At Just 2% Share, Huge Scope For ILS Capital To Expand Into Re/insurance

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Includes: GLRE, HVRRF, HVRRY, SSREF, SSREY, TPRE
by: Steve Evans

The entry of alternative capital into reinsurance has slowed somewhat, at a time when achieving cost of capital returns has become increasingly challenging in reinsurance. However, data from reinsurance firm Swiss Re (OTCPK:SSREY) shows the massive potential for continued expansion of ILS into insurance risks.

Despite ongoing pressure from softening, during the first-half of 2016 both traditional and alternative reinsurance capital recorded growth, according to Swiss Re.

The rapid rise of alternative reinsurance capital and structures within the global reinsurance industry has slowed somewhat in recent times and, while third-party capital remains attracted to the sector, highlighted by its persistent growth, the kind of growth witnessed in 2013/2014 has abated, says reinsurance giant Swiss Re, in its latest Global Insurance Review and Outlook report.

"The rapid expansion of alternative capital which caused a sudden supply/demand imbalance in property catastrophe reinsurance in 2013-2014 has abated, as average returns for several alternative capital business models have fallen below their cost of capital," explains Swiss Re.

As the softening landscape has persisted and rates have continued to fall across the majority of business lines, particularly the in the property catastrophe space, both reinsurers and ILS players have found cost of capital targets increasingly difficult to meet.

A need for discipline and efficiency in the current operating environment has resulted in numerous reports of insurers, reinsurers, and ILS funds/managers walking away from business that is priced too low, or with terms that are unfavorable.

Despite the slowdown of alternative reinsurance capital in more recent times, market conditions and the ongoing benign loss period (although losses have picked up somewhat in 2016 when compared with previous years) means the marketplace remains overcapitalized, suggesting that cedants could take advantage of favorable terms and pricing metrics at the upcoming 1/1 renewal season.

However, reinsurers have shown a desire to put an end to the falling prices as the market searches for a floor, in an effort to increase profitability on the underwriting side of the balance sheet.

Excluding retrocession capacity, the global reinsurer states that alternative capital was estimated to total $61 billion by mid-2016, an increase from the end of 2015, which highlights the continued expansion of the space even during testing market times.

"It has maintained a roughly 18% share of global capacity in property catastrophe reinsurance. In the broader context of all risks covered by the global non-life reinsurance market, however, the market share of alternative capital is less than 2%," says Swiss Re.

To date, the majority of alternative capital has focused on property catastrophe lines, which includes risks that are better understood, have advanced modelling capabilities in most instances and are generally easier to access for players in the insurance-linked securities (Pending:ILS) space.

As noted by Swiss Re, almost a fifth of global property catastrophe reinsurance capacity now comes from third-party sources, but with rates in this area under the most pressure in the softening landscape, owing to stiff competition and exacerbated by the benign loss experience, alternative capital has reduced its entry here.

However the fact that just 2% of global insurance risks are covered using capacity from capital market investors shows the enormous scope for the ILS market to expand further, more deeply into reinsurance and also into insurance markets.

Overall, traditional reinsurance capital increased by 7% in the first-half of 2016, which was mainly driven by unrealized gains on investments, says Swiss Re.

Artemis has discussed before that there's scope of ILS capacity and features to play a role outside of the property catastrophe space, and other market participants have suggested that this will need to happen if the alternative market is to continue to experience the kind of growth it has been accustomed to in recent times.

The fact that alternative reinsurance capital accounts for just 2% of risks covered by the international non-life reinsurance industry, but 18% of the property catastrophe reinsurance space, highlights the opportunity for ILS to expand its remit and access a broader range of insurance and reinsurance-linked exposures.

The investor base appears willing and able, and provided the risks are well understood and the returns are desirable, stable, diversifying, and uncorrelated, it's likely that the sophisticated base of capital market investors that participate in the space would be eager to capitalize on business lines that compliment their overall investment portfolio, outside of the property catastrophe reinsurance space.

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.

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