The expanding, reported $70 billion of alternative capital in the global reinsurance landscape is seeking out its most efficient home in the overall risk transfer industry, according to Andy Palmer, Vice President at reinsurance giant Swiss Re's (OTCPK:SSREY) Capital Markets division.
"What I think we've been seeing over the last year or two is just alternative capital findings it's most efficient home within the market. And it's taken a long time to get there, and now I think we are starting to see exactly where and how it should be used," said Palmer, addressing an audience at the ILS & Cat Bonds London 2016 event, held in March.
The insurance-linked securities (ILS) and catastrophe bond market has been around for some time now, with the first cat bond being issued in 1996, but only in more recent years has its volume and influence grown and matured so much to enable its capacity and structures to have a meaningful influence on the wider insurance, reinsurance, and overall risk transfer landscape.
Discussing the rise of alternative reinsurance capital and where it can, and should have a larger impact than it does currently, Palmer explained that despite traditional reinsurance still having great value and leverage in today's world, "there are roles for alternative capital, which traditional reinsurance can't do."
"For a start it's got much bigger pockets, enormous pockets, and it's much more efficient in certain circumstances where reinsurance can't play," continued Palmer, echoing the widespread opinion of the capital markets being a deep, and liquid source of capacity.
To date, the majority of ILS capacity typically finds its way into property catastrophe risks, either directly through dedicated ILS funds and managers or via primary insurers and traditional reinsurers in-house ILS teams, the latter referring to the trend of centralized reinsurance purchasing that many in the space expect to continue and possibly intensify.
In order for ILS to continue down its impressive growth path of the last few years, and move away from the overly competitive property cat space, Palmer underlines the need for accessing new risks and regions, while also noting that regulatory changes in markets across the globe will help to facilitate growth opportunities for both traditional and alternative reinsurance players.
Limitations with modelling capabilities in risks like cyber and the longer-tailed casualty lines, for example, hinder the potential for expansion here, while regulatory barriers in some regions mitigate the amount of insurance, or reinsurance-linked capacity that is permitted.
So, if ILS is serious about broadening its scope and reach, what area can, and should it be focused on making its presence more widely felt?
For international reinsurance player Swiss Re, Palmer states that "the protection gap is the number one" place that alternative reinsurance capital should be focused on, likely owing to the enormity of the task, and the fact that insurance and reinsurance capacity and features alone is most likely insufficient to tackle the issue.
"The ILS market has to sit up and take note, it will play an enormous role in this as well," stressed Palmer, referring to the growing international protection gap.
Catastrophe events across the globe have increased in terms of severity and frequency in recent times, despite economic and insured losses being relatively benign in the most recent years.
Furthermore, reports and research into the potential impacts of climate change on adverse weather events, has led some to predict an even greater threat from nat cat events in the years to come.
Ultimately, this suggests that more severe and frequent catastrophe events will result in higher economic and insured losses post-event, with the protection gap being the disparity between the two, and is significantly broader in poorer parts of the world where insurance penetration is lower.
That being said, some of the most mature markets in the world, like U.S. flood for example, suffer from dangerously low penetration levels owing to high rates and a lack of innovative solutions, underlining that the protection gap really is a global issue and far from isolated to emerging regions and markets.
The scope for ILS to assist in closing the protection gap is clear, with mechanisms like the parametric trigger, as seen with a host of catastrophe bonds, and the use of third-party investor-backed capital to supplement, and even increase the efficiency of catastrophe risk pools, as seen with the Turkish Catastrophe Insurance Pool (TCIP), among others.
With the lines between traditional reinsurance and alternative capital continuing to blur as more and more primary insurers and reinsurance companies look to utilize its efficiency and structures, it's fairly safe to assume that in some form at least, ILS will play a role in closing the protection gap.
However, the impressive knowledge, sophistication and capabilities of the ILS and cat bond space presents an opportunity for ILS market participants to innovate and come up with affordable, adequate solutions that help to bridge the gap independent of more traditional re/insurance avenues, and ultimately build global economic stability and disaster resilience.
"The role of ILS within the insurance market is not going to go away, if anything it's about efficiency, it's finding its natural home," said Palmer.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.