ILS to continue expansion despite efficient traditional reinsurance: Moody’s

A recent Moody’s survey reveals that property & casualty (P&C) reinsurance buyers don’t expect to increase their use of alternative capital in 2018 in light of competitive pricing in the traditional segment, but Moody’s still expects the expansion of insurance-linked securities (ILS) to continue.

According to Moody’s, alternative reinsurance capital has grown at a compound annual growth rate (CAGR) of roughly 20% since 2008, increasing its share of total, dedicated reinsurance capital to 14.2% at the end of Q1 2017, amounting to roughly $86 billion.

In more recent times, the flow of alternative reinsurance capital into the global reinsurance landscape has slowed as competition intensifies and pressures mount across most reinsurance business lines, but in particular the U.S. property catastrophe space.

But despite the slowdown, Moody’s expects the ILS space to continue expanding as “insurance risk becomes an increasingly important source of diversification for pension funds and other investors.”

As well as the launch of Global Reinsurance outlook, which notes that Moody’s has changed its outlook for the sector to stable from negative in light of the market’s solid capitalisation, Moody’s has launched its P&C reinsurance buyers survey, which discusses cedents’ use of alternative, or non-traditional reinsurance capital.

According to Moody’s, the majority of cedents that responded to its survey still don’t use alternative capital, although many of them did acknowledge the expanding part of the market and routinely consider it when establishing their reinsurance programmes.

Furthermore, most reinsurers that participated in the survey said they don’t have any specific plan to increase their utilisation of alternative capital in 2018, as the competitive price of traditional reinsurance limits the need for ILS capital.

The supply/demand imbalance in the reinsurance industry, that’s exacerbated by the rise of alternative reinsurance capital, has created a buyers’ market where reinsurance purchasers are able to secure efficient protection under more favourable terms.

As a result, it could be that more efficient traditional coverage is limiting the growth of alternative reinsurance capital, suggests Moody’s.

One survey responded, said; “While we evaluate various types of covers and capital sources on an annual basis, standard reinsurance pricing has remained the most competitive for our program.”

While another, added; “We will definitely consider using alternative capital in the future under the right circumstances. To date, our traditional reinsurance partners provide us with the same if not better structures and rates.”

It’s worth noting that outside of the U.S., in parts of Europe and Asia, for example, traditional reinsurance is heavily discounted for the diversification these regions offer large reinsurers, and as such ILS capital has a challenge to compete here.

“We are constantly in touch with the price level / conditions of the insurance-linked securities (ILS) market. Today we do not have any ILS products and I do not foresee the traditional market pricing to increase to a level where cat bonds will outperform the traditional market,” said another survey respondent.

In contrast, there’s less to diversify in the U.S. where the margins are higher, so it could be that survey respondents that feel alternative capital is more expensive than traditional coverage, could well have a focus on markets outside of the U.S. where diversification discounts can be high.

The survey also reveals that of the respondents that do use alternative capital, roughly 20% of their catastrophe reinsurance, on average, is sourced from alternative capital.

“Many insurers routinely compare the costs of alternative and traditional reinsurance, demonstrating that alternative capital has established itself as a competitor to traditional reinsurance, at least for natural catastrophe coverage,” says Moody’s.