Capital markets to continue to have profound implications for reinsurance industry

A new PricewaterhouseCoopers (PwC) report titled ‘Daring to be Different‘ which was launched at the Monte Carlo Reinsurance Rendez-vous suggests that the inflow of capital and investment from the capital markets are destined to continue to have profound implications for the reinsurance industry. The report discusses the fact that capital markets interest in traditional reinsurers seems to be stagnating but interest in the alternative aspects of reinsurance remains strong.

The report says that the speed at which capital can flow into the sector from the capital markets has been transformed in the last decade and cites insurance-linked securities and derivatives (industry loss warranties we assume) as one of the reasons for this. They say that these developments will continue to have profound implications for the future shape of the industry.

The report discuss the importance of analytics and new technologies such as cloud computing and says that these will help to lower the barriers to entry in the industry. It also suggests that the transformation towards ‘data-driven decision making’ within reinsurance will lead to increased transparency and “lead to a value chain transformation facilitating a direct connection between the insurance risk and capital markets.”

Anand Rao, a Partner with PwC U.S. commented; “Reinsurers should use information and analytics to better understand existing risks as well as to identify new emerging sources of risk. In addition, alternative risk transfer mechanisms and capital market instruments should be explored to allow more efficient capital management.”

The report shows that investors from the capital markets continue to show considerable interest in risk and insurance linked investments which are uncorrelated to other asset classes and the wider financial and economic variables. However PwC hold a similar opinion to ratings agency Standard & Poor’s regarding the way reinsurers stocks are trading at below book value and PwC suggest that perhaps capital markets investors fail to see the diversification opportunities in traditional reinsurer equities that they see in alternative risk transfer mechanisms such as insurance-linked securities and catastrophe bonds. S&P recently suggested that reinsurers look to alternative routes to encourage new capital inflows from investors and it seems PwC hold a similar position.

These positions are in line with the sentiment of capital market investors we speak with, who say that the flexible, uncorrelated investment opportunities offered by insurance risk investments in ILS, cat bonds, sidecars and collateralized funds are often a better fit for them than straight equities in the sector.

Interestingly, the PwC report says that some Sovereign Wealth Funds are considering increasing their exposure to insurance risk through investments in insurance-related securities. That could be another significant source of capital, of similar to or even larger size than pension funds, for the ILS and cat bond markets.

You can read the full press release from PwC and request a copy of the report here.