ILS pricing efficiency decouples it from reinsurance: Paul Schultz, ABS

The rise of alternative asset classes combined with the decoupling of insurance-linked securities (ILS) and traditional reinsurance market pricing, are key contributing factors to the current state of the market, according to Aon Benfield Securities Paul Schultz.

Speaking to A.M. BestTV at the SIFMA event in New York earlier this year, Paul Schultz, Chief Executive Officer (CEO) at Aon Benfield Securities discussed the “fundamental changes” sweeping through the global reinsurance space, the drivers of this and the influence of increased alternative capital.

Conventionally, and over a fair few years now, the pricing trends of ILS and traditional reinsurance markets have converged. When one market was proving more efficient, the other would generally catch up, advised Schultz.

But in recent years the pricing efficiency convergence trend between the two markets has somewhat deteriorated.

“Now what we saw a couple of years ago, almost two years ago to be exact, is we saw a little bit of decoupling, and what I mean by that is that the ILS market started to price itself in a way that was much more efficient to clients,” explained Schultz.

The increased pricing efficiency within the ILS asset class results in much cheaper costs for clients, ultimately leading to a growth in popularity and emphasising the ever-rising volume of alternative capital in the traditional reinsurance sector.

Interestingly, and to highlight this point further, Artemis recently covered Aon Benfield’s estimation on the growth of alternative reinsurance capital, which notes that by 2018 the ILS, collateralized reinsurance and catastrophe bond space will reach $150 billion of capital.

At the end of 2014 the amount of alternative reinsurance capital in the space had increased by 28%, finishing the year at almost $64 billion.

With all the extra capital now available from third-party investors occurring at a period benign of major catastrophes, it’s clear to see what Schultz is referring to as “fundamental changes” in the traditional reinsurance space.

But while traditionally the convergence of the two markets was the key driver of price or rate declines, Schultz notes that with the current market the drivers have changed.

“Now I think what we’ve seen in terms of the driving of price or rate declines in the ILS market is really the other alternative asset classes that are available to the investors,” said Schultz.

Adding; “So what we’ve really seen over the last couple of years is a more or less stability between the way investors are looking at the return of this asset class versus other alternatives.”

This again highlights the increased acceptance of alternative reinsurance capital within the space, as market participants learn to embrace and utilise the ILS capital in the global reinsurance market.

Discussing whether he felt the drivers of market pricing trends were likely to change in the near future, away from the current disparity of ILS and traditional reinsurance, Schultz advised “it’s hard to answer without a truth crystal ball.”

“I would say where we sit in the market today, which is benchmarking the return of this asset class versus other financial asset classes is probably the way that we’re going to be looking at pricing this market for the foreseeable future.”

One aspect that appears evident is that the alternative or third-party capital volume is set to increase further, as the market looks to expand towards the $100 billion mark, “that growth is truly going to come in from investors who are looking to create alternative returns and returns that look attractive versus the other asset classes,” advised Schultz.

For the traditional reinsurance market then, change appears to be imminent, and the distribution chain from brokers to underwriters will require innovation and revision to ensure and maintain a “true value proposition to clients,” Schultz said.

Client relationships will likely prove as valuable as ever and to keep strong relationships, traditional players will need to embrace the abundance of ILS capacity.

Schultz said; “ I think what we’re seeing is really traditional markets embracing the ILS capacity as opposed to looking at it as a threat, to try and create solutions that are valuable to clients and have those trading relationships going forward.”