Ed Noonan, the CEO of Bermuda domiciled insurance, reinsurance and third-party reinsurance capital management group Validus Holdings, spoke at some length about the insurance-linked securities (ILS) market and alternative reinsurance capital during the firms recent earnings call.
With Validus one of the world’s largest reinsurance groups, as well as being an active player in ILS and alternative reinsurance capital through its AlphaCat third-party capital management arm, it is always interesting to hear what Noonan has to say. On the recent third-quarter earnings conference call Noonan was particularly candid about ILS and new capital entering the space and also discussed some potential opportunities which may present themselves.
Noonan explained that Validus sees excess capital in the reinsurance market and not just from ILS managers. Validus felt that throughout the year rate decreases in certain reinsurance lines were driven as much by well-capitalised reinsurers competing for business as by third-party reinsurance capital moving into the sector. The influence of ILS players has been most apparent in the higher layers of the U.S. market, while Noonan said other reinsurers are tending to target areas where more profit can be made.
Noonan said that even with the price decreases and competitive pressures in the market Validus still foresees catastrophe reinsurance pricing as ‘broadly adequate’ for 2014. He said that Validus’ job is to assemble the highest returning portfolio possible given its risk tolerances. He said that the pool of attractive business will likely be smaller for 2014, and that significant oversubscription of programs is likely at the renewals, meaning that the battle will be over signings and the most attractive pieces of business.
Here, Noonan feels that Validus has an advantage due to its size and reach. He explained that Validus is seen as having the highest percentage of lines signed, relative to lines authorised, of any reinsurer. Noonan said; “Essentially we get what we ask for. Our balance sheet and the size of our capacity make us a go-to market on any meaningful programs.”
In terms of the cost-of-capital argument, that ILS capital can typically be deployed at lower-rates due to lower return requirements and lower frictional costs, which is getting increasing focus as ILS players grow their share of the reinsurance market, Noonan said Validus answers that with AlphaCat.
Noonan said; “We know that on some layers on programs ILS provides a lower cost of capital and we can deliver that to our clients seamlessly through our integration with AlphaCat.”
In terms of how Noonan and Validus views competition from the ILS market, his comments were refreshing in that it shows an acceptance of changing market dynamics and a desire to simply get on with doing business.
Noonan commented; “As far as the competition from the ILS market our basic view is that the world is changing, so just adapt and get on with it.”
Noonan further explained how Validus itself has a symbiotic relationship with ILS and alternative capital, saying; “ILS markets compete primarily on the capital-intensive higher layers. As such, they help us to be more efficient users of capital, both in our assumed business and our retrocession purchases.”
He acknowledged that ILS does eat into the business that Validus underwrites, but feels that Validus’ position and its AlphaCat unit leave the reinsurer in a good place to work with, rather than against, alternative capital. Noonan said; “They may shrink the pie, but we have spent 8 years building skills, relationships and making acquisitions to ensure that we’re one of the few legitimate franchises in the cat business and so we believe we’ll do just fine.”
Validus has been actively making moves to boost its portfolio to counter the competitive effects of a well-capitalised traditional reinsurance market and a growing ILS market by growing its portfolio weighting strategically in Europe and Japan. These markets place a higher value on the traditional reinsurance product, explained Noonan, and will help Validus build a strong portfolio for 2014 despite its expectation that overall reinsurance market conditions will be worse than in 2013.
Noonan was asked about demand for ILS and alternative capital products and whether he felt it had tailed off due to the reduction in spreads. Noonan explained that the market may have reached a bit of a plateau, as has been evident in terms of inflows through the middle of 2013.
He said that the comment he hears most often in Bermuda recently has been that there is no point in taking in new capital if there are no opportunities to deploy it effectively. He said that this is reflective of a plateau of sorts being reached. Investor demand remains extremely strong, said Noonan, but the available pool of business may be reaching a saturation point.
He said that this is a fluid situation, meaning that dynamics could change again allowing a flurry of further capital into the space, as new opportunities emerge. Validus’ AlphaCat unit has itself turned away investor capital in 2013, but at the same time has managed to grow.
Noonan commented that smart underwriters won’t take money unless they know it can be put to work and that investors are themselves getting more savvy about this as well; “Some of the smarter pension plans are having that conversation independently, like they’re putting the question to us, “Hey is this really the right time to try and put money to work in this sector?” It feels like things have squeezed.”
The questions from analysts participating in the earnings call then moved to two key topics which are raised frequently in reinsurance and ILS conversations, the Terrorism Risk Insurance Act (TRIA) and the U.S. National Flood Insurance Programme (NFIP).
On the TRIA, Noonan said that there is no reason that terror risks should be pushed to the government and that the reinsurance industry should be pushing to obtain more of this business.
Noonan also feels that the ILS market has a role to play in terrorism risks, saying; “Frankly, perhaps not on day one, it won’t take too long before you can start packaging it up into the ILS market. We know investors in the ILS market today who would like to take on that risk. And so it won’t take very long I think for ILS to start to provide the high-layer type of capital required.”
On the NFIP, Noonan said that his feeling was that the NFIP should not exist and that the private insurance and reinsurance market can adequately cover that risk. It is Noonan’s belief that the private market could handle the rate setting aspects of U.S. flood insurance better, not surprising customers with large increases year-on-year, and ample capacity is available in the private reinsurance and ILS market to reinsure it.
He said that if ILS capital is needed, or is attractive, then the private insurers and reinsurers would no doubt access it as required. The private markets are more than capable of dealing with flood risk, said Noonan, and it’s time for the government to hand it back over to let them deal with it.
It’s clear that Noonan has a realistic view on using ILS and alternative capital, managing ILS and alternative capital and how it can be utilised to assist the growth of the traditional insurance and reinsurance market as well. With its AlphaCat segment growing to nearly $1 billion of third-party assets under management, Validus is among the larger players in both traditional reinsurance and also the ILS market so it is good to hear Noonan discuss the relationship between the two pragmatically.