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Original Risk: A Society for Change Agents

Don’t miss chance to restructure reinsurance using ILS: WCMA


The majority of insurers and reinsurers are missing an opportunity to restructure their reinsurance or retrocessional protection to integrate ILS, with the opportunity to achieve a radical change in efficiency perhaps greatest right now, according to Willis Capital Markets & Advisory.

At the same time Willis Capital Markets & Advisory highlight that the ILS market is perhaps at the very early stages of “dramatic structural change.”

This may come as a slight shock to some traditional market incumbents who may feel that the last few years has seen a constant evolution of the market, as alternative and ILS capital made its presence felt. It doesn’t look ready to stop yet.

Recent initiatives, such as the partnership between the world’s largest ILS fund manager Nephila Capital and fronting and program specialist State National, which sees Nephila’s capital being put to work as reinsurance capital to access primary insurance risk more directly, signal that we’re still at the earliest stages of a market in development, WCMA highlights.

“Initiatives like Nephila’s fronting relationship with State National to enter the U.S. direct insurance business are more toward the beginning and not the end of a wave of dramatic structural change caused by ILS moving from reinsurance to insurance,” WCMA’s report states.

This wave of structural change and also disruption of existing intermediary relationships can be expected to continue and also accelerate, as the appetite of capital increasingly moves to getting closer to the risk, squeezing out any unnecessary processes in between.

The report highlights that cedents, particularly in Florida, have been taking advantage of the opportunity to strategically restructure their reinsurance programs, with the help of alternative capital and ILS structures.

This move brings commensurate gains to both shareholders and policyholders, WCMA insists, enabling ceding insurers and reinsurers to take advantage of the efficiency of third-party capital and ILS, while also benefiting from performance gains.

However, some insurers and reinsurers risk missing out. By sitting back and relying on traditional coverage alone, or by seeking to simply replace one layer of cover with a product from the capital markets, cedents are missing an opportunity to restructure their reinsurance programs with the assistance of ILS and alternative capital.

Bill Dubinsky, Managing Director and Head of ILS at WCMA, explained; “Ceded reinsurance executives should not focus on using ILS to buy the same reinsurance program as in the past more cheaply.”

Dubinsky and WCMA believes the time is now for cedents to take advantage of lower-cost and more efficient capital from ILS markets, as well as the securitised structures and vehicles that are offered, to make a more radical change to their protection buying.

“Insurers instead should be looking to restructure their reinsurance programs to better integrate ILS capacity and make more dramatic performance and efficiency gains, ultimately to the benefit of shareholders and policyholders,” Dubinsky continued.

By better integrating ILS capital within cedents reinsurance programs they can stand to realise performance and efficiency gains, WCMA explains in the report, which will benefit both shareholders and ultimately the policyholders the cedents serve.

“In the reinsurance programs of many Florida reinsurance programs, we see relatively more strategic restructuring of reinsurance programs and commensurate gains to the benefit of shareholders as well as policyholders,” WCMA’s report continues.

Savings and efficiencies realised from embracing ILS and capital markets backed reinsurance capacity can have a “dramatic and non-linear effect” on the ability to offer a competitive insurance product, WCMA note.

In times when the market is searching for either efficiency or scale, perhaps embracing ILS in a strategic approach to reinsurance or retrocession buying could be a far quicker win, enabling cedents to ultimately improve the profitability and quality of their own offering.

It’s an interesting angle that WCMA has taken in the report, highlighting that strategic restructuring in this way could provide tangible benefits which can be much more easily and swiftly realised than the search for scale through mergers or acquisitions.

Also, for those cedents that have recently been through a radical restructuring of their reinsurance buying, as so many have with the trend towards centralisation, if that has not involved establishing how to bring ILS into the mix it is perhaps worth asking your brokers and reinsurance buyers why.

But further disruption is almost certainly ahead, according to WCMA’s report, with new initiatives that seek to enable ILS and alternative capital to more closely attach itself to risks seen as a new wave in the evolving ILS landscape.

“Such ventures are more toward the beginning and not the end of a wave of dramatic structural change caused by ILS moving from reinsurance to insurance,” Dubinsky said.

This is perhaps the natural next wave of evolution for the market, sourcing risks from new counterparties and cutting out an increasing amount of intermediary costs and established players.

The fact that this is happening before the ILS market seems to have truly expanded into reinsurance, it still remains largely focused on peak catastrophe perils, should perhaps be a cause for concern for traditional incumbents.

The capital markets are now establishing the ground-work for bringing their capital closer to the primary source of risks, while at the same time working to expand into new areas of reinsurance and new regions of the world.

This top down and sideways expansion at the same time can only lead to more disruption and pressure on those traditional players that have not yet worked out how to profit from the entry of new capital into the reinsurance and now insurance market.

So not only could cedents be missing a trick on ILS if they have not yet learned to use it to enable structural change in their risk transfer. They could also be missing a trick if they have not yet learned how they can assist in and profit from marshaling investor capital to the risks it seeks to access.

WCMA expect this change, as ILS players seek to access risk from the most primary source, will be quite unlike the changes we’ve seen in insurance and reinsurance to date.

“As evidenced by the State National example, this change will not look the same as the many changes to the reinsurance landscape,” WCMA wrote.

As an example they say that catastrophe bonds, in their current form, would not be directly applicable to risk at the primary level. So we can expect to see fundamental structural change to the way insurance risks are ultimately ceded to risk capital, with the ILS market expected to be leading the way.

WCMA also notes that the next wave of evolution in ILS, which is only just beginning, will follow the first in seeking out the best understood risks and markets first and then expanding on it.

“As with the changes sweeping reinsurance, while the entry of ILS into insurance may start in the U.S. and in London, it will not end there,” WCMA explained.

As a result, regardless of how the catastrophe bond market and instruments such as reinsurance sidecars do in the coming quarters, WCMA says; “We will see further penetration of ILS capital to the insurance business – and not just for nat cat.

“This will in turn create substantial winners and losers (with some in each category being surprises) and begin to dramatically upset well settled market practices ultimately for the benefit of policyholders through the increased availability and affordability of insurance.”

In fact, WCMA expects the next wave of the capital markets push into insurance and reinsurance will be even more dramatic and widely felt, with ramifications for industries beyond the borders of the defined world of risk transfer.

The report concludes; “This is change that will impact the larger world and not just a handful of industry insiders whose fortunes rise and fall from the cyclical rhythm of the insurance and reinsurance marketplaces. It will be noticed.”

WCMA’s report is a timely reminder that the ILS market we see today is still rapidly evolving to meet both cedent and investor needs.

The innovative approach, taken by the frontrunners in ILS, to matching capital to risk with a desire to make the join between the two as short and efficient as possible, threatens to step on the toes of incumbents for many years to come.

This change won’t just be noticed, it will be acutely felt by players in all areas and sides of the re/insurance and wider risk transfer market.

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