The 57th Reinsurance Rendez-vous is winding down, and, while it’s been another successful networking opportunity for the re/insurance industry’s movers and shakers, most of the discussions have ended on a note of uncertainty.
The elephant in the room this year was the increasing contribution of “alternative” or “third party” capital in the reinsurance market. Essentially placements by hedge funds, private equity firms, pension funds and other money managers. They are making more investments in reinsurance markets as they seek higher returns than are currently available in the low interest rate environment that has dominated global financial markets since 2008.
According to Aon Benfield, insurance linked securities, or ILS, now account for $44 billion of capital dedicated to the reinsurance market, out of $510 billion (Aon) or $515 billion (Swiss Re). Collateralized reinsurance ($20 billion) and cat bonds ($18 billion) are the two largest categories with sidecars accounting for around $4 billion.
As a result rates in the property sector have declined slightly. Many reinsurance professionals have also expresssed concerns that this capital poses a threat to underwriting, because money managers are more interested in earning profits than assessing risk, which could create problems, especially following a serious natural disaster. It is also feared that it will be a transitory source of capital that will flow out of the market, as soon as the investment climate gets better.
According to Kurt Karl, Swiss Re’s chief economist, this is already beginning to happen. [See his video interview on IJ TV] The U.S. is showing the strongest growth, he said, while Europe and the UK have registered smaller GDP gains and Japan is emerging from its decade long quiescence. Although growth has slowed in China, India and Brazil, they are still registering growth rates above four percent (China’s is 7.7 percent), that would be cause for celebration in the developed countries.
Some of the big boys are concerned have expressed these concerns at the Rendez-vous. Lloyd’s Chairman John Nelson thinks the influx of ILS vehicles could weaken underwriting standards. Willis Re’s CEO John Cavanagh said third party capital is affecting “rates and the competition” in the property catastrophe reinsurance market, and that an additional “influx of $100 billion” would “have a number of profound consequences.” As much as $20 billion excess equity capital would have to be deployed.
Most of the other big reinsurers and reinsurance brokers – Aon, Swiss Re, Munich Re for a start –however, don’t seem to be overly concerned. At its press conference Swiss Re said it “expects the demand for natural catastrophe reinsurance to double in high-growth markets and to rise by around 50 percent in mature markets by 2020.”
In addition, about 70 percent of ILS investments are concentrated in the U.S. property catastrophe market. Other lines aren’t affected. The additional capital is also seen as a motor for growth in other areas, particularly emerging markets, where insurance and reinsurance penetration has been historically low, but is now increasing as the countries – China, India, Brazil and others – continue to industrialize and modernize.
Bryon Ehrhart, Chairman of Aon Benfield Analytics, sees an additional $100 billion in capital coming into the market by 2020. He said at a press conference: “The benefits of this new capital will begin to extend beyond property catastrophe and mortality risks that are common features of the current ILS market and extend into many other reinsurance lines where loss frequency and severity are more predictable.”
At a breakfast meeting hosted by PwC, Nelson said “capital in the reinsurance market will grow to $2 trillion by 2025.” That would be an increase of approximately 4 times over the present level, which is the largest amount of reinsurance capital the industry has ever had since it began with Cologne Re and Swiss Re in the 1860’s.
Nelson has backing for his assertion, however. The head of PwC’s Bermuda insurance operations, Arthur Wightman, explained that the $2 trillion figure is “largely consistent with projections on likely GDP growth per capita.” He sees this growth coming from three sources: the first, and most important is from emerging markets as they industrialize; the second area will come from the development of new products to cover emerging risks, and the third from the possibility of covering existing risks, such as earthquakes and floods, that aren’t being adequately reinsured.
If the people who believe in the positive scenario are correct, the reinsurance industry will need all of the capital it can get in the coming years from whatever sources can provide it, and alternative capital will cease to be a problem; unless the negative concerns prove to be true – underwriting suffers and a significant amount of this capital decides to seek opportunities elsewhere.