Follow-form facilities best suited for ILS to enter primary markets: S&P

Global reinsurers are increasingly underwriting primary specialty business, as competition and challenges in the reinsurance market persist. But for insurance-linked securities (ILS) players seeking to enter the primary landscape a form-following approach is more likely, according to S&P.

“The primary P/C market could be the answer to transformative changes needed in the reinsurance sector,” argues insurance and reinsurance ratings agency Standard & Poor’s (S&P), predicting a continued trend of traditional reinsurance companies’ “shifting to primary insurance from reinsurance with a persistent focus on specialty writings.”

The majority of reinsurance firms that operate today are no longer pure-play reinsurers, but instead adopt a hybrid approach, offering reinsurance and insurance solutions, says S&P.

Furthermore, S&P highlights that where previously reinsurers with a presence in the primary market relied on their Lloyd’s Syndicates to access the business, companies are increasingly making direct investments into the primary landscape, through merger and acquisition (M&A) activity or elsewhere.

However, while the ratings agency expects to see an influx of reinsurers entering into “even more standard commercial lines with a specialty bias, which may or may not be accomplished through M&A,” it doesn’t predict the same trend with ILS, or alternative capital providers in the space.

“Conversely, we do not anticipate as many deals from third-party capital (versus reinsurance) because we view investments in the primary insurance market as longer term and less nimble,” explains S&P in its recent report, ‘Mergers and Acquisitions Among U.S. Property/Casualty Insurers Are Becoming More Frequent Despite Valuations.’

Instead the firm notes that a more suitable method for ILS players to access primary market risks to deploy their capital, lies with the ability to participate in form-following programmes, something seen recently with insurance-linked asset management giant, Nephila Capital.

The transaction sees the company enter into a 10% follow-form facility agreement to participate in property insurance brokered by wholesale firm Amwins, whereby Nephila follows the underwriting of the coverage and puts its capacity to work to back a 10% share of the deals transacted.

The establishment of and entry into a follow-form facility enables third-party capital providers to deploy some of their capacity into diversified, less-competitive, primary business, away from the pressures of U.S. property catastrophe reinsurance lines, for example.

However, warns S&P, a potential hindrance to the greater entry of third-party capital into the primary markets is that “insureds might be wary of alternative capital entrants given their lack of track record for paying claims.”

Since the volume of alternative reinsurance capital really started to grow into a powerful market force, it’s been considered a largely untested model, absent any large, significant insurance and reinsurance industry loss events. Of course that doesn’t take into account the fact that ILS managers are regularly paying claims on private and collateralised reinsurance deals.

S&P continues; “Conversely, insureds might be agnostic or even unaware of alternative capital participation in the re/insurance market because the coverage is issued by an established primary carrier that still must pay claims even though risk is transferred to the alternative capital vehicle.”

In that scenario, the ILS fund manager or investor is simply providing the capacity to back someone else’s underwriting and claims management, which allows the efficiency of the capital to be maximised to a degree, while leaving the claims tasks with those often best placed to deal with it.

As the competitive reinsurance operating environment continues, exacerbated by the benign loss environment, ample capacity and intense competition, it’s likely that ILS players will continue to search for other ways to deploy their capital into diversified, higher returning business lines.

This looks set to increasingly include accessing risk through new vehicles and arrangements, including follow-form facilities and working alongside fronting carriers in the primary markets.