As reinsurers hold ground on rates, insurers may turn to ILS: A.M. Best

As reinsurance companies of the world hold their ground and push through increased rates for their products, as seen at recent renewals in Florida and beyond, insurers and protection buyers may increasingly look to find more cost-effective options raising interest in ILS, according to A.M. Best.

Reinsurance capacity providers, including insurance-linked securities (ILS) funds, are seen to have been “holding their ground with higher pricing for Florida” the rating agency explains in a new report.

As markets have differentiated cedant pricing, based on performance and loss experience, while rates were seen to rise 15% to 20% widely, the most loss impacted insurers have in some cases paid much higher prices for their reinsurance renewals, A.M. Best said.

Cedant performance, loss development, program mix and quality of risks are all coming under greater scrutiny from reinsurance capital providers, on both the traditional and alternative sides of the market.

This can pressure those with business models that have been created on the back of lower-cost reinsurance capacity, as has also been seen for reinsurers that have relied on cheaper retrocession in the past.

“These rising reinsurance costs have the potential to pressure some of the more thinly capitalized Florida-specific companies in the market,” the rating agency continued.

Adding that the currently, “Higher reinsurance costs may give way to greater use of insurance-linked securities and alternative risk transfer mechanisms such as catastrophe bonds.”

A.M. Best believes that insurers pressured by losses and feeling the strain of more expensive reinsurance cover may redouble their efforts to work with the ILS market as an alternative source of capacity.

We’ve seen some evidence of this in 2019 already, as there has been some evidence that sponsors of catastrophe bonds have come forwards to leverage ILS efficiencies in this way, while at the same time some reinsurers have approached the cat bond market in search of new sources of retrocession.

The pull-back among ILS funds in the retro space has clearly driven some renewed interest in cat bonds for reinsurers and it seems the rating agency believes that higher priced reinsurance could drive primary insurers to also renew their interest in cat bonds, or other forms of ILS as well.

“Insurers will look to expand their programs to include more cost-effective options to expand capacity and provide both company and policyholders with adequate protection,” A.M. Best explained.

Naturally this could result in more opportunities for the most efficient and lowest-cost capital to play a growing role in these insurers reinsurance programs, which should naturally result in more focus on cat bonds and other ILS instruments.

However, it should also heighten the focus on the costs of reinsurance risk transfer as well, perhaps pushing forwards the topic of unbundling the services in the value-chain (key to all markets, not just in delivering protection gap products) and finding better ways to apportion and pay market participants for their roles in getting transactions to market.

Here, there could be more opportunities for these pressured primary insurers to seek out efficiencies through utilising their own third-party capital vehicles to cede risks directly to investors, or in partnering with established ILS funds.

Thereby removing some of their capacity needs from the open market and renewal cycle, securing their own pools of efficient reinsurance capital that can expand and contract alongside their other capital sources.

At the same time, renewing relationships with the catastrophe bond market can also help these insurers to recognise capital efficiencies, as well as expand the diversification of their risk capital sources, both positive for companies pressured by market forces and higher rates.

“Rising reinsurance costs can diminish potential earnings and strain operating performance,” A.M. Best said.

Adding, “Companies with stronger risk-adjusted capital or flexible reinsurance programs (such as the use of multi-year reinsurance contracts) will be better prepared to face any significant changes in reinsurer pricing or appetite.”

A.M. Best said that those insurers that are most thinly capitalised may have to adjust their reinsurance programs, given the higher pricing, which can negatively affect their business models.

As a result, the ILS market could face increased inbound inquiries from these insurers, as they look for solutions to bring efficient capital more closely into their businesses, which could help them ride out the higher rates for longer, or adjust their strategies to source risk for fee paying and profit sharing investors.

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