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Reinsurance has an identity crisis, increasingly like ILS – S&P


The reinsurance market and its reinsurers are suffering from an identity crisis, increasingly borrowing from the insurance-linked securities (ILS) market as they behave more like ILS players and third-party capital providers, according to rating agency Standard & Poor’s.

The line between the traditional reinsurance and the insurance-linked securities (ILS) markets are becoming fuzzy, S&P says. With reinsurers dealing with competitive pressures, the softening market and other negative macro environment factors, “traditional reinsurers are beginning to behave like third-party capital suppliers.”

It’s an interesting angle on the structural change in the reinsurance market that we’ve been documenting here on Artemis. It’s more typical to think of ILS fund managers bulking out their teams, adding expertise, underwriting more reinsurance on a collateralized basis and generally acting increasingly like reinsurers.

But S&P feels that traditional reinsurers are also borrowing from the ILS market, as they seek to deal with perhaps the largest competitive threat to their existence in the history of the reinsurance market.

“To remain relevant in the current buyers’ market, traditional reinsurers have been behaving like insurance-linked securities players,” the rating agency explains.

“Traditional reinsurers are starting to borrow underwriting terms from the ILS market in the forms of multiyear policies and inclusion of nonmodeled perils in traditional reinsurance treaties,” S&P continued.

As reinsurance and ILS become more similar and the lines blur between the traditional, balance-sheet backed reinsurance product and the capital market-backed, fully-collateralized (or collateralized and fronted) reinsurance product, it likely opens up more options for cedents.

At the moment, S&P says that “large cedants are balancing reinsurance optimization and top-line growth.” That makes their reinsurance choices increasingly important, with efficiency, effectiveness and ease of transacting high on the agenda. However, at the same time diversification of counterparties and quality of reinsurance capital are also high, particularly with regulatory changes coming into play.

S&P notes that some reinsurance buyers may choose to; “Get the best of both worlds by skipping the costs and time of setting up special-purpose vehicles, marketing their securities, running independent modeling, paying legal fees, and providing related documentation required for an ILS placement beyond the requirements for an individual reinsurance placement.”

But of course that statement doesn’t take into account collateralized reinsurance, which can be transacted as simply (for the cedent) as a traditional reinsurance contract. The option to elect for traditional over a securitised product such as a catastrophe bond has always been there, but cedents still choose the cat bond for its security, flexibility of cover and the resulting broadly syndicated capital quality.

S&P notes that when primary insurer Allstate was “rebuffed by the ILS market” earlier this year, when ILS investors refused to meet its requirements for a 7 year term on its cat bond, it secured the same cover in the traditional market.

However, this is not such an example of the markets converging as it is of reinsurers seeking to secure premiums and so going the extra mile to fulfill the cedents requirements. Many observers feel the ILS market was sensible not to lock in a cat bond price with Allstate for 7 years. Have the traditional markets been sensible to do so?

Of course it’s also worth noting that collateralized markets likely participated in that multi-year cover for Allstate, so some of the risk will still have made its way through to ILS investors.

S&P also highlights ACE’s renewal, but doesn’t mention the fact that the insurer recently turned to ILS for a catastrophe program additional layer of protection, with a collateralized note issuance.

While the lines are blurring, the buyers are also getting increasingly sophisticated. The traditional and the collateralized reinsurance product both have an important role to play in provision of risk transfer and reinsurance. As buyers approach their reinsurance renewal in an increasingly sophisticated manner, it is expected that the mix of traditional to collateralized will remain important and that diversifying and gaining more control over their purchases will rise in priority.

At the same time there is an expectation that reinsurance buyers are going to structure their programs and purchases in such a way as to ensure they extract as much of the premium from the risk they have put the effort into underwriting as possible.

S&P discusses the launch of ABR Re by ACE and Blackrock, which is an internal reinsurance vehicle with a more active asset management strategy, akin to a hedge fund style reinsurer. This allows ACE to retain more of the risk premium, by effectively self-reinsuring it, a trend that S&P believe will grow in prevalence.

S&P explains that it expects to see; “More momentum toward shortening the chain between the capital market and insurers, bypassing intermediaries, and putting pressure on established reinsurers on cedants’ panels.”

For us at Artemis this is likely to be the major trend of the next few years and really signifies the blurring of lines between insurance, reinsurance, capital market players, but also origination, structuring, distribution, where the modelling will take place and other pieces of the insurance value chain.

This wholesale disruption of insurance and reinsurance is also going to be exacerbated by the introduction of increasingly sophisticated financial market technology and risk modelling tools. Add to that a continued desire to see some risks traded in a transparent and liquid manner on an exchange and things really start to get interesting, but also challenging for incumbents.

So while reinsurance may have an identity crisis, it’s no different from the identity crisis facing primary auto insurers, for example, who are grappling with the emergence of telematics, ride sharing, group buying of insurance and shared risk pools.

Both reinsurance and the insurance-linked securities (ILS) market are adapting rapidly and while the lines will continue to blur, a key distinction remains capital source and efficiency. That actually makes the two very complementary, particularly while diversification of risk capital remains so important.

It’s encouraging that reinsurance is behaving like ILS and that reinsurers are borrowing from the ILS manager business model. The ILS managers have been borrowing from reinsurance for years and the whole meaning of ‘convergence’ has always been that the two sides would be drawn closer together.

The key differences will always mean there are distinctions between the two and as the market becomes increasingly disrupted by external forces, new capital providers, technology and innovation, both sides stand an equal chance of being able to gain a leap ahead of the other.

That suggests that while ILS, or alternative, capital and traditional reinsurance capital are complementary, the competition between the two could perhaps become fiercer still in years to come, as the desire to break down the value-chain between original risk and capital continues to grow.

Also read:

Reinsurers’ management of catastrophe exposures diverges: S&P.

Berkshire Hathaway copycats will pressure reinsurance pricing: S&P.

Reinsurance M&A no panacea, but momentum to continue: S&P.

Reinsurer net investment yields down 30% in four years: S&P.

Alternative reinsurance capital pressures ASEAN insurers: S&P.

S&P warns on reinsurers protecting profits through reserve releases.

ILS market growth should not be at the expense of discipline, S&P warns.

M&A won’t stop the tide of reinsurance price declines: S&P.

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