The experience of the reinsurance market with COVID-19 and business interruption, as well as the expectation that uncertainty will persist over the eventual industry loss impact of the pandemic, will all combine to elevate the preference of cedents for rated paper, RenaissanceRe’s CEO believes.
Kevin O’Donnell, speaking during his firms third-quarter earnings call yesterday, believes that cedants may look to rated balance-sheets for greater certainty that the potential tail within property contracts are covered.
At the same time of course, his company offers collateralized reinsurance and retrocession capacity to its cedants, through structures including its Upsilon vehicle.
But RenRe, with its multiple balance-sheet approach, feels that the preference for a rated balance-sheet could be accentuated by the COVID-19 pandemic, as cedants look to have certainty of coverage.
O’Donnell explained, “The ILS industry will likely suffer significant amounts of trapped capital yet again in 2020 due to the impact of COVID-19, catastrophe loss events to date and an already-active fourth quarter.
“The potential for trapped collateral highlights an important difference between collateralized coverage and traditional reinsurance. In a collateralized deal, a cedant enjoys protection for as long as collateral is available. Consequently, in a year like 2020, cedants would prefer to maintain protection against the heightened uncertainty of losses, while providers will want to roll their capital into new deals and new premium.”
Of course, this debate, of collateralized coverage or rated paper, has always been a feature of the insurance-linked securities (ILS) market and some cedants have always demanded the rated paper, resulting in a burgeoning industry in fronting for ILS capital.
That segment is likely to benefit from the uncertainty trend generated by COVID-19, as fronting service providers can put their balance-sheets up to cover tail-risks, while helping ILS funds and investors to move collateral around more readily, even when uncertainty over losses is present.
O’Donnell continued to explain that, “Business interruption-related COVID-19 claims only intensify this inherent tension. The industry remains in the early stages of assessing the myriad of factors affecting potential BI losses, a process that will play out over years. Given this, going into 2021, we expect that cedants will increasingly prefer the certainty of rated balance-sheet providers over collateralized vehicles.
“If this occurs, we have the flexibility to transact with our customers through their preferred means of risk transfer which is likely to result in us deploying more rated paper and shrinking Upsilon.”
Which raises a question though, why should Upsilon’s investors suffer from the changing preferences of cedants that is driven by uncertainty related to the pandemic the world is currently facing?
Perhaps RenRe could front for its Upsilon vehicle, providing a solution that would work for the cedants and the investors and making collateral roll-over a much easier process?
There are a number of companies looking into a 2.0 version of fronting for ILS at this time, trying to identify a way to enable investors to access the reinsurance returns they want on a fully collateralized basis, while putting the rated balance-sheet in front of cedants and enabling roll-over even when there is clear uncertainty over losses still.
It’s not yet clear how this can be achieved, but a company like RenRe surely has the platform and the capabilities to provide this level of service to its third-party investors, to prevent them having to take a down-sized share of risk just because cedant preferences have changed.
Previously, O’Donnell highlighted that third-party investors have a right of incumbency on the business written in the structures they invest in.
However, sometimes these rights are just not practical, if the cedant prefers another way, or if the most efficient way to structure the reinsurance or retro business calls for a different solution.
O’Donnell feels well-positioned and able to capitalise on such trends, given RenRe’s multi-balance-sheet approach, with owned and third-party capital.
“We find ourselves in a very enviable position heading into the January 1 renewal cycle,” he explained.
Analysts questioned O’Donnell on the shifting of business from Upsilon to RenRe’s own balance-sheet and he expanded by explaining that the potential for retrocession arrangements to be restructured at the January renewals may also mean some business is better suited to the rated balance-sheet approach.
“The retro that we put into Upsilon was retro that on a rated balance-sheet is capital consumptive because of the structure, so it fits well within a collateralized structure,” he explained.
“I anticipate that much of that retro is going to be restructured,” he said, explaining that as retro prices rise cedants will often look to restructure their protection to maintain coverage.
However, he clarified that it’s not just a case of shrinking Upsilon for the sake of it, saying that, “My hope is that much of the Upsilon portfolio can be renewed in Upsilon, with the capital that we bring in for 2021.
“But the stuff that will not fit into Upsilon, will likely be restructured in a way that is more suitable for a rated balance-sheet and we have the flexibility across our platforms to provide solutions for every deal within Upsilon. It just depends on which balance-sheet we choose to put it in, or which vehicle we choose to put it in.”
One of the questions around alignment that investors often ask is how sticky business will be in the structure they invest in, should the market change and it look more attractive to underwrite it through a different capital source or vehicle.
This precise issue is going to be a feature of the January renewals it seems and companies like RenaissanceRe will have to deal with the questions it raises.
Investors in Upsilon may feel that risk premium is being shifted away from them, to the benefit of RenRe’s own revenues and shareholders.
But the reality is, that in the cyclical reinsurance market it’s not just a cycling of prices we see. It’s also a cycling of demand factors and practicalities, as the market moves and risk sits better on one structure or another.
The work going on in certain corners of the ILS market to develop next-generation collateralized products and better ways to front for fully-collateralized capacity could solve some of these issues in year’s to come. But still, this market will have a cycle, with motives and modes of risk transfer changing to meet the economic and risk environment.
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