The BofA Securities analyst team say they are increasingly constructive on the reinsurance sector, one reason being that alternative capital growth is not being driven by the collateralized side of the ILS market, while catastrophe bonds are seen as a more compatible instrument and complementary to traditional reinsurance.
The current hard reinsurance market is expected to run into 2024, the analysts believe, with favourable dynamics available to reinsurers.
A key reason is the lack of capital inflows to the traditional and collateralized reinsurance side, meaning capacity issues are not yet fully-resolved.
The analysts note that they see “limited scope for further margin expansion in 2024” unless we see major loss events, but they foresee the still “very attractive margins” available as an opportunity for reinsurers to push for growth.
The lack of new capital flows mean reinsurers have had very strong results at recent renewals, the analysts believe, that should earn out positively for the sector, losses allowing.
While alternative reinsurance capital has reached a new high and traditional capital recovered somewhat, the analysts are more positive now that insurance-linked securities (ILS) market growth is largely coming via catastrophe bonds.
“Despite the overall long-term growth in the alternative reinsurance capital, the composition of this market has changed dramatically over recent years. In particular, growth has been fuelled by the catastrophe bond market (+84% since 2016 levels) which is much more liquid, with well-defined risks. We estimate outstanding cat bonds (over US$40bn) now account for 42% of the alternative reinsurance capital,” the analysts explained.
Adding, “While all alternative capital presents competition for traditional reinsurance capital, we view cat bonds are much more complementary to traditional reinsurance.”
The BofA Securities analyst team say that catastrophe bonds “help to provide additional capacity where traditional reinsurers might not want to compete or have exposure to certain catastrophe risks.”
They note that despite a very strong first-half for the catastrophe bond market, “this healthily growing market has had very little impact on overall pricing in the hard market.”
Leading them to state that, “Continued growth in the cat bond market, in our view, is not incompatible with a prolonged hard reinsurance market.
“As such, we are not concerned with this market development.”
Collateralized reinsurance though poses “a greater competitive threat to overall market pricing dynamics for reinsurance,” the analysts believe.
While collateralized reinsurance still makes up the largest share of the ILS and alternative capital market, it has not grown much in recent years, the analysts estimate just 2% since 2016.
They cite the increased competition for capital in a higher yielding investment universe, as well as the poor performance of some collateralised reinsurance funds as reasons.
“Given these dynamics are unlikely to change over the near-term, we also think it is unlikely that collateralised reinsurance net inflows will return quickly,” they explain.
“This leads us to a fairly constructive medium-term view for reinsurance market dynamics, as we believe capital is likely to remain disciplined for longer.”
Which is all positive commentary for reinsurers hoping rates will hold at new and higher levels, for the cat bond market and its investors, but also for those private ILS and collateralised reinsurance fund strategies and vehicles that continue to hold onto their assets and are still active participants in the marketplace at this time, with meaningful client relationships to service.