Analysts at RBC Capital Markets highlighted a good point in a recent report, that the growth of insurance-linked securities (ILS), particularly the increasing market share of collateralised reinsurance, has taken away demand from the traditional market.
In recent years the rationalisation of reinsurance buying has resulted in a steady drop in cessions to global reinsurers, but this has also affected ILS funds and collateralised players.
As the large primary insurers of the world centralised their reinsurance buying across groups, while restructuring and rationalising their spend, lower amounts of premiums have been ceded to both the traditional and alternative markets.
But despite this trend ILS and alternative reinsurance capital has continued to grow, reaching an estimated $78 billion recently, outpacing the growth of traditional reinsurance capital.
And as ILS grows it is steadily taking away demand that would otherwise be serviced by the traditional market, meaning that reinsurers have felt a two-pronged attack on their premiums in recent years, both from lower cessions and cessions that get covered by alternative capital.
RBC’s report discusses the fact that reinsurance demand is likely to increase in the coming years, that the analysts already see signs of an uptick in demand in European markets and that the U.S. is likely to follow suit.
We’ve been saying for some time that after the rationalisation and centralisation of reinsurance buying will come an increase in demand, as insurers gain a better view and understanding of their exposures and the market is better able to provide a wider range of risk transfer solutions to serve them.
Uptake of ILS and alternative solutions continues to grow, so it is natural to assume that the ILS market takes its share of any new demand potential in the market.
In particular RBC’s analysts highlight that quota share reinsurance is a particularly efficient form of capital to fund insurer growth, as well as to remove volatility from results, making demand growth here highly anticipated.
RBC suggests that perhaps the traditional reinsurance market may be best placed to take advantage of this, as insurers seek volatility protection, due to the fact that “Catastrophe bonds might be efficient for covering tail risks but it is not as effective at managing earnings volatility from non-tail risks.”
But of course the capital markets is just as familiar with quota shares as are traditional reinsurers, with many collateralised reinsurance arrangements involving quota shares, as well as quota share reinsurance sidecars, segregated cells and other third-party capital backed vehicles.
So if quota share reinsurance demand does rise, we would anticipate the ILS fund managers and investors taking just as much a share, perhaps more, than if insurers were demanding tail risk protection.
Also catastrophe bonds do provide protection against non-tail risks, as evidenced by the growth of aggregate protection in the market, which as we noted recently has actually outstripped per-occurrence protection for the first time lately.
Aggregate covers are a way to protect against multiple smaller events eroding earnings, effectively capping the loss over the course of an aggregate period, typically of one year.
Demand factors change in reinsurance all the time, based on results, the occurrence of loss events, trends and product availability.
But with the ILS market presenting such a stable and increasingly widely accepted alternative to traditional reinsurance now, going forwards one factor is almost certain, that a growing ILS market participation in any uptick in reinsurance demand is now assured.