Capital market capacity could slow the return of a hard market

Property catastrophe rates and reinsurance prices have been rising, particularly in loss affected lines of business, however despite the heavy catastrophe losses of 2011 we’re not really seeing the hard market that many predicted. In a recent post on the Willis Group blog Bill Dubinsky of Willis Capital Markets & Advisory raises an interesting point; that the capital markets and the inflow of convergence capital through instruments such as catastrophe bonds, insurance derivatives and collateralized reinsurance could be slowing the hard markets return.

Bill notes that one of the ideas behind instruments such as cat bonds was to allow sponsors to diversify beyond their traditional sources of coverage and capacity. This lead people to believe that these alternative sources of capital could help to smooth the reinsurance cycle and prevent or soften the effects of a hard market. Could this be what has slowed the hardening of the market?

Bill goes on to contrast the current market conditions with those after hurricane Katrina, when a hard market took hold very rapidly, the availability of alternative sources of capital from instruments such as we named above along with hedge fund backed reinsurance vehicles and sidecars is much greater today. After Katrina the market hardened and then these alternative, convergence capital sources appeared where as today many were already available and new capacity has been established much more readily.

As the capital and convergence markets grow and become more established this could lead to a much smoother reinsurance cycle. The key though is for these alternative capacity sources to be flexible, to allow them to be set up quickly and simply when capital needs call for them. The strong start to the year from the catastrophe bond market along with the growing prevalence of hedge fund backed reinsurance vehicles clearly shows the growing importance of the capital markets as an alternative source of capital for the reinsurance market. It will be interesting to see how the cycle continues over the course of this year and whether the capital markets can continue to ward off a real hard market.