The latest reinsurance market renewals report from broker Aon Benfield has been published and it’s no surprise to see pricing in the insurance-linked securities and catastrophe bond markets getting a mention. Aon Benfield said that clients renewing significant capacity in the ILS markets have experienced risk adjusted price decreases of 25% to 70% for U.S. hurricane and earthquake exposed transactions.
The report begins by acknowledging the impact that continued inflows of third-party capital into the collateralized reinsurance and ILS markets are having on rates and renewal conditions. Aon Benfield said that new capital inflows have “Materially altered the course of April renewals for peak U.S. perils” noting that third-party capital is expected to continue to have a material benefit for its clients in the forthcoming June and July renewals as well.
With risk adjusted price decreases of up to 70% possible for those choosing to place significant capacity in the ILS and catastrophe bond markets, Aon Benfield said that the ILS market is now offering the lowest cost for reinsurance on certain peak perils seen since hurricane Andrew in 1992.
That’s a significant statement as the cost of reinsurance has now dropped to levels which market participants and observers might have suggested were impossible just a year or two ago. As insurers now weigh up their options for reinsurance protection, and reinsurers look again to ILS for retrocession, could this drop in pricing help to stimulate further growth of the ILS and cat bond markets?
Aon Benfield said that if the new price points offered by ILS and collateralized reinsurance markets persist, which they note is a big question given the amount pricing has dropped, then property insurers suddenly have new strategic options at their disposal. The price levels that recent catastrophe bond deals have completed at can make issuing a cat bond or ILS suddenly much more cost-effective and within reach of even smaller primary insurers.
The report notes that if insurers can access multi-year sources of risk capital for their catastrophe risks at prices well inside the cost of equity capital then Aon noted that; “At the extreme, primary property growth in active zones could resume for companies previously restricting supply.” Aon also said that even moderate plans could begin to consider the lower cost of catastrophe risk transfer.
These are bullish statements and certainly suggest that we are entering a new reinsurance market paradigm where catastrophe risk transfer, facilitated by third-party capital in collateralized and ILS form, becomes much more accessible resulting in changes to the insurance and reinsurance landscape. It is early days and yet to be proven whether the drop in pricing in ILS and collateralized markets will become a permanent feature in the market. However it does seem that the pricing at these recent April renewals has been sufficiently disruptive to create a focus on the sector and force traditional reinsurers to think about their responses.
Aon Benfield’s report says that it is now clear that ILS and collateralized markets can now be competitive with traditional reinsurers in peak zones and it expects that this will result in changes to the largely equity financed business model of the reinsurance market.
Aon Benfield expects insurers and reinsurers to react by finding new and innovative ways to use the ILS and collateralized reinsurance markets to their advantage. It expects that we will see new types of securitizations, such as complex commercial property, commercial liability and other new classes of risk which will seek to access alternative sources of reinsurance capital and risk transfer. Insurers, it says, will look to leverage the ILS and collateralized markets, to gain access to new and diversifying sources of risk capital which in turn will enable them to compete and grow.
These are great predictions from Aon Benfield and fully support the suggestions we’ve made that the insurers and reinsurers who will win in this time of change will be the ones who look to adapt, innovate and leverage the alternative and third-party capital to their advantage.
Of course one of the reasons for the flux in the market and more attractive pricing is the continued interest from capital market investors in what they see as a source of strong yield and diversification in a difficult economic climate. But while alternative capital supply has grown, so also traditional reinsurance capital has grown with an 11% increase in 2012 to end the year at $505 billion, according to Aon Benfield’s estimates. This means that reinsurance supply continues to outstrip demand in all major global catastrophe regions, according to Aon, which makes the price drop in ILS markets even more outstanding.
Aon Benfield said that traditional reinsurers are beginning to respond to the increased competition from the alternative reinsurance markets, noting that relationships and continuity continue to be highly valued by cedents.
Continuity is a word we are likely to hear a lot until we see the first major test of the new alternative reinsurance capital in the form of one, or a number of, major catastrophe events causing significant losses across the sector. Some traditional reinsurers will hope that such an event, or series of events, would result in a signficant pull-back by third-party capital from the space. However it is possible that those reinsurers are risking being left behind while some of their competitors adapt and find ways to work with and leverage this third-party capital.
The fact that the reinsurance market is changing as it accommodates more and more third-party capital from investors cannot be debated anymore. How meaningful this change will be is cannot yet be fully understood, but rest assured we’ll be here to help you get to grips with it.
You can access the full report, 2013 Reinsurance Market Outlook – April 1 Update, via the Aon Benfield website.
Here are some other recent articles on the alternative capital trend in reinsurance that may be of interest if you missed them (older articles first):