Reinsurers align third-party capital with their needs

Reinsurers have embraced third-party capital through instruments like sidecars, collateralized reinsurance, and catastrophe bonds and the retrocession market increasingly depends on this convergence capital, a new report by S&P Global Ratings states.

Insurance-linked securitization (ILS), which brings third-party capital into the reinsurance sector, has transformed the market, especially in the property catastrophe space, S&P says in the report called "How Reinsurers Have Learned To Align Third-Party Capital With Their Needs”.

Even after severe natural catastrophe events in 2017 caused $138 billion in insured losses globally, there was more than enough inflow of alternative capital to renew coverage for cedants on Jan. 1, 2018. This had, however, the effect of limiting the price hikes that would traditionally have followed such severe losses and reinsurers had been hoping for.

The latest figures show that ILS funds had combined assets under management of nearly $100 billion by July 2018. Even as the reinsurance industry digested the effects of 2017's three major hurricanes--Harvey, Irma, and Maria, which affected the Caribbean Islands, Texas, and Florida--alternative capital continued to grow, contrary to the expectations of some market observers. Investors, scenting the chance of increased returns, replaced capital that had been put aside as collateral to cover insured losses, enabling them to participate in the Jan. 1, 2018, round of renewals. As a result, the price hikes the industry has typically seen after previous catastrophe events were limited.

Many observers had assumed that investors who entered the ILS market during the recent string of benign catastrophe years might take fright when investment returns turned negative. However, S&P saw no capital flight following the negative investment returns that followed the 2017 hurricanes as losses were within investors' expectations. Indeed, the market was able to more than restore the collateral trapped following the 2017 events.

Overall, the use of collateralized reinsurance, sidecars, and catastrophe bonds has helped the reinsurance industry to increase its premiums while maintaining its net exposures, S&P noted. Collateralized reinsurance will continue to represent the majority of convergence capital.

Having conquered the property catastrophe business, S&P continues to see alternative capital testing products in new areas, such as casualty or life reinsurance. The increased complexity and longer tail of products in these sectors have yet to strike a chord with investors, however, the report notes.

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