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The continued flow of new capital into the (re)insurance industry constitutes the largest change to the sector’s capital structure in recent memory. New capital has entered the market through investments in insurance-linked securities (ILS) funds, sidecars, hedge fund-backed reinsurance companies and collateralized reinsurance vehicles. Investors have increasingly been attracted to low correlation returns from catastrophe risk relative to traditional capital markets risks and the attractive yield for the measured (re)insurance risk relative to other investments, particularly in the current low inflation, low yield era.
Guy Carpenter’s estimate of dedicated reinsurance sector capital as of July 1, 2015 is approximately USD 400 billion of which the convergence capital, including catastrophe bonds, industry loss warranties, collateralized reinsurance and sidecars is USD 66 billion.
Insurers and public sector buyers are benefiting from the increased supply of catastrophe capacity from reinsurers and are also turning to capital markets and convergence capital solutions to supplement their traditional reinsurance placements. Catastrophe bonds have provided new sources of risk capital where traditional reinsurance markets were not positioned to increase the capacity commitments they made.
Catastrophe bonds issued by public sector entities currently account for nearly 30 percent of the USD 22 billion of total risk capital outstanding in the catastrophe bond market. Further, there is a strong pipeline of potential new entrants taking advantage of the streamlined issuance process while existing public sector entities have renewed and repeated their use of catastrophic bonds and/or collateralized reinsurance. Some are beginning to tranche maturity dates to mitigate refinancing risk.
The Texas Windstorm Insurance Association (TWIA), California Earthquake Authority (CEA) and Florida Citizens exemplify these trends. TWIA has USD 1.1 billion of catastrophe bond capacity in-force representing almost 50 percent of its total risk transfer limit. CEA has USD 850 million of catastrophe bond capacity that represents 20 percent of its total risk transfer limit. Florida Citizens has USD 2.05 billion of catastrophe bonds in-force for the 2015 hurricane season, which represents 53 percent of their total limit purchased. For Florida Citizens, their ability to adequately finance risk has reduced the threat of post-event premium assessments to private-market policyholders (including those who are not Florida Citizens policyholders, including but not limited to homeowners, auto and specialty and surplus lines policies) as a result of Florida Citizens’ policy losses from one or more hurricanes. The fact that significant market capacity now exists to shift the burden from taxpayers to diversified markets is a welcome option to the politically unpalatable post-event scenarios faced by many public entities.
Competition has increased as capital sources entering the reinsurance market have expanded. Buyers of reinsurance have seen costs come down and coverage flexibility increase across the range of reinsurance products available to them. Innovative cover triggers such as the one devised for the Metropolitan Transportation Authority (New York MTA ), National Railroad Passenger Ltd. (Amtrak), the Turkish Catastrophe Insurance Pool and the Caribbean Catastrophe Risk Insurance Facility (CCRIF) demonstrate the ability of the catastrophe bond market to respond to the unique needs of public sector entities. Improved liquidity features and multi-peril loss triggers are being utilized with greater regularity to refine and increase the utility of these products. At the same time, aggregate coverage protection, broader reinstatement and occurrence definition features, as well as innovative coverage features such as second or third-event coverage have been made available by traditional reinsurance practitioners as they look to position themselves against the evolving capital landscape.
The convergence of (re)insurance with the capital markets is a significant development for the private sector’s ability to assume and diversify catastrophe risk and assist in de-risking public sector entities. While the growth of this form of reinsurance capital has been strong, it still represents less than 20 percent of total reinsurance capital. When compared with the USD 30 trillion of global pension funds’ assets under management, the current level of capital market involvement in ILS is only 0.22 percent of total global pension assets under management. The risk bearing potential of capital markets that now exists for new insurance risk is enormous. The challenge will be to create motivation to transfer risk through a process of risk identification, cost allocation and development of a conduit to transfer risk.