The convergence market will play an important role in both risk transfer and risk mitigation for catastrophe exposures, with the result being an expected dampening of reinsurance price volatility and a flattening of the traditional market cycle, A.M. Best says.
The expectation is that convergence, the introduction of capital market money and structures into reinsurance and insurance markets, is here to stay, will grow and play an increasingly important role as an asset class, a source of risk transfer and ultimately the future of the re/insurance markets.
One of the topics we’ve discussed previously here at Artemis is that we expect the reinsurance cycle to be changed and in fact it may already have been. If nothing else, we expect the ample capital market interest in reinsurance will flatten out some of the peaks and troughs, that have historically affected reinsurance pricing after major catastrophe events.
It appears that rating agency A.M. Best agrees.
A.M. Best believes that convergence “could help dampen the pricing volatility observed in the reinsurance and retro markets, which has been a recurring phenomenon during capacity contraction and expansion.”
A.M. Best believes that for the convergence side of the reinsurance market, where capital market investors and alternative capital bear the risks in return for sharing in the risk premium rate-on-line, the costs need to continue to come down.
“The growth of the market will depend on the continued decline in the structuring and transaction costs,” A.M Best explains.
Additionally, the rating agency believes that as investors become increasingly comfortable in the risk modelling and gain enhanced appreciation for the risks they seek, the convergence side of the market will continue to gain acceptance.
Another factor that will ensure continued capital market influence on insurance and reinsurance pricing will be innovations that enable development of secondary market trading liquidity for catastrophe bonds first, but in the future for other insurance-linked securities (ILS) structures.
This is very important. As the market develops new structures, products and ways to match capital with risk, the investors behind it are going to demand enhanced liquidity options. Exchange-trading, online markets, mechanisms to slice and dice contracts and catastrophe risk layers into tradable chunks, are all likely to stimulate future growth of ILS and the convergence space.
The state of the traditional reinsurance market is the other factor likely to stimulate further growth of convergence and ILS.
As capacity and pricing constraints (as well as demand, catastrophe occurrence and availability of risk opportunities) create an ebb and flow in traditional reinsurance capital, capital markets and ILS players stand a chance to step in, augment the traditional capacity and help to remove the volatility out of these pricing patterns that have been seen historically.
The dampening of reinsurance and retrocession pricing volatility effectively means a flatter reinsurance market cycle, which ultimately should be of benefit to the insurance consumer. While this may mean the same levels of payback are not as easy to demand, the cost of risk capital should still be driven by the risks assumed.
That should help convergence to grow, remain an increasingly relevant part of insurance and reinsurance capital and find new opportunities to become more deeply embedded in the traditional market.
A.M. Best believes that the attraction to ILS as a source of risk capital will continue, resulting in ongoing growth.
The rating agency said; “The attraction for cedants to use programs like cat bonds or collateralized reinsurance, which are totally collateralized, versus unsecured promises–to-pay from a rated entity, the hallmark of traditional reinsurance, will continue to be the leading catalyst for growth of the convergence market.”