Unhappy new year

Alternative insurance impact may be felt at January renewals

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Many traditional reinsurers may be looking ahead to the New Year with a sense of dread amid predictions that prices will take a battering at the January renewals. Suggestions are that catastrophe reinsurance could see at least double-digit price drops, along with new terms and conditions more favourable to reinsurance buyers, and the reason for this is being laid at the foot of the new kid on the block – insurance linked securities and collateralised reinsurance.

In fact, the new kid has grown up into a formidable rival to traditional insurance that is rapidly growing in maturity. In less than 20 years since it first appeared the alternative reinsurance market has grown to around $45bn in size, according to a recent report by Credit Suisse equity research analysts Michael Zaremski and Crystal Lu, and it is expected to double in size by 2018.

Non-traditional reinsurance has found increasing popularity as a source of diversifying risk because it is largely uncorrelated with capital markets and due to its relative value, especially as interest rates remain at historic lows. Enthusiasm for it has continued to rise as alternative reinsurance products have matured and innovated, and as familiarity with them has grown.

Expansion into new areas of the reinsurance industry is expected to drive further growth. Currently, the majority of alternative reinsurance products are focused on North American wind and/or earthquake catastrophe cover, where there is advanced data and modelling. But this is beginning to change, both as a result of improved data from other regions and because of a desire to enter new markets where penetration is low.

Its rapid encroachment into the territory of traditional reinsurance is a worry for players in that market, some of whom fear a case of cannibalism rather than convergence as the alternative reinsurance market expands.

It was suggested that the two markets ‘decoupled’ earlier this year as a result of an influx of capital, alongside robust activity in the catastrophe bond, sidecar and collateralized reinsurance markets. Commentators claimed this decoupling meant alternative reinsurance pricing ceased to be influenced by traditional reinsurance pricing and instead began to feel the influence of issues such as cost-of-capital, investor risk appetite and supply side dynamics.

The idea of decoupling was dismissed by Goldman Sachs managing director Mike Millette, who is reported to have described it as an ‘optical illusion’. And indeed it does now seem that these two markets remain tightly bound.

On top of this, a benign hurricane season has meant that 2013 is looking to be a banner year for reinsurers whilst the uptick in valuations has made it difficult for reinsurers to shrink their balance sheets. This excess capital in the traditional market will have an additional impact on prices.

Traditional reinsurers have not taken the impact of alternative reinsurance lying down, hitting back with questions about the sustainability of modelling used by the industry.

Munich Re board member Torsten Jeworrek reportedly cast doubt over the sustainability of the economic model that underpins alternative reinsurance, arguing that it is able to undercut traditional reinsurance in part because it uses cheaper risk modeling than mainstream reinsurers.

He also questioned whether alternative reinsurance buyers would stick with the asset class in the event of a major catastrophic loss or in the event of an interest rates rebound leading to an increase in returns from mainstream financial assets.

“How sustainable is this market? We don’t have the final answer here,” Jeworrek is reported to have said.

But attacks on the alternative reinsurance market look rather defensive in the face of its growing popularity, which, according to Guy Carpenter chief executive Alex Moczarski, reached a “tipping point” during the Florida renewals in June, when for the first time competition from alternative reinsurance led to a direct fall in traditional reinsurance pricing.

A growing number of traditional reinsurers have moved on from criticising the new structures and begun to embrace them. There is now a long list of reinsurer funds and sidecars that are opening for business in 2014. But these new initiatives will only draw yet more capital into the market with a predictable effect on pricing.

Posted: Monday, December 16th, 2013