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Where is the giant wall of reinsurance capital?


With property catastrophe reinsurance rates having risen by at-least double-digits for many cedents at the renewal seasons so far in 2022, analysts from RBC Capital Markets pose a valid question. Why aren’t we seeing a wall of capital flood into the space?

wall-capital-money-dollarHistorically, during any hard market, we’ve seen classes of new reinsurance startup company launches coming into the space, as well as an inevitable flurry of activity in launching reinsurance sidecars and raising capital for new insurance-linked securities (ILS) fund ventures.

But, in 2022, “Where is this giant wall of capital that has long plagued the reinsurance sector, squashing out hard markets with head spinning efficiency?” the analyst team from RBC Capital Markets ask.

We’re in a market environment where many companies have been dialling back their exposure to property catastrophe reinsurance risks, with some choosing to stop explicitly writing that stand-alone business, such as AXIS, while others have shifted their property cat risks onto third-party capital, like Markel.

Even stalwart writers of catastrophe risks like RenaissanceRe has become steadily more balanced, in terms of catastrophe risks versus other classes and other Bermudians once known for their appetite for cat risks are now reducing their books to less than 10% focused on property cat risks.

“So what is going on here? Don’t they know that property rates were up at a double-digit clip at each of the January 1 and April 1 renewal dates (and almost surely were up a like amount or more at June 1 though we have seen no formal reckoning by any of the large brokers just yet)?” the analysts ask.

“Where is this giant wall of capital?”

Repeatedly, we’ve seen periods of hard reinsurance market stress result in explosions of new capital and new company launches, particularly in Bermuda.

The analysts highlight that even with the significant catastrophe loss years since 2017, yes we’ve seen some new companies, but nothing they would call a “Class of” has emerged.

On the insurance-linked securities (ILS) side, we did see the so-called “great reload” as ILS fund managers raised relatively significant sums before the 2018 underwriting year.

But even this did not constitute the “giant wall of capital” that the reinsurance industry had historically seen.

One difference in recent years is the pricing environment, the analysts believe.

Anyone considering launching a reinsurance startup between 2017 and 2019 would have found pricing still relatively muted, and while 2020 on has been better, the analysts believe that most of the value is flowing to incumbents.

Also different is the price of admission, the analysts say.

“Simply put it takes a lot more capital commitment just to get into the game,” they explain.

Adding that “the form and structure” of capitalisation has also “changed dramatically” in recent years.

“Reinsurance buyers were open to a better mousetrap and Bermuda made it easy for companies to form and be chartered and a shortage of alternatives meant buyers were obliged to give them a chance,” they say of previous Classes of reinsurers.

But now, the range of options available through which capital to enter reinsurance is significantly broader, meaning we’re unlikely to ever again see a single wall of capital flowing via a single entry point.

“Bermuda remains just as attractive as it ever was what is changed is the Lloyd’s market is back on its feet and there are an assortment of sidecars, subscription companies and collateralized vehicles ready made for capital injection,” the RBC analysts wrote.

Adding that, “Someone interested in investing in reinsurance no longer needs need to find a reinsurance executive, call an investment banker and make a registration filing.

“Now they can basically call an incumbent company like RenaissanceRe, any of the large reinsurance brokers or companies like Nephilla and have their capital working inside of insurance structures within weeks.

“Quicker still would be investments in cat bonds or other insurance linked notes.”

But back to the current state of the reinsurance market cycle and why aren’t companies filling their boots in the hardening market environment?

Reinsurers are reducing their catastrophe exposed writings at just the time that you’d typically have expected them to be underwriting more.

This has become especially evident at the Florida renewals this year, where capacity has been lacking and cedents struggling to fill their reinsurance towers, even at greatly increased pricing.

That’s a dynamic the reinsurance market is not so used to and while discipline is a significant factor here, seemingly discipline at a level not seen for well over a decade we’d suggest, plus the general state of Florida’s reinsurance market, there could be more underlying market dynamics than is at first obvious.

The RBC analysts put this down to “profit maximisation.”

Reinsurance firms and ILS funds should be focusing on profits, not premiums and the fact the players out there are more mature, not just a batch of new startups, is actually quite positive in this respect, as they understand the need to deliver profits and returns.

