Traditional Bermudian reinsurers under threat

The flood of alternative capital in the reinsurance market is likely to sustain the wave of merger and acquisitions, particularly in Bermuda.

This is according to rating agency Fitch, which added that the alternative sources of capital are pushing the sector’s capitalisation levels higher and pressuring pricing.

Traditional, stand-alone Bermudian property catastrophe reinsurers, which compete most directly with the alternative reinsurance market, face the greatest threat from this with their business models having fewer diversified sources of earnings.

Fitch explained that the timing of the alternative capital influx is especially challenging given the pronounced absence of large catastrophe losses since 2012, which by itself has held reinsurance pricing down.

“Combined with low interest rates, the industry's returns have the potential to trend meaningfully lower over the coming years. The Bermudian market as a whole had a combined 11.1 percent net return on average equity through the first nine months of 2014, down from 12.9 percent in 2013.”

Although alternative capital can be seen as beneficial to the industry, Fitch believes that an excessive amount of alternative capital, combined with expanding coverage options amid shrinking premiums are factors that have combined to drive intense, industry-wide competition. Fitch added that these factors contributed to its negative outlook for the reinsurance market globally.

“Alternative sources of reinsurance capital are coming from hedge funds and private equity managers seeking to expand the breadth of investment opportunities by structuring risk-transfer solutions, or ‘sidecars’. Previously, the sidecars that write property catastrophe risk have been adopted by Bermuda-based reinsurers. However, the vehicles have not established a lasting impact on market capacity.

Fitch believes there is a higher potential for more partnering deals where an established reinsurer pairs with an established hedge fund.

“The Validus and PaCRe partnership in 2012 was among the earliest examples of established players partnering. These deals face fewer challenges in establishing track records, launching operations and attracting new customers. Potentially more credit threatening, however, is the point that hedge fund-backed reinsurers are more likely to employ alternative investment strategies for the reinsurer, where higher returns may be viewed as providing greater flexibility on premium pricing,” said the rating agency.