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Influx of convergence capital means more competitive pricing terms for some ILS products: Guy Carpenter


September 9, 2013   by Canadian Underwriter


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Reinsurers are facing soft pricing and excess capital and, as such, must decide how to strategically deploy capital to generate returns that will satisfy the expectations of investors and/or shareholders, suggests a mid-year market report from Guy Carpenter & Company, LLC.

Investors are moving to supply capacity through a convergence of alternative and traditional vehicles, notes the report, Capital Stewardship: Charting the Course to Profitable Growth.

“This new supply of what appears to be a permanent allocation to the reinsurance space is changing the nature of the sector’s capital structure as it adds to the competitive environment for reinsurance capacity and comes with an expectation of a relatively lower return per unit of risk.”

Over the past 18 months alone, an estimated US$10 billion of new capital has entered the market in the form of catastrophe bonds, structured industry loss warranties and collateralized reinsurance, states a release from Guy Carpenter, a global risk and reinsurance specialist and member of Marsh & McLennan Companies.

“Capital emanating from alternative markets has grown significantly during this period and now accounts for an estimated US$45 billion, approximately 14% of global property catastrophe limit purchased,” notes the market report. More specifically, “convergence capital contributed half of the growth in global deployed reinsurance capital from US$178 billion at the end of 2011 to US$195 billion at the end of the second quarter of 2013,” it says.

The influx of convergence capital has also resulted in ILS (insurance-linked securities) catastrophe risk pricing decoupling from price expectations in the traditional reinsurance market. For the first time, some ILS products are now offering more competitive pricing terms than seen in the traditional market,” notes the press release from Guy Carpenter.

“Despite a significant decrease in ILS pricing over the last 12 months, investor demand continues to be robust. Projections by GC Securities indicate that the catastrophe bond market could reach US$23 billion by the end of 2016,” the statement adds. (Securities or investments, as applicable, are offered in the U.S. through GC Securities, a division of MMC Securities Corp.)

The report details strategic approaches for capital stewards, including the following:

  • maintaining the status quo – by maintaining an excess level of capital, carriers can quickly deploy funds following a catastrophe, but holding on to excess capital for too long will dilute returns on equity and consequently to market valuation;
  • returning capital to shareholders – during the last eight years, reinsurers have been relatively disciplined in returning capital when the pricing environment has softened and GC Securities expects the level of capital returned to shareholders to accelerate in 2013;
  • pursuing organic growth – the excess capital available in the reinsurance market today, coupled with increased competition from convergence players, means that 2013 will likely see more risks assumed for the same, if not less, return than in 2012; and
  • identifying merger and acquisition (M&A) opportunities – the need to adapt business models to respond to new market dynamics provides the ingredients for an increase in M&A activity.

“Although the best capital stewards will employ a strategy that encompasses all four of these approaches, the market is increasingly turning to strategic M&A opportunities to achieve scale, global reach and a more diversified product suite in order to remain competitive,” Des Potter, head of GC Securities, EMEA (Europe, the Middle East and Africa), notes in the press release.

The impact of new capacity on current market conditions and where the opportunities exist for profitable growth was also discussed as part of Guy Carpenter’s sixth annual press briefing, held Sept. 7, at the Reinsurance Rendez-Vous 2013 in Monte Carlo.

“The biggest issue this year by far has been the continuing influx of new capital into the reinsurance market. A record amount has entered and it has had a clear and direct effect on market conditions,” Alex Moczarski, president and CEO of Guy Carpenter & Company, and chairman of Marsh & McLennan Companies International, noted during the briefing.

David Priebe, vice chairman of Guy Carpenter, added the impact of the new capital has been most dramatic in the U.S. during 2013. “For the first time, the ILS market offered prices comparable to or lower than those of the established reinsurers, ending the general stability and consensus of post-Katrina catastrophe pricing, especially in Florida,” Priebe said.

“Strong appetite tightened spreads for U.S. hurricane catastrophe bonds, forcing the traditional reinsurers to react by cutting Florida risk-adjusted renewal prices by around 15% at the June 1 renewal. It was a tipping point for the reinsurance industry,” he suggested.

“The U.S. property catastrophe reinsurance market has been most affected by the influx of convergence capital, with double-digit rate reductions observed during the 2013 mid-year renewals,” notes the mid-year market report.

While the impact was less dramatic elsewhere, “general downward rate movements have also been observed in several other regions and across some other classes, including retrocession and casualty business,” the report adds.

Guy Carpenter reports that global property catastrophe reinsurance capacity by source is as follows: US$268 billion, traditional reinsurance; US$16 billion, catastrophe bonds; US$15 billion, collateralized reinsurance; US$8 billion, retrocession; and US$6 billion, ILWs.

“Institutional investors are gaining confidence in the asset class and, providing they do not experience material surprises significantly outside the range of modelled expected loss probabilities from the risks they are assuming, they will continue to support, or even increase, their allocations to the sector following a large catastrophe event,” the report states.

“Market conditions for the remainder of the year and the January 1, 2014 renewal will be influenced by loss activity,” Moczarski noted during the press briefing.

“The influx of new capacity will also continue to exert pressure on market conditions, especially in the USA. Consequently, in the absence of further significant catastrophe losses, the market trends observed in recent months will continue or accelerate,” he added.