Of course, there is a batch of privately funded re/insurance startups that have come to market over the last decade and of these some are lacking in repeatable profitability.

Now, given the state of broader capital markets and investor aversion to risk, plus demand for returns, even in private equity, we may see a little more pressure on some of these companies to perform as well at this time.

The issue is not just writing more business, “Its managing their exposures in a market that seems to be producing a lot more losses resulting from both increased frequency and severity of natural catastrophe events as well as rising inflation which makes determination of losses that much more difficult,” the analysts state.

Not only is there more choice in how to channel capital into reinsurance, there are also a far more diversified bunch of experienced reinsurers from previous “Class of” waves of entrants.

“There is a hard market underway in primary and specialty insurance too. Diversified companies do not need to go ‘all in’ on writing property cat, they have choices and indeed their shareholders reward them for making those allocations,” RBC’s analyst team explain.

Adding to this, the analysts believe that diversified underwriting companies tend to get a better valuation these days, helping to make diversifying increasingly attractive to maturing companies.

Another factor is that, “The laws of supply and demand have not been repealed.”

Reinsurance remains extremely well-capitalised right now, even for all the news of Floridian companies failing to fill all the layers of their reinsurance towers.

Ample capital and a more discerning bunch of underwriters, is having an effect on the more sub-prime areas of catastrophe exposure in 2022, we’d suggest.

Importantly, the analysts note, “While the behavior of pricing in 2022 suggests that most of the excess supply may finally have been worked off, it does not necessarily suggest that a lot more capacity is needed. Indeed if the sector does manage to earn double digit returns as a result of the pricing improvement they have already achieved that would imply some $40-50 billion of newly generated capital from profits (less anything returned via capital management).”

Another factor is that management teams are all too aware that they need to deliver to their shareholders and private capital providers, after a period of lower profits and in the current macro environment.

This goes for ILS fund managers too, who are all too cognisant of the need to deliver returns in all but the more severe catastrophe loss years.

As a result, “Industry incumbents are smart enough and experienced enough to know that after patiently waiting out a 5-6 year soft market, they would be wise to move slowly in adding capacity less the cook the goose before it has a chance to lay any golden eggs,” RBC’s analyst team wrote.

“In our view property reinsurers are playing their hand well by playing it patiently,” the analysts believe.

But they do note that the current market environment may encourage some more “capacity seeking returns” in time.

We’re already hearing of some ILS fund managers that are seeing more promising signs from the investor pipeline at this time, with discussions of end of year capital raises taking place.

Encouragingly though, it seems capital raises are coming with conditions, in some cases, and we’re aware of institutional investors that want to deploy more into insurance-linked securities (ILS), but who also want to see the improvement in underwriting terms evidenced through a cycle of typical loss activity.

With ILS funds generally having moved up towers and tightened down on their underwriting terms, while catastrophe bonds have also generally come with more stringent deductible levels and conditions, there is a need for investors to understand how that can positively affect performance going forwards, before some are ready to commit their capital, it seems.

We wouldn’t discount the chances of a relatively significant level of new capital entering the reinsurance sector towards the end of 2022, especially if the wind season proves more benign than the forecasts might suggest.

But, even then, it feels like those managing the capital, both on the startup company, incumbent reinsurer and ILS fund manager side, might be a lot more disciplined in its deployment still, with rates expected to hold up.

Inflation is a factor, but so too is climate change, as investors are incredibly focused on ensuring their capital is deployed with climate in-mind, while managers and underwriters are aware they need to demonstrate their ability to account for all potential inflationary effects, be they man-made or natural.

So, the answer to the original question, is that the wall is not coming in the form we’ve known it before, it’ll be more diversely distributed across structures and forms of capital, deployed more thoughtfully and with more discipline (at least it currently seems that way).

The one wildcard is, that a more significant entry of new capital, that enters more quickly, would seem to need to push aside incumbent capital to make space for itself and also have a significantly more efficient and lower-cost entry point, as well as lower-cost to the capital itself.

We’d suggest that isn’t out of the question still, as there are innovative capital market business models that could be combined with innovative technology, to upend the traditional model of capital deployment and risk syndication in reinsurance.

But with entrenched motives to sustain the traditional ways of doing business still very high in reinsurance, getting to that point of significant value creation (and destruction of traditions) still seems a long way off.

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