The insurance-linked securities (ILS) market is likely to consolidate with the highest quality managers of third-party reinsurance capital the likely winners, according to RenaissanceRe CEO Kevin O’Donnell.
After the period of losses suffered in the last two years the CEO of RenaissanceRe (RenRe) expects that investors will look to switch allegiances to those with the best track records, access to risk and ability to deliver returns with lower volatility.
Of course O’Donnell believes that his firm stands well positioned to benefit from the trend he expects to emerge, but he also believes that the amount of capital allocated into ILS structures will shrink slightly year-on-year in 2019, which stands to reason given the amount of collateral still trapped and unavailable for deployment.
“We believe capital allocated from the ILS market to the reinsurance market will be down in 2019 compared to 2018. Part of that is based on the fact, how much is tied up and how much has been lost,” O’Donnell explained during the RenRe quarterly earnings call this week.
Continuing, “Regardless of what happens with third-party capital going into the renewals that I mentioned in my price expectations, we’re in a preferred position to access that business and also manage the third-party capital as it comes in.
“I believe going forward the market is going to continue to consolidate with the highest quality managers, of which we’re certainly one, and I think the formation of Vermeer Re in the fourth quarter points to success in that management.”
On the subject of a shrinkage in ILS capacity in 2019, O’Donnell suggests there is work to do on evaluating the structures underpinning ILS and ensuring they are always fit for purpose.
“For the first time in many years however, in 2019 I anticipate third-party capital will play a smaller role in protecting our customers risks. This contraction is the result of the increased loss frequency and severity affecting the business. While we believe that third-party capital is an important component of our business, the structures that deliver this capital should be scrutinised,” he explained.
Hinting at the potential for a flight to quality among some investors in ILS, which we’re written about recent here, O’Donnell said that it is his belief that a hybrid approach to combine the benefits of collateralised capacity with rated reinsurance entities is the future.
“Capital needs to be intermediated by strong underwriting and we’re increasingly seeing more sophisticated due-diligence being conducted by investors, in order to assess the underwriting expertise of their managers. This is a natural next step in the maturation of this market.
“Ultimately I see the market migrating to the hybrid model of rated and collateralised capacity, that we pioneered with our integrated system,” he said.
O’Donnell later explained that he sees RenRe’s approach as better integrated than some reinsurers managing third-party capital, as the same underwriting teams write the risks and then distribute it to different balance-sheets backed by a range of capital providers and investors.
“We’re able to leverage our infrastructure in a way that’s difficult for many others, who are managing their third-party capital in a less integrated way,” he commented.
Of course this raises the question for some investors of how risk is selected for their capital versus a reinsurers own balance-sheet, or partnerships, meaning for some investors the independent ILS manager or Chinese walled underwriting team may remain preferable.
But it is certain that larger investors in the ILS space will have watched closely as PGGM established its Vermeer Reinsurance rated entity in a joint-venture with RenRe and will be intrigued by that model. How many of those one reinsurer could support remains to be seen, but there are certainly other reinsurance firms that would be attracted to doing similar with major institutional investors.
Actions that O’Donnell said, “Demonstrate our ability to raise the most efficient and effective capital from multiple sources, but also provide us considerable liquidity and financial flexibility heading into 2019.”
Of course consolidation to the highest quality managers should be a given, as investors in ILS should be selective and demanding of those looking after their capital.
But it’s by no means certain that any one winner will emerge, as choice in terms of managers and options in terms of strategy are also key for an asset class that will continue to expand.