The impact of third-party capital, from capital market investors, on the reinsurance market has largely been contained to property catastrophe risks to date, but its influence has widened and its impact on the casualty reinsurance market is growing.
So said reinsurance broker Willis Re in a briefing to its clients this morning. The broker has noticed that capital is flowing into casualty reinsurance both from traditional and non-traditional, or alternative, third-party sources, which is increasing competition and pressuring casualty rates.
Traditional reinsurance capital has been pouring into casualty reinsurance, as reinsurers once more focused on property catastrophe reinsurance business look elsewhere for a better rate and pricing environment. The irony here is that, of course, it is third-party capital which has largely created the catastrophe reinsurance rate environment that traditional reinsurers are trying to offset.
As these reinsurers have increasingly allocated capacity to the casualty reinsurance space it does help to offset some of the rate declines seen in property catastrophe risks. But the traditional reinsurers are also being joined by capital markets money, as ILS fund managers and dedicated third-party backed reinsurance start-ups increasingly look to the casualty space.
Andrew Newman, Global Head of Casualty at Willis Re, commented; “This new capacity has resulted in a much wider choice of reinsurers for cedants, with increased supply also creating more competition in terms of coverage, structure and pricing.”
The entry of the capital markets into casualty reinsurance could be game-changing, according to Newman. He cites the recent launch of Watford Re, a third-party capital backed reinsurance vehicle which will focus on casualty risks as part of its business, as evidence of this.
Newman explained; “Two aspects of this model make this potentially transformational. First, it confirms that new capital, in search of non-correlating returns, is willing and able to enter the Casualty space and participate at the risk level, just as it has in the Property catastrophe market. Second, it expressly offers clients a product that has a lower cost of capital, or an improved investment yield, or both, integrated into its pricing model. This at least conceptually represents a possible game changer in long tail lines.”
As ever the issue of whether the capital will be sticky or not is raised, something that is truly untested in casualty risks and with the longer duration of these risks it really is uncertain how investors would react to long periods of loss development, which could result in capital lock-up.
Hence the ILS players Artemis has discussed casualty risks with in recent months are working on ways to enable investors to either be locked in for fixed periods, or are looking to develop mechanisms which would allow collateral to be released more easily.
These developments are ongoing and it could take some time until we see a broad range of casualty risk and reinsurance investment opportunities emerge. In the future though, it is likely that we will see a range of opportunities within casualty risk investments as we do today in catastrophe risk investments.
Newman continued; “As a collective, new capital entering the Casualty space could be exciting, dynamic, cost-effective and valuable at an increasingly competitive point in the market cycle, and as such cannot and should not be ignored. At the same time all new entrants with whatever operating model should be scrutinized in the context of continuity given the significant time lag aspect of Casualty business.”
As capacity from capital markets and third-party investors spills over into casualty risk, alongside increased traditional reinsurance capacity from reinsurers feeling the pressure in property catastrophe, the outlook is for greater competition in terms of coverage, structure and pricing, said Newman.
Newman said that the result of this trend is; “Clients are, therefore, experiencing not only increased choice from amongst established reinsurers but also the potential for a new casualty reinsurer model that, at least in theory, could command a tangible competitive advantage relative to the more conventional reinsurer model.”
It has always been clear that casualty reinsurance would eventually begin to feel the effects of third-party capital, as these investors are interested in accessing the space. Some ILS funds are already writing small amounts of casualty risk within their business, a trend which is likely to grow. The introduction of dedicated, third-party capital backed, casualty reinsurers like Watford Re is just one more development in this trend.
Other initiatives, looking at how to manage the collateral and investor expectations within a casualty risk linked investment strategy could change the game even further. The market is determined to find ways to allow investors to access the returns of casualty risks. It also seems determined to bring the lower-cost of capital associated with ILS and alternative reinsurance capital strategies to the casualty reinsurance market as well.
This could take time to develop, but it certainly increases the pressure on traditional casualty players. We may find in years to come that casualty splits, with third-party capital taking the more easily modelled or forecast and shorter-duration casualty business, while traditional reinsurers focus on the more difficult, longer duration casualty liabilities.
In essence, this is what has happened in catastrophe risks, as the more efficient and lower-cost capital from ILS and the capital markets continues to take the peak, well-modelled risks. The same kind of split might be seen in casualty reinsurance business in the future.