At the recent Bank of America Merrill Lynch 2013 Insurance Conference held earlier this month William Babcock, the Chief Financial Office and an Executive Vice President at Bermudian reinsurer PartnerRe, made some interesting comments about the increasing flow of third-party capital into the reinsurance space. His comments reflect the trend being seen for reinsurers to move towards becoming the masters of underwriting while leveraging third-party sources of capital.
The conference features senior executives of insurance and reinsurance firms being quizzed by analysts on their firm as well as the broader industry. Coming around the time of the recent results season and just after the renewals the event generally leads to some interesting conversations.
Discussing the renewals for the catastrophe reinsurance market, William Babcock suggested that we may never again see a return to the times when post-catastrophe event price increases ran as high as in previous hard markets. He said that capital flows have changed in the sector, not just in third-party capital but also in large capital providers, and he sees them using a different strategy for capacity deployment.
Babcock said that he thinks that we’re in a market that has fundamentally changed, and the idea that there is more capacity and that capacities ability to move in and out of the market, especially post catastrophe event, has contributed to this change compared to five or ten years ago.
Babcock was then questioned specifically about the way pension fund and hedge fund type capital is impacting the reinsurance market, whether there is any concern over ability to compete with the new breed of collateralized reinsurance funds and operations and whether PartnerRe is seeing any impact from this segment.
He responded by suggesting that the question is really about how reinsurers react to this and whether they become more specialist on the underwriting and knowledge side while allowing someone else to more efficiently provide their capital base for capacity purposes.
That’s a fascinating comment and echoes discussions we’ve had with reinsurers lately which suggest that they may be beginning to feel like their focus is being dragged away from their core skill set of underwriting and into a world of capital management which they often don’t feel so confident about. Hence the growing trend for reinsurers to establish their own third-party capital management operations, which allows their traditional arms to focus on what they do best while having a new managed pool of dedicated capital to call on as capacity.
This makes a lot of sense for the market as a whole. The reinsurance market needs capital and capacity injections in post-catastrophe market conditions. The capital markets and investors such as hedge funds and pension funds are the ideal candidates to supply this capacity, but the reinsurers are where the domain knowledge and underwriting expertise exists and so a flexible capital management model through a subsidiary makes a lot of sense in this respects.
We’ve even been involved in discussions suggesting that the future of the reinsurance market could look like specialist structuring firms working alongside specialist capital managers. This could lead to a blurring of the lines between broking, underwriting and actuarial expertise (in the structuring) and a separation of the capital and capacity aspects of reinsurers to the new capital market, third-party funded operations. It’s particularly interesting given the increasing trend for ILS funds becoming capable of originating, structuring and underwriting their own private transactions.
Babcock stressed, on the subject of pension funds, that even small injections of capital from the pension market into reinsurance have the ability to cause large impacts given the scale of the pension fund sectors capital base.
Babcock clearly thinks the third-party capital trend is one that is going to continue. He cites sidecars which take capital from investors such as pension funds and use a reinsurers expertise to underwrite business on that capital. He said that he expects the next time the industry experiences a large event most capital inflow to the space will be in structures such as sidecars and third-party funds.
The trend of late, according to Babcock, has been for recapitalization of the sector to not be through the traditional routes of reinsurers but rather through structures such as sidecars and alternative vehicles like funds. He explains that this allows investors to also exit the sector much more easily, citing the difficulties some investors in 2001 had flipping investments they’d made in traditional reinsurance companies.
In reality investors want to participate in a hardening catastrophe insurance market for a short period of time, Babcock said. The alternative capital vehicles clearly provide this opportunity to investors. Babcock commented that they have a defined life and are changing, and have already changed, the market.
Finally, Babcock said that the investors behind the alternative capital vehicles have different return motivations, but that if an alternative source of capital is willing to take a lower investment return it may put more pressure on reinsurance pricing. This is again interesting as we know that there are large sources of pension fund capital exploring the reinsurance space which have lower return targets, such as Japanese pension funds. As yet Japanese pension funds are not big investors in the space as they often find the return higher than their targets allow. If these funds find a reinsurance capital management model which works for them it could alter the pricing landscape dramatically.
You can read the full transcript of William Babcock’s comments over at Seeking Alpha.