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“End of free money” to impact reinsurance prices: Goldman Sachs

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According to Goldman Sachs equity analyst team, the “end of free money”, by which they are referring to the end of quantitive easing by Central Banks, is set to have ramifications for reinsurance pricing and also for the insurance-linked securities (ILS) market.

free-money-cashThe insurance and reinsurance market has in the past been a beneficiary of the money printing trends across Central Banks, with quantitive easing and low interest rates seen as factors that have attracted capital to the sector.

This goes for traditional reinsurance as well as insurance-linked securities (ILS), with both traditional and alternative sides of the market benefiting from these macroeconomic trends.

Now, the era of “free money” has ended, as Central Banks tighten policy, easing has stopped and interest rates are surging.

Which Goldman Sachs analysts highlight as a headwind for the industry that could ultimately serve to drive reinsurance pricing higher at future renewals.

Over the medium-term, higher interest rates are expected to be a “tailwind for the sector” Goldman Sachs analysts note.

But, in the shorter-term, these macro effects may dent investor demand and also push investors to look elsewhere for returns.

“The higher interest rates and end of quantitative easing will also impact the alternative capital in the industry, which has been competing with the reinsurers’ capital,” Goldman Sachs analysts explain.

“Higher interest costs and the end of ‘free money’ will allow reinsurers to charge more for their capital and increase the value of their offering,” they believe.

Where and how investors deploy their money has a significant bearing on the reinsurance market these days.

Availability of capital is key to reinsurers that leverage retrocession, while also being a factor that can drive opportunities for them in terms of partnering with third-party investors.

At the same time, ILS capital has been a competitive force, exerting the efficiencies of direct deployment at certain layers in reinsurance towers that have both helped reinsurers, but also driven a competitive response that has softened pricing too.

The change in the macroeconomic environment and the future changes that are coming, as bond markets continue to have the potential to deliver additional challenges and to depress economies going forwards, will have significant ramifications across markets in insurance and reinsurance.

For the ILS market, while there can be some realignment of priorities expected, among investors, there will also be another opportunity for the sector to display the benefits of diversification.

While hurricane Ian has proven a major hit to the ILS market, it’s important to also put it in context of the hits investors are taking in other areas of their portfolios.

Stock portfolios are down significantly, bond investors facing severe challenges, private equity declines are not even priced in yet (but are coming in spades for some).

There are plenty of asset classes, more traditional and alternatives, that are down much further than catastrophe bonds in 2022, for example.

It’s also important to remember that ILS are generally a floating rate instrument, so benefit from returns of the collateral that investors funds are allocated to and are used to underpin obligations.

Right now, Treasury Money Market funds can yield more than 2.3%, which when provides a significant boost to underlying ILS instrument returns.

Some types of collateral can yield even more and this serves to make ILS a more attractive option for investors.

In the period following hurricane Ian there is bound to be challenges raising new capital for many segments of ILS, but longer-term, as Ian’s losses become clear and the full decline of ILS strategies after the storm understood, the asset class may benefit from Central Bank policy, especially as many investors are still laser-focused on diversification at this time.

While there are some ramifications for reinsurance pricing related to availability of ILS capital coming, there are also ramifications for reinsurers own capital, especially should financial market volatility pick-up again.

In addition, inflationary effects are making claims more costly, as well as driving up demand for reinsurance, all of which will have ramifications for reinsurers ability to raise prices in future too.

Register today for ILS NYC 2023, our next insurance-linked securities (ILS) market conference. Held in New York City, February 10th, 2023.

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