From a pricing perspective... we've reached a low zone and that's where it's going to stay until something takes it out of here - Morton Lane
Lane Financial was founded in 1995 in the earliest days of the catastrophe bond market. Since then, Morton Lane and Roger Beckwith have provided regular analysis and insight as the asset class has developed. In the first part of a wide ranging interview, InsuranceLinked spoke to them about the current pricing levels in the reinsurance and ILS markets.
Readers who have registered (for free) can read part two of the interview here. In the second part Lane and Beckwith share their view on the prospect for further growth in 2015 and discuss a controversial new book.
ML: There have been extended soft markets in the past. The first one I was involved with was at the end of the 1990s and, from the point of view of lack of catastrophes and lower prices, I honestly don't think this one is very different. What is different is that the structure of the market has changed since the 1990s.
When we've had soft markets in the past, they have been extended, they are painful and they lead to certain predictable sorts of behaviour. This time around you've got the alternative market involved. But I don't think you should confuse the presence of alternatives with the causation of soft conditions, as some are want to do.
In soft markets it's not just the yields that become compressed. Terms and conditions become expanded. Some changes in terms and conditions are relatively benign – new peril coverages, extended maturities lack of credit ratings – but some are more subtle and may be unseen.
The dangers to the industry don't lie in low yields or big losses. I think they lie in being sloppy about terms and conditions. If you're an investor, understanding terms and conditions is as important as understanding covenants if you are making bank loans. That danger of the soft market may be more consequential than yields going up or down.
ML: It has and it will but it's not exclusive to the soft market at the moment. When there is a demand for capital, alternative capital gets into the market more quickly than traditional capital can. What this means is that any future price peak that we have won't be as big next time as we have experienced in the past. Alternative capital has reduced the amplitude of price spikes. On the opposite side, capital can leave the market faster too.
What are your thoughts on the current spate of M&A that's taking place in the traditional reinsurance market?
ML: I gave an interview back in December and said I was surprised we hadn't seen more mergers and acquisitions, and it wasn't a week or two later that we began to see a lot. That's something that happens in soft markets in the traditional market. If we have a benign year this year and an extended soft market we'll see more of those. And you may even see this in the alternative market too, such as consolidation between dedicated ILS hedge fund managers.
Warren Buffett recently dismissed the reinsurance sector as "a fashionable asset class" whose prospects have "turned for the worse". How optimistic do you feel about the industry's future?
ML: Well it has become a fashionable asset class. It's grown. That doesn't mean it's a passing fashion. It doesn’t mean that it’s a fad. It's an investment now that wasn't on everybody's radar screen before, and it is now.
Are the returns today as good as they were if you paid attention four or five years ago? I don't think so. But yields on corporate bonds in the US are much less than they were five years ago. Does that mean that corporate financing through high yield bond issuance is a passing fashion whose prospects have turned for the worse? Yes, most fixed income securities have “turned for the worse”, why pick on ILS?
How low can we go in terms of pricing and will the product continue to be attractive to investors?
ML: It's at this point that I usually remember the quote by John Maynard Keynes which is, "Markets can remain irrational longer than you can remain solvent". This quote isn’t just directed to this market, it's directed to all markets. Markets can go to extreme points and they can stay there. You expect them to return and they can stay there longer than you have the capital to hang out for that return.
In our last report I said we were crawling along the bottom from a pricing perspective. I still hold to that view that we've reached a low zone and that's where it's going to stay until something takes it out of here. If a lot of people decide there's no money left in this market and there are better alternatives elsewhere, yields will start to go up.
So could investors fall out of love with the reinsurance sector?
ML: If interest rates rise in such a way that it makes it more attractive to invest in traditional corporate bonds or government securities then investors who are in it for the yield play may go to those new higher yields.
Part II of the interview (free for registered users) includes:
- Predictions for 2015
- New types of risk for cat bonds
- Discussion on the controversial new book, Making a Market for Acts of God
Posted: Monday, June 8th, 2015