Higher reinsurance costs may boost ILS use among carriers: A.M. Best

In a market environment where reinsurance capital increasingly wants to be paid a higher return for the risks it takes on, there is a growing chance that primary insurance carriers look to the capital markets, insurance-linked securities (ILS) and alternatives, according to A.M. Best.

U.S. homeowner insurers have benefited from particularly favourable reinsurance market conditions for a number of years, as capital targeting U.S. catastrophe risks in particular swelled, driven by a series of relatively benign catastrophe loss years and growing capital market investor interest in ILS.

Insurers have been able to put together comprehensive reinsurance programs, featuring both ample top-end and robust sideways protection, which many have now built their business models on top of.

But in the wake of 2017 and 2018 catastrophe losses, reinsurers are looking to get paid a higher return for deploying their capacity, while at the same time the insurance-linked securities (ILS) market also wants to ensure that rates are sufficient to cover long-term loss costs.

At the same time interest in supporting aggregate and sideways deals has waned somewhat, unless the price is right.

Rating agency A.M. Best says that reinsurers are noticeably demanding price increases, while also working to limit their risk concentrations at the same time.

As a result, the rising costs of reinsurance protection may give rise to homeowners insurers in the United States increasing their use of ILS and other alternative risk transfer structures, A.M. Best believes.

With reinsurance prices rising, the capital markets has a further chance to demonstrate the efficiency of its capacity.

“Insurers will look to expand their programs to include more cost-effective options,” A.M. Best believes, which could lead to more of a focus on the alternatives available.

Alternatives could be in terms of risk transfer structure itself, as well as capital source, potentially leading to increased interest in ILS such as catastrophe bonds and other collateralised reinsurance covers.

Some homeowners insurers in the U.S. are so thinly capitalised that rising reinsurance costs could add significant pressure, making the hunt for more cost-effective alternatives more urgent.

This is especially the case for some of the more geographically concentrated insurers as well, A.M. Best says, which may point to rising interest in ILS options in Florida and other coastal catastrophe focused regions perhaps.

In general, insurers have become increasingly focused on exposure management in the wake of heavy catastrophe loss years, which for some could lead them to seek out even more coverage as part of their toolkit in managing exposures.

Reinsurance firms have found that use of third-party capital and ILS structures such as sidecars have helped them to manage their exposures and maintain underwriting operations in peak catastrophe zones.

Could we see primary insurers looking to achieve similar, leveraging ILS and third-party capital as a tool to help them sustain their underwriting books rather than having to shrink them?

It would make sense for this strategy to slip down to the primary insurer level, as partnering with ILS capital or funds could help them to better manage their exposure and volatility on a gross to net basis, while also earning fee income for sharing risks with investors that can make this an even more efficient form of partnership reinsurance capital.

Some large primary insurers are already doing this, through their catastrophe bond programs or the few primary sponsored sidecar-like structures.

As reinsurance rates rise it would make sense for there to be an increasing in-sourcing of alternative capital within (or alongside) the business models of primary insurers, helping them to benefit from cost effective reinsurance capacity and capital to drive further growth and earn fees, all while better managing their exposure.

Of course, the same is being seen in retrocession as well, where rates are rising and capacity squeezed, which is driving increasing interest in retro catastrophe bonds as well as fresh demand for ILW’s.