The flow of so-called alternative capital into the global reinsurance market is continuing, bringing it closer to the “convergence” in which traditional providers will eventually become conduits to the capital markets, said panelists at the 2016 Bermuda Reinsurance Conference sponsored by S&P Global Ratings and PwC Bermuda.
Much of the evolution of the market has come in the form of insurance-linked securitization (ILS) such as catastrophe (cat) bonds, which were created to transfer risk beginning 20 years ago in the aftermath of Hurricane Andrew.
Still, convergence is in its early stages, the panelists told attendees at the November conference.
“We’re just starting to see securitization change the underlying industry,” said Michael Millette, managing partner at Hudson Structured Capital Management. He added that the cat bond market has reached roughly $25 billion outstanding, but that it can “take a long time for other asset classes to gestate.”
Nevertheless, the influx of alternative capital has grown rapidly in recent years (with a slight slowdown in 2015) to reach more than $75 billion with dozens of funds engaged in collateralized reinsurance. This comes as historically low interest rates–particularly in the U.S.–have pushed investors to seek returns outside traditional fixed-income assets.
Dirk Lohmann, chairman and managing partner at Secquaero Advisors, said that although there’s a limit to what the capital markets can do, securitizations are a benefit to insurers.
“There’s a lot of potential for securitization to optimize insurance companies’ capital structures,” Lohmann said.
Some in the market see the distribution chain of insurance as inefficient, with too many entities involved including brokers/agents, insurers, reinsurers and retrocessionaires in getting the capital to the risk, with each one taking some of the profit. Some estimates suggest 20 percent of premium is going to the distribution chain.
Panelists said this raises questions about which entities will take on which roles in an evolving market. All agreed that there’s a symbiotic relationship between traditional players and the capital markets, and that the former will continue to be a valuable part of the market, even as many see alternative capital as more nimble.
“The industry is so much different from the way it was when we did the first securitizations,” said Hudson’s Millette. He added that as information flows more smoothly, this will create opportunities for intermediaries to add value in other ways.
“The relationship has always been complementary. The capabilities of the formats are different, and they work together,” Millette said.
Lohmann agreed, adding that although the industry has often been reluctant to absorb technological change, such innovations as blockchain (which can record and secure transactions) will make the transfer of information more efficient.
“I don’t think the intermediary is going to disappear,” he said. “The intermediary serves a valid function–but there’s going to be a discussion about how the intermediary is compensated for what he does.”
Robert Pagnani, CEO of Mt. Logan Re, said he could foresee a day when there would be a straight-to-the-customer market, comparing a future industry that works akin to the way Amazon does in the retail sector. Until that time comes, he added, the trend of steadily growing alternative capital and securitizations will continue, especially as investors look for yields better than the very low (and, in some cases, negative) rates they get, for example, on risk-free assets such as sovereign debt.
“There is demand, and you’re going to see that continue.” Pagnani said. “And we will come up with markets to satisfy that demand.”
With regard to the potential pitfalls associated with this trend, the panelists largely agreed that investors–who 20 years ago would have considered the market for cat bonds to be too opaque–are much better informed in the current market.
“I would say, for the most part, it’s a very sophisticated investor base,” Pagnani said.
Still, more transparency is needed, Secquaero’s Lohmann said. “This is going to require education of the investors as to what they’re buying,” he said. “When you get to other areas of risk, it’s even more opaque.”
Moreover, deal structures need to evolve along with investor appetite, Hudson’s Millette said.
“We get caught up trying to structure everything like a cat bond. Casualty risks don’t work that way–neither do life risks,” he said. “We need to expand our toolbox a little bit. The cat bond is a nice invention, but it certainly can’t be the last one.”
Areas that might be ripe for ILS are flood coverage and cyber protection, panelists said, though the latter would likely take several years. Either way, that there will be growing pains associated with the expansion of that market–specifically with regard to pricing.
“Nobody really knows how to price cyber, so that’s going to take some time,” he said.
Certainly, some caution is warranted, Millette said.
“Where we will get in trouble is where we think we’re on safe ground,” he told conference attendees. Even so, he added, he sees no end to the current trend. “Getting something up and running in these markets is important.”
Source: S&P Global Ratings and PwC
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