Asian insurers look to diversify risk capital, cat bonds one option: Fitch

Asian general and property casualty insurance companies are typically reliant on traditional reinsurance capital for funding in the event of a major natural disaster striking, but increasingly they are looking to alternative capital and catastrophe bonds, says Fitch Ratings.

In an update on the Asian insurance and reinsurance market, ratings agency Fitch notes that although reinsurance penetration and use remains lower in Asia than in western markets, some insurers are beginning to feel too reliant on the traditional reinsurance market and are beginning to look for other sources of direct funding for their catastrophe exposures.

Fitch says that interest in alternative sources of reinsurance capital is igniting in catastrophe prone markets in Asia, such as Japan. As the alternative capital, insurance-linked security (ILS) and catastrophe bond trend has developed, one of its key remits has been to provide alternative sources of risk capital to those insurers or reinsurers who want to diversify.

Becoming over-reliant on risk capital from traditional reinsurers could be a risk in a market which is concentrated on a few major reinsurance firms and which has huge natural catastrophe exposure, like Japan. In these markets there is increasing interest in tapping into other sources of risk capital, such as from ILS funds, the catastrophe bond market and other collateralized forms of reinsurance protection.

Fitch notes the recent issuance of a number of catastrophe bonds for Japanese sponsoring insurers in 2014. Cat bonds such as the $300m Nakama Re Ltd. (Series 2014-1) for sponsor Zenkyoren, $100m JPY denominated Aozora Re Ltd. (Series 2014-1) for Sompo Japan and Nipponkoa Insurance Company and the $245m Kizuna Re II Ltd. sponsored by Tokio Marine & Nichido Fire Insurance Co. Ltd. all underscore the important role that alternative reinsurance capital and ILS is playing in markets like Japan.

While these forays into the catastrophe bond market help to reduce large Japanese insurers reliance on global reinsurers, Fitch still expects traditional reinsurance capital will play a critical role in these risk transfer markets and are unlikely to be pushed out by new capital. The expertise and technical skill of the reinsurer is critical in structuring more complex risks and this requirement is not going away.

As the reinsurance market plays out the trend of the last few years of growing non-traditional capital being leveraged alongside traditional, it will be interesting to see how the alternative penetrates these high-growth, catastrophe prone markets. It’s likely that an increasing amount of the new risk capital delivered to these markets may come from alternative or capital markets sources, while the traditional reinsurers continue to maintain their market shares.

The question is whether the traditional reinsurers can grow their shares alongside the entry of more alternative capital, maintaining the balance between the two, or whether alternative reinsurance capital gradually grows its portion of the Asian reinsurance market.

Softer reinsurance pricing and rates has helped to stimulate some additional demand in Asian markets, according to Fitch, but the rating agency puts the softening largely down to a decrease in the frequency and severity of natural catastrophes in the regions since 2011. Alongside this environment, a number of new start-ups have also entered the Asian market, seeking to build reinsurance capital in the region to take advantage of the clear opportunity in a disaster loss prone region of the world.

This growth opportunity is also attracting established reinsurance players and most of the major reinsurers have initiatives which are focused on attempting to open up new markets and increase insurance penetration.

For ILS and alternative reinsurance capital the opportunity is also clear. These are markets which require risk capital for peak catastrophe exposures, something ILS is perfectly suited to provide. These are also markets which while relationships matter, perhaps do not have the established traditional reinsurer relationships in place yet (or for long) meaning that ILS funds and players have an opportunity to build these long-lasting relationships for themselves in some frontier markets.

Finally, the Asian market has considerable catastrophe risk which is not considered insurable interest. These catastrophe exposures, that corporations, governments, fiscal budgets, banks and other global organisations face in Asia, could be well served by the development of markets in contingent risk transfer products. Here the parametric trigger could be the structure of choice, for providing contingent catastrophe risk financing for risks which sit outside of insurable interest in the emerging economies of the world.

Both traditional reinsurers and the ILS market along with alternative sources of reinsurance capital have huge opportunities to tap into the demand for catastrophe risk financing in Asia. Often, market participants have cited the need for insurance markets to become established before reinsurance is required, but pure risk capital serves a purpose as a catastrophe contingent capital buffer no matter what the state of development of the local insurance economies is.

As the Asian property catastrophe reinsurance market develops it could well be seen to be even more capital agnostic than the market is becoming in Florida. ILS players need to embrace opportunities in this region and we expect to see a number of initiatives in the coming years which will leverage ILS sourced capital to tap into high-growth Asian markets.