more ILS acquisitions, as other major insurers look to bring a manager of catastrophe risks in-house.

AIG is in the process of acquiring Bermuda headquartered reinsurance firm Validus, which has a well-established ILS and third-party capital manager in AlphaCat Managers.

AXA is in the process of acquiring fellow Bermudian re/insurer XL Group, which also has a recognised ability in third-party reinsurance capital management, not least through its stake in specialist ILS investment manager New Ocean Capital Management, as well as its other alternative capital activities.

Both of these acquisitions therefore feature major global re/insurance players that will, once the M&A is completed, have an internal unit that can specialise in managing their catastrophe risks, using third-party investor capital to do so.

For global insurance and reinsurance players who find returns on catastrophe exposed underwriting to be moving below where their balance-sheets would normally demand them to be, the opportunity to shift some catastrophic risks onto lower-cost forms of capital managed by specialised units is a way to continue to earn some return from business that is no longer attractively priced to underwrite using owned capacity.

Of course reinsurance firms and the Bermudian property & casualty specialists have been doing this for some time, but major global players, particularly on the primary side, are not as yet fully versed in the potential benefits of having an in-house ILS management team, meaning there is an opportunity to watch and learn.

The AIG and AXA examples could offer the perfect ILS use-case for the industry to observe, as in both instances they will demonstrate the role of alternative reinsurance capital management within a much larger, primary insurance industry-focused player.

Of course both of these re/insurers recognise the advantages that an in-house ILS team could bring to them.

AIG’s CEO Brian Duperreault said that he is “very positive” about the growth potential for AlphaCat Managers as part of the AIG business, seeing “tremendous potential for big upside.”

Similarly, AXA’s CEO Thomas Buberl recognised that XL Group’s reinsurance and ILS operations can help him to better optimise his firm, saying that with the addition of XL’s expertise in alternative capital he expects to “re-think origination, packaging, and also then ceding out risk in a very different way.”

Having the ability to rethink and repackage the way you approach underwriting of catastrophe and weather exposed property underwriting business, leveraging the third-party capital managed by your internal ILS unit as a form of reinsurance capital while also earning a share of returns on that business and management fees for looking after the investors interests could offer some re/insurers a way to stay engaged in markets that they were on the verge of pulling back from.

With a pool of efficient reinsurance capital that catastrophe and weather risks can be ceded to sitting within your own capital structure, there are also potential benefits in reducing brokerage costs for reinsurance, effectively shortening and perhaps more importantly owning the entire risk value-chain from origination to reinsurance capacity.

Both AIG and AXA stand to benefit greatly if they can work out the most effective way to integrate their new ILS outfits into their overall business strategy.

These units could enhance the efficiency of the parent company considerably, if put to work in a meaningful way, while also offering their investor base access to a unique source of risk that may become less available through the more traditional reinsurance value-chain sources.

If the pair can set an example, matching their catastrophe risks with the ILS capacity of these third-party capital units, and growing the amount of capital under management to a much more meaningful size at the same time, it could stimulate other major re/insurance players to think about bringing more of this business in-house themselves.

Of course the typical questions of alignment of interests with investors, conflicts of interest surrounding who gets access to which risks, as well as potential challenges when it comes to securing a reinsurance program, could all rear their heads as major global re/insurance players try to embed ILS units within their structures.

But the benefits of having more seamless access to the capital markets, facilitated by experienced catastrophe risk portfolio managers leveraging efficient third-party capital, while still earning a share of income and fees from business that otherwise may have been ceded outside of the corporate structure, could be too tempting to miss out on.

As insurers and reinsurers aim for global diversification and technological efficiency, bolting on capital markets access to complement sources of reinsurance while extracting more premium profit out of the business you underwrite seems a very sensible move right now.

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