Brooks: The noisiness around convergence capital over the last few years has increased even though the pace of growth has not changed that much following capital dislocations in 2005 and 2011. Those events allowed ILS capital to grow without really stepping on anybody’s toes.
What has happened in the last year or two years is that as the amount of overall capital required by the industry has stabilised, increases in convergence capital require a more direct trade-off with the rest of the market. So growth in convergence capital, at least in the last year, has meant a necessary trade-off and decline in the syndicated reinsurance market for traditional reinsurers.
Going forward, to what extent will the actual opportunity set increase? As pricing decreases in reinsurance, you should see greater demand. If that’s not the case, then this would be the only market in the world where pricing decreases don’t cause increases in the quantity demanded.
The largest part of the market is actually the direct reinsurance market which makes up 50 to 60 percent of the whole and that doesn’t seemed to have changed at all. Are the players in the direct market going to see changes in their return on capital that cause them to change their behaviour? Even a 5 to 10 percent decrease in the size of that part of the market could have a huge implication on what happens in the syndicated and convergence markets.
What have been the impact of rates and the dampening of investor appetite on those looking to deploy capital?
Kramer: There are people sitting out there saying ‘call me after the hurricane’—I think we’ve all heard that. Other than that I don’t think there’s been an impact because the market is so big and the influx is so heavy.
Brooks: As rates have declined and return expectations have moderated, in convergence specifically and reinsurance generally, there’s been a shift in the investor base, so some of the investors who were originally in the market five to 10 years ago have started to decrease their allocations, but they’ve been more than subsumed by new investors coming into the space.
So in that respect it’s less a concern for the manager about what the absolute return expectations are from a philosophical perspective
“To my surprise—and this is counterintuitive—as the price of reinsurance has gone down, many of the primary companies have actually bought less.” Don Kramer
and more an exercise in making sure that the investors we work with understand what the appropriate return expectations are. And if you give investors the tools to evaluate what the opportunity set is and what the risks involved are, then they can make their own decisions as to how it fits into their portfolio—because they’re working with multiple asset classes and have a better idea of how ILS fits into their own portfolios.
Marsh: It’s up to us as managers to educate the investors and help make decisions about investing in the space—which is needed a lot less now than it was 15 years ago. We have also seen a shift in the investor base: those that have benefited from the harder markets of the past and those who are more recently seeing the benefits of the asset class.
The early investors may feel as though the return differential is significant compared to five to 10 years ago, which may cause some pause in their allocation to ILS. However, a lot of the new capital that is coming in is less sensitive in terms of the current pricing environment. For them, they don’t have that same comparison, so they look at it with a fresh set of eyes and it’s still attractive compared to other asset classes.
Pollett: They’ve observed this cyclical behaviour in most other asset classes over the decades. They have tactics to be able to play the market in different cycles. How we differentiate ourselves as managers is to have a strategy that deals with the current marketplace. In the market today, the smaller, standalone ILS funds who are investing only in industry loss warranties (ILWs) and cat bonds are at a disadvantage, but this market plays much more to the strengths of an established franchise that has access to the full market and has the ability to navigate through the different sectors and capital structures.
29 Bermuda Finance | 2014
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