September 16, 2014 by Canadian Underwriter
Innovations – including more types of risk directly accessing capital markets in insurance-linked securities (ILS) form – are contributing to reshaping a reinsurance market that saw the entrance of about US$20 billion of new capital over the past 24 months, Guy Carpenter & Company, LLC notes in a new report.
About US$20 billion of new capital has entered the market through ILS investments, funds and sidecars, as well as the formation of hedge fund-related reinsurance companies and collateralized reinsurance vehicles, states Reinsurance: The Capital Markets Evolution Continues, released Tuesday by Guy Carpenter, a global risk and reinsurance specialist and wholly owned subsidiary of Marsh & McLennan Companies.
Guy Carpenter reports that a notable major innovation over the past year is the transfer of risk directly from the risk-bearing entity to the capital markets, without an intervening traditional insurance company.
The company cites the MetroCat Re Ltd. bond – whose cedent is the captive insurer of the Metropolitan Transportation Authority – which transferred the risk associated with storm surge and flooding directly to capital markets investors without a traditional insurance company acting as an intermediary.
“As the quality of catastrophe modelling continues to increase and as capital markets investors become more comfortable with innovative terms and conditions, more types of risk may directly access the capital markets in ILS form,” Guy Carpenter suggests in a statement.
The amount of limit placed using ILS and collateralized products continues to grow, and some markets are broadening the line of business and product focus, the statement adds.
Utilization of capital markets capacity in the first six months of 2014 saw a continuation of the growth trends seen in 2013, notes the report, which focuses on the growth in the ILS market over the past year and some of the recent developments in catastrophe bond structure and risk transfer.
“Revealing a widening of application, capital markets investors continue to be drawn to the (re)insurance space primarily due to the advantages it offers as a non-correlating asset class,” the report states. “Also, the recent availability of meaningful risk opportunities continues to drive investors to focus on the insurance-linked security space.”
Collateralized markets continue to increase in importance as an alternative to both traditional reinsurance and ILS, Guy Carpenter notes in the statement.
“One common theme in the development of both ILS and collateralized markets is the change in the location of where the capital to back insurance claims is held,” the report points out. “In the case of traditional reinsurance, using a rated carrier, premiums are paid by a cedent to a reinsurance company, then the reinsurer will pay any claims out of its capital base after the insured or the cedent has made a claim. In the case of ILS structures, the insured or the cedent holds the proceeds of the security until either the equivalent of claim has occurred or the proceeds are returned to the investor when the security matures,” it explains.
“This major structural difference between rated and collateralized markets has given rise to well-defined structures and verifiable parameters as alternatives to the traditional claims process. The continued development of these structures and parameters will provide for further risk transfer to the collateralized markets,” the report states. “As the ILS and collateralized markets continue to innovate in these areas, rated reinsurance markets will utilize some of these same triggers and techniques, creating another form of convergence between the rated and collateralized markets,” it adds.
“As the focus grows on increased integration and consistency in coverage provided across products, GC Securities has seen a growing request for incorporating certain terms and conditions, for example, hours clauses and definitions of named storms, from capital markets structures into traditional reinsurance placements,” notes the report. “Historically, capital markets-based risk transfer structures have been pushed to mirror traditional reinsurance terms. The decoupling of pricing and terms and conditions is a key attribute of capital markets-based risk transfer capacity relative to traditional reinsurance.”
In the wake of Superstorm Sandy, many corporate clients came to the realization that they were exposed and retained significant unreinsured risks. “Companies in this situation are increasingly evaluating and utilizing capital markets-based risk transfer solutions, including catastrophe bonds and collateralized reinsurance, given their increasing cost-effectiveness and simplified processes,” the report states. “GC Securities expects substantial growth and activity in this area through 2015.”
Guy Carpenter notes that up to this point, insurers and reinsurers have relied on capital markets-based capacity primarily for property catastrophe risks. “Moving forward, there is a question of the degree of expansion into longer tail, less volatile insurer lines given the growing prevalence of hedge-fund backed reinsurers seeking to reinsure asset intensive long-tail liabilities. With the dialogue just beginning at the C-suite level, further innovations are a matter of when… not if.”
The report offers an overview of how Guy Carpenter assists its clients in managing counterparty risk and limiting credit exposure. “We are committed to finding the optimal form of risk mitigation for our clients from the vast array of potential solutions across all markets,” David Priebe, vice chairman of Guy Carpenter & Company, says in the statement.