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Structurally lower cost of reinsurance capital an opportunity: Credit Suisse


The structurally lower cost of reinsurance capital presents an opportunity to property & casualty insurers, as innovations in structures and business models prompt a rethink of insurers risk profiles and their role in the value chain, according to analysts at Credit Suisse.

In a latest research note which focuses on property and casualty (P&C) insurance sector coverage, which the Credit Suisse analysts initiated recently, they discuss how the reduction in cost of reinsurance capital and increased efficiency generated by ILS structures and business models can benefit insurers.

The analysts believe that the proliferation of insurance-linked securities (ILS) and alternative reinsurance capital is growing and permanent, providing new pools of efficient capital for primary players to tap into for reinsurance and capital management needs.

Innovations that are being seen such as longer-dated catastrophe bonds and the launch of hybrid reinsurance vehicles, like the ACE and Blackrock start-up ABR Re, are prompting a rethink around the risk profile of some companies, such as homeowners insurers, as well as a rethink of the role of the insurance carrier in the value chain, the analysts explain.

As a result Credit Suisse in initiating analyst coverage on the P&C insurance marketplace, highlights companies which it feels have the opportunity to benefit from a more efficient reinsurance marketplace over the near to medium term.

Capital in the reinsurance market now has a “structurally lower cost” according to the analysts, who believe that the new lower-cost capital is permanent. The greater efficiency and reduced cost of reinsurance capital may “favorably alter the risk profile of some P&C lines,” the analysts continue.

The insurance companies that are in a position to take advantage of the lower cost of reinsurance capital are the ones that Credit Suisse expects to receive higher valuations, demonstrating the clear importance of leveraging the historic low price of risk capital at this time.

The low-cost of reinsurance capital is set to persist as well, with even a repeat of hurricane Katrina not expected to move rates substantially, the analysts insist. They cite the “latent pool of ILS capital” that lies ready to replace the existing reinsurance capital base should large catastrophes occur, as well as sidelined traditional reinsurance capital that has not been deployed due to the soft market environment.

In looking ahead and trying to forecast the pricing environment, the analysts note the difficulty in separating the cyclical and structural issues that the insurance and reinsurance industry currently faces. Alternative capital is one factor that is expected to increasingly weigh on primary insurance players and rates.

“While we think it will be some time until alternative capital markets become relevant direct competitors with the U.S. primary insurers, we expect product innovation and cheaper capital to begin to have a direct impact on pricing starting in 2015,” the analysts explain.

There is evidence of this already in some of the arrangements that see primary fronting carriers leveraging ILS capital, or in broker relationships that see ILS capital put to work as reinsurance backing for primary underwriting.

The analysts note that any impact from alternative capital and ILS on primary insurers and rates is likely to be additive to the pricing pressure that is already evident thanks to traditional reinsurance capital being displaced into primary markets.

“We think it’s hard to dismiss the notion that innovations in alternative capital may have a profound and direct impact on the primary insurance world over the next 12-24 months,” the analysts wrote.

New innovations from the alternative capital and ILS space are expected to play an important role in enhancing profitability of some lines of business, while also reducing their capital intensity.

Insurers are positioned to benefit from access to reinsurance capital to support their entire risk profile and reduce its cost, something which could result in additional demand for risk capital and reinsurance.

The Credit Suisse analysts also see a blurring of lines between primary carriers, traditionally the underwriter and warehouser of risk, and the broker, traditionally the distributor but more often than not involved in capital provision in some way now.

If large primary insurers can learn to embrace and use alternative capital and cheaper sources of reinsurance capital as a way to optimise and rework their risk profile, while gaining better protection and leveraging low-cost capital for efficient growth, it could result in a steady uptick in demand.

ILS and alternative capital clearly has the appetite to innovate and support large primary P&C insurance carriers risk transfer needs, however it is equally as keen to support their growth needs as well.

As innovation continues apace in a reinsurance market that is undergoing structural change, it is expected that ILS and alternative capital providers will increasingly find ways to access the returns of primary insurance business, through novel risk transfer or financing arrangements.

That should help alternative capital to break out of the reinsurance cycle once and for all, providing capital across the insurance and reinsurance value chain and enabling companies that learn to leverage efficient capital to perhaps become in greater control of their own destinies.

Also read:

ILS to grow strongly, reinsurers to be increasingly pressured: Credit Suisse.

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