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Property & casualty reinsurance firms are deriving “significant benefits from their ability to leverage alternative capital” according to broker Aon Benfield, helping them to lower the cost of their underwriting capital and raising efficiency.
The penetration of alternative reinsurance capital continues apace, with the latest figures showing that alternative and ILS capital grew 13% and reached $81 billion recently, sustaining its recent growth rate and actually increasing its rate of growth in the fourth-quarter of 2016.
As alternative capital has continued to grow, now contributing an impressive 14% of total global reinsurer capital of $595 billion, according to Aon Benfield’s numbers.
In its latest Aon Benfield Aggregate report (available here) the broker explains that those reinsurers that have embraced insurance-linked securities (ILS) and the capital markets are deriving tangible benefits from alternative capital.
Reinsurers are finding benefits thanks to lower priced catastrophe risk transfer, with alternative capital and ILS vehicles an increasingly prominent piece of their hedging and retrocession strategies.
The formation of collateralized reinsurance sidecar vehicles, sponsorship of catastrophe bonds and increased use of collateralized retrocession, are all helping reinsurers manage their risk profile more efficiently.
At the same time, reinsurers are increasingly securing and growing asset management mandates with capital market investors, enabling them to earn fee revenue as interest in investing in insurance risks and ILS structures grows among institutional investment markets.
This has multiple benefits, adding a source of fee income, a diversified source of earnings revenue, and at the same time helping them to cultivate relationships with capital market investors that will be essential after major losses occur, according to Aon Benfield.
The upshot of this increasing use of alternative capital, as hedging and as a source of lower cost underwriting capacity, is a general reduction in the cost of reinsurers underwriting capital, which at a time of pressured rates and high competition has been invaluable for some players.
Use of alternative capital has also allowed reinsurance firms to grow their positions with certain key clients, while also reducing their exposures to certain peak zone probable maximum losses (PML’s) relative to the capital they need to hold.
These benefits cannot be understated in the current reinsurance market environment and it is no surprise that some reinsurers are consistently growing the amount of alternative capital and ILS they use, including through increased sponsorship of catastrophe bonds.
As significant benefits are felt and the use of alternative capital becomes embedded in these reinsurers it is hard to see this trend reversing. Even should major losses occur, it still stands that the capital markets will likely be the most efficient source of reinsurance and retrocession capital, meaning that reinsurers who recognise the benefits now will likely upsize their use of third-party capital when any major loss occurs, market turning (to some degree) or otherwise.
The questions of conflicts do remain, as it is still vital to be able to explain to capital market investors where alignment lies and how their capital is being used versus how the balance-sheet capital is deployed for underwriting, or indeed where alignment doesn’t lie if that is the strategy.
However, as reinsurance firms embrace alternative capital more wholeheartedly the conflict issue lessens, as third-party investors become more embedded across the underwriting platform.
Still, the holy grail for a reinsurer is to find a harmonious mix of capital, where both alternative and balance-sheet can be used most effectively, with both generating profitable returns for their respective investors and for the reinsurer itself.