One of the hot topics at last week’s SIFMA Insurance-and-Risk-Linked Securities (IRLS) conference in New York was the increasing competition that ILS and third-party investor sources of reinsurance capacity are posing to traditional reinsurers. Some opinions suggest that ILS and investor-backed collateralized reinsurance capacity is moving beyond being purely complementary coverage and is becoming ever more competitive with traditional capacity.
Over the last few years this has been a topic which has received increasing amounts of attention and the discussion has evolved as the scale of the interest and appetite being shown in ILS and collateralized reinsurance by institutional investors around the globe has become apparent. The discussion began as one on the niche but complementary nature of ILS, catastrophe bonds, instruments such as ILWs and the small amount of collateralized reinsurance deals that were being completed.
As we moved through 2011 the discussion evolved into one about the convergence of the reinsurance and capital markets, with investor capital playing a growing, but still small, complementary role in the wider reinsurance market. The next evolution in the discussion was around pricing parity, largely driven by the value that was found in the cat bond and ILS markets in 2012, which towards the end of last year morphed again into a discussion about whether alternative capacity could actually be cheaper in some cases. Now, in 2013 the conversation has evolved again, to become one focused on investor backed capacity as a real alternative to traditional reinsurance, often seen as cheaper or at least equally cost-effective, offering both complementary cover and true competition for traditional reinsurers capacity.
So at the SIFMA IRLS conference this theme of competition came up a number of times, largely in relation to either catastrophe bond pricing, the recently completed Caelus Re deal still fresh in everyone’s minds, and on the competition that collateralized reinsurance contracts backed by investors are becoming versus traditional reinsurers.
The Swiss based ILS investment manager LGT Insurance-Linked Strategies team shared some of its insights on the SIFMA event and this topic with us. It saw the key discussion topic at the event as being the increasing participation of investors in what the LGT team term ‘financial insurance contracts’ (FIC), which refers to privately transacted fully-collateralized reinsurance deals.
The LGT ILS team said that in the past investor interest was largely in ILS such as catastrophe bonds, due to their liquidity and the ease of access to ILS as an investment. Now sophisticated investment managers are building platforms with more restrictive liquidity terms which allow them to participate more in private FIC or collateralized reinsurance deals, which is resulting in investors and investment managers becoming more indifferent to the form of reinsurance-linked investment (FIC or ILS).
The LGT ILS team sees the collateralized reinsurance capacity as superior to traditional reinsurance capacity, as due to its collateralized nature the full limit is paid up front and guaranteed for the term of the transaction. This ensures that when a claim is made on a contract the capital is always available to cover the insured losses.
The LGT ILS team have noticed increasing amounts of capital going into FIC and collateralized reinsurance lately, as the ILS and cat bond market has failed to grow quickly enough to soak up investor demand on its own. In this FIC, collateralized reinsurance segment of the market investors are now competing directly with traditional reinsurers, said the LGT ILS team. Over the last two years well in excess of $10 billion of capacity has been placed on FIC and collateralized reinsurance deals, which would in the past have been supplied by traditional reinsurance players.
The second key topic that was discussed on a number of panels at the SIFMA event was whether these investors would stay the course and stick around in the reinsurance market after a major catastrophe event or series of events? Some traditional reinsurers believe that alternative reinsurance capacity from third-party investors is likely to dry up in the event it faces some serious losses, and will not be there to support insurers and reinsurers with fresh capital.
The LGT ILS team told us that this is not how it sees this issue. Capital markets investors in the main would see a series of major losses as an opportunity to invest as premium rates would likely rise offering an interesting prospect for any investor keen on the returns and diversification that reinsurance can offer.
Some investors would of course cut their losses and not return until the market settled a little more, that is inevitable in any investment market after major losses occur. However, the average ILS investor has become incredibly sophisticated and many are actually acting as underwriters in their own right, originating, modelling and completing their own transactions. These sophisticated ILS investors and investment managers, who control the lion’s share of the sectors capital anyway, would certainly find an investment opportunity in supporting the coverage needs of traditional insurers and reinsurers after a severe catastrophe.
The LGT ILS team said that capital markets investors are no longer seen as a purely temporary, niche source of reinsurance capacity in the market. Investors are increasingly viewed as competition by traditional reinsurers and are viewed as valued partners providing much-needed catastrophe reinsurance capacity by primary carriers.
The discussion is likely to continue as 2013 progresses. Recent pricing for the Caelus Re 2013 Ltd. cat bond showed the appetite that investors have for catastrophe risk, and the latest cat bond Everglades Re Ltd. (Series 2013-1) is likely to test pricing and investor appetite even further. Over the longer term, it’s likely that the traditional reinsurance market and the collateralized and ILS market will find the sweet spots where their business models are best suited and a symbiotic relationship will develop. Over the shorter term we expect discussion of the competitive nature of these two forms of capacity will continue.
Read our article from earlier this week discussing another of the theme’s from the SIFMA event: Innovative and client focused approach required to drive growth in ILS.
Also read our article from February discussing private ILS and collateralized transactions: Investors increasingly seeing opportunity in private ILS & reinsurance transactions.