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September 2012 Bermuda Re/insurance
“Investors were pleased to have the choice of products offered by the alternative market, from industry loss warranties to parametric triggers and indemnity deals.”
Into the supply-demand dynamic Developments are a happy turn for the insurance sector, but
traditional reinsurers aren’t entirely convinced that they are enamoured of the pop-up players. That said, Markey indicated that they probably regard developments as an evolution, rather than a threat. “Portable capital is a whole new way of managing capital in our business and it is clearly an attractive option for not only new start-ups, but also for existing reinsurers to further utilise their underwriting capabilities and manage third party capital, with fees always an attraction.” Faries concurred that it was part of an evolving marketplace, with the involvement of traditional players likely to paint the area as complementary. He added that many of the biggest reinsurers are already leaders in the alternative risk transfer field and that “by their actions they are looking to put the message out there that these are complementary products”, he said.
Despite being seen by an increasing number of reinsurers as complementary, alternative plays do nevertheless have a competitive effect on reinsurance pricing. As Faries explained: “if you flood the marketplace with additional capacity, it will inevitably affect pricing”. Some reinsurers worry about the cannibalistic implications of additional capacity driving down already soft rates. Many would argue they are right to worry. Watson—speaking from the perspective of someone who purchases insurance—said that portable capital “does not necessarily create more competition—although it has—but what it does create is more choice”.
He said that insurers appreciate the flexibility now afforded them when they are considering structuring their reinsurance programme, with some of the alternatives offering the opportunity to save money. Despite the potential ramifications of portable capital on the pricing environment, Faries said that there is nonetheless a “drive among reinsurers to be involved—whether as issuers or participants in the alternative space”.
What seems inevitable is that additional capital will mute a hardening of the market. Reinsurers have been talking up the possibility of a turn for the past couple of years, but recent catastrophe events— while significant—have proven insufficient to turn the wider market. Additional capital from the markets is unlikely to help matters. Watson said that he expected it will mean the industry “won’t see another rock hard market”. Rather, products like ILS will smooth
out changes in the cycle, he said. Catastrophe events create sudden supply-demand imbalances, but with the ability of this new capital to enter and leave the market so quickly, the cycle—both in terms of upward and downward development—will be less marked, he said.
Not going away any time soon
With trouble in the wider capital markets and investors looking for new ways to deploy their capital, and insurers keen to consider new ways to reinsurance their programmes, it seems likely that portable capital—despite the name—is here to stay. The question then becomes, will interest be sustained once the financial markets pick up. Faries predicted that when the financial markets “return to a healthier place, demand will abate somewhat, but there will always be demand for uncorrelated risks within the wider investment community”.
Watson indicated that products such as ILS are likely to remain popular
despite wider economic conditions. He did however raise concerns about whether investor appetite would lessen in the face of losses that will, in time, inevitably hit such products. “There has not been a wholesale call on these bonds and until that happens we don’t know exactly how the market will react,” said Watson. However, Faries added that now that such products are increasingly tried and tested, there will be continued and growing confidence in their potential. Watson likewise argued that once such products become securitised and investors feel comfortable with them, interest will continue to grow.
Watson said he expected portable capital’s share of the catastrophe market to continue to increase and by as much as 10 percent in the next few years. Markey was similarly confident about its potential, arguing that it will continue to expand and, in all likelihood, faster than the traditional marketplace. Addressing the potential for growth in the ILS and collateralised space, he said that US, European and Japanese risks dominate the offering, but that there is potential for growth in other emerging geographies. “What may surprise some is the potential scale of risk-taking and capital that is in this area,” said Markey.
The growing influence of portable capital in the catastrophe space
may yet change the make-up of the landscape. As Markey indicated, present catastrophe business is a mix of traditional and more alternative forms of capital, but it remains to be seen whether alternative forms will emerge as the dominant play. As Markey explained “a lot of investors in the traditional space are pretty illiquid at present and that is something of a nuisance. The old model of creating a new company, running through three to five years and then IPOing—while certainly not impossible—is clearly not the flavour of the current marketplace”.
Alternative plays, on the other hand, evidently are, as they continue to gain traction and market share. What seems likely is that reinsurance products will necessarily have to attend to the appetites of insurers and investors, and as these grow more sophisticated and the types of investor more diverse, we can expect more demand for easily deployable and understood portable capital.
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