One of the factors that has been driving down catastrophe reinsurance rates, both in catastrophe bonds and recent traditional reinsurance renewals, is the lower cost associated with capital sourced from third-party investors. Reduced cost means capital can afford to be deployed for lower returns, which some believe is going to continue driving growth of alternative reinsurance capital.
Capital sourced from third-party institutional and capital market investors has reduced costs for a number of reasons. It is not sourced from shareholders and so is looking for a return which is not linked to the overall performance of an organisation, it is also very focused, zeroing in on the underlying return of the investments. Third -party capital can also have a reduced target return as it doesn’t have the burden of an entire organisation to finance and finally the investors the capital is sourced from can have very different motivations and risk/return ambitions.
This means that the operational aspects of those managing the capital is not so important, budgets are lower and third-party reinsurance capital tends to be managed by smaller, more nimble teams of specialist underwriters or insurance-linked securities (ILS) fund managers without the huge overheads of large, global reinsurance underwriting firms.
On Wednesday 12th June, executives from Aspen Insurance Holdings Ltd. presented at the Morgan Stanley Financials Conference and this topic was discussed, alongside the strategy of the firms newly launched Aspen Capital Markets division, which will directly target managing third-party capital for deployment in underwriting capacity.
CEO of Aspen Insurance Holdings Ltd., Chris O’Kane began by commenting that there is a lot of capital, principally from pension funds and hedge funds, which is looking at the reinsurance space which they see as non or low-correlating with other asset classes. This new money has seen the profitability of recent years reinsurance rates and believes that it can afford to do the same work for lower return or ROE.
This capital is cheaper, both in terms of the return its willing to accept and its costs of deployment. O’Kane said that this capital is entirely rational, adding that no one is foolish here. That’s an important point as many observers suggest that capital is being deployed without the same stringent checks and balances that traditional reinsurance capacity has. This isn’t true of the vast majority of alternative reinsurance capital, the checks and balances employed to ascertain where and how to deploy capital are in some cases even more stringent in the alternative reinsurance space, plus the motivations can differ meaning that it can be hard to compare the two types of capital.
O’Kane believes that this lower-cost, third-party reinsurance capital is well-positioned to continue taking market share from traditional reinsurance players. He commented; “I think the cheaper capital is going to win, and that’s why we have founded Aspen Capital Markets, which is essentially an endeavor to turn part of our catastrophe reinsurance expertise into asset management.”
Where the main requirement is to get the best rate possible for a cedent, and the source of reinsurance capacity does not concern it, the cedent may well see the fully-collateralized, nimble and still rational, cheaper capital as far more attractive.
It’s early days for the Aspen Capital Markets venture, said O’Kane, a team is still being hired although some are already in place and working hard. O’Kane said that Aspen will leverage its brand, knowledge and underwriting skills to help propel its capital markets ambitions forwards.
The Aspen business is destined to become partly a traditional underwriting operation, partly fee and commission-based. O’Kane also sees an opportunity for third-party capital in other lines of reinsurance business, outside of property catastrophe risks, and from his comments it looks like Aspen will target this as well if opportunities arise.
O’Kane commented; “I think you’ve got to view convergence as an opportunity and a threat.” He continued by saying that it is absolutely right to see it as a threat, noting that reinsurance brokers are fearful of being disintermediated, and this threatens Aspen too if market distribution models change.
He said that Aspen are working with the market to reduce that threat, but that if clients come along who have needs for a different type of capital and approach them via investment bankers or another route, then Aspen needs to be able to accommodate those clients as well. Hence Aspen Capital Markets will operate an equal opportunity underwriting policy, focusing on the deal itself rather than how it came to it.
It’s an interesting topic, that of broker disintermediation. With third-party capital having different motivations, return dynamics and wanting to keep a lower-cost of capital, it needs to keep the supply chain as short as possible. This could lead to more direct business being done, through the likes of banks rather than brokers, or directly through the more sophisticated ILS and collateralized reinsurance managers, some of whom are more than capable of originating, structuring and transacting business on their own.
Brokers are a vital piece to the reinsurance market, owning the relationships that matter in many cases, but they too need to innovate and adapt as the market transitions to one utilising multiple sources of capital.
Cheaper capital in the reinsurance market is one reason for the reduced rates of 2013 and this trend won’t go away until we see some major market turning catastrophe losses. The question at that time will be how much rates rise and whether some capital can maintain much lower than historical rates.
Traditional reinsurers need to ready themselves for how they would react to such a scenario. How would reinsurers react to a major Florida hurricane loss which then only resulted in a 10% rate rise because lower-cost capital stayed in the market and more flooded in? Would traditional reinsurers lower their underwriting standards to keep writing business or would we see another seismic shift in where reinsurance capacity comes from?
You can read the full transcript from the Aspen executives presentation over at Seeking Alpha here.
We also covered comments made recently by Aspen CEO Chris O’Kane in an article last week, titled; Don’t put a ceiling on alternative reinsurance capacity, it’s just getting started.
Finally, we also covered comments made at the Morgan Stanley event by RenaissanceRe executives: Current third-party capital trend “evolutionary, not revolutionary”: RenRe.