The size of the alternative reinsurance space, consisting of third-party backed reinsurance capacity in the form of insurance-linked securities, collateralized reinsurance, sidecars, funds and other vehicles, is becoming increasingly difficult to gauge. Right now it is growing on a weekly basis as new inflows come into the space and new third-party capital management units emerge.
Depending on who you ask it’s been said that alternative capital sources could account for anywhere from 14% to 30% of the catastrophe reinsurance market. Useful measures and certainly a meaningful contribution to the overall reinsurance landscape. But how far can the current trend of increasing interest and participation from capital market investors go? Could we see a time in the future when alternative reinsurance capacity, in whatever form, makes up as much as 50% of the reinsurance landscape?
At the recent Standard & Poor’s insurance conference, one person who suggested that the size of the alternative reinsurance market would keep growing was CEO of Aspen Insurance Holdings Ltd., Chris O’Kane. We followed up with O’Kane to clarify his comments on the subject.
“The convergence of traditional and alternative capital sources is changing the dynamics of the reinsurance marketplace with the increasing influence of third-party capital markets set to continue,” said O’Kane. Despite this changing market dynamic, O’Kane believes that the market is maintaining its discipline, even as third-party capital continues to pour in.
“This is the most disciplined reinsurance market I’ve seen,” commented O’Kane, “With a greater emphasis on risk management over the past 10 years, better pricing tools, and perhaps a fairly widespread commitment to price risk more intelligently.”
O’Kane clearly believes that we are still seeing this trend, of third-party capital being leveraged for underwriting reinsurance risks, in its infancy and that it has room to grow its contribution to the market. “While it is not possible to predict by how much alternative capacity will grow, I would not view 30% of the limit of the catastrophe market as anything like a ceiling for this. It could be even higher than that.”
For the market to continue growing it is going to need to diversify and find new opportunities in the market which meet investors risk and return ambitions. O’Kane sees the third-party capital trend broadening its scope into new areas of the reinsurance business and new classes of risk in the future and that this will help it to grow beyond the contribution it makes to the wider reinsurance market today.
“Some alternative capital sources are already attracted to non-cat classes”, said O’Kane. “The majority of the attention for now is on cat business, but the direction of this fundamental shift in capital supply to the reinsurance industry will lead to alternative sources for many more lines of business over time.”
The inflows of alternative capacity from third-party capital markets sources are clearly having an impact on pricing and the reinsurance cycle. At the recent AIRMIC event in Brighton, England (which oddly is where Artemis is published from) executives mentioned the third-party capital trend as significant.
According to a Business Insurance article, Steve Hearn, chairman and CEO of broker Willis, said that the influx of capital is a significant change, and one which should benefit buyers of insurance in the long-run.
The reinsurance cycle is changing as a result of all this additional capital, with differing costs and motivations, coming into the market. Stephen McGill, President of Aon PLC, said that he questioned whether we would see hard markets again in the same way as we have historically and expected the new capital landscape to smooth the pricing peaks out somewhat.
This non-traditional reinsurance capacity, sourced from investors such as pension funds, may not exit the market as suddenly as some people may think, according to these executives. It has the potential to become a longer term source of capital for the reinsurance market, McGill said that because investors such as pension funds are putting such small amounts of their assets into the sector it may well stick around.
Another person who thinks third-party capital is here to stay is David Flandro, Global Head of Business Intelligence at reinsurance broker Guy Carpenter. In a speech to the Association of Lloyd’s Members conference earlier this week Flandro said that alternative capital is likely to be more sticky than many expect.
There’s a real divergence among the market and its observers over whether capital will be sticky or not. Our opinion is that some will definitely be sticky and having spoken to managers of this capital at pension funds, and other large institutional investors, it is clear that they see reinsurance as an alternative asset class that they are just getting started with.
The general opinion seems to be that if major losses occur, due to a Florida hurricane for example, some investors will choose to leave, others will choose to enter and still more may increase or replenish their allocations to the market to take advantage of increased rates. Of course until that major loss event happens we can’t say for sure how it will play out.
The other story of global interest rates, and whether a hike in rates across other asset classes will see money withdraw from reinsurance, is considered a non-story by many pension fund and institutional investors. They are in reinsurance for the alternative asset diversification properties, not purely because it has a better return than many other asset classes right now. That has helped to get them interested in the asset class and raised its profile, but the more they have learnt about reinsurance and catastrophe risk the more attracted to it they have become as a longer term complement to their investment portfolios.
So with that in mind O’Kane’s comment of ‘don’t put a ceiling’ on the potential size of the alternative reinsurance market is worth bearing in mind. Capital continues to come into the space and it is still very early days for the world’s major pension funds in this space. We won’t hazard a guess as to how big this space could get, but we definitely agree that it has not yet hit its ceiling.