Bermuda’s reinsurers are at the vanguard of third party capital opportunities, says Henry Kingham.
As one of the largest traditional catastrophe reinsurance markets in the world, Bermuda provides an attractive home for third party capital. The short duration of property catastrophe contracts and the ability to commute loss free contracts in a relatively short space of time matches the liquidity requirements of large institutional investors, who now make up a sizable proportion of providers of this capital.
These conditions have led to a flurry of activity, with the volume of third party capital on the Island doubling over the last five years, climbing from around $10 billion in 2008 to approximately $20 billion now. This is nearly half of the total insurance-linked securities (ILS) capital currently deployed globally.
With so much of the Bermuda reinsurance market focused on US property catastrophe in particular, it is little wonder that many reinsurers on the Island are paying so much attention to this influx of capital.
It is certainly having a material effect on property catastrophe rates. As reported in our July 1 renewals report 1st View, some Florida catastrophe loss free accounts were down as much as 15 to 25 percent, as several property catastrophe reinsurers moved to protect their market share by reducing prices.
Interestingly, while much of the discussion around third party capital has centred on the threat it might pose to the business models of some traditional property catastrophe reinsurers, many firms in Bermuda have viewed it more as an opportunity. A good example of how reinsurers on the Island have adapted to profit from new market conditions is through the setting up of sidecars that allow them to generate fee income, while removing more volatile risks from their balance sheet by using third party capital to underwrite those risks. This is either as an internal quota share or through a market-facing vehicle.
Sidecars typically fall into one of three categories: those fully funded by third party capital; those that traditional reinsurers have invested a stake in alongside third party capital; and those that are 100 percent composed of the reinsurer’s own capital.
Reinsurers’ ability to adapt to these new market conditions is likely to be further tested in the coming years. A significant additional influx of capital is likely, particularly given that cat risk is currently in vogue with investors, and that the current influx of third party capital represents a small fraction of the capital that could potentially arrive from the capital markets. A 0.5 percent allocation of global pension funds’ assets under management into ILS products would be sufficient to deliver $150 billion of ILS capacity.
To put that in context, that is just over three times the amount of capacity that is currently in the market. This would present traditional property catastrophe reinsurers in Bermuda with even more challenges in terms of competition, but also extra opportunities for those willing to innovate.
There is, however, a debate over the longevity of third party capital in the reinsurance market. It is our belief that the pension funds and other similarly conservative investment funds—which now provide the lion’s share of third party investment—are unlikely to make frivolous decisions about where they invest, and so are likely to be here for the long term. In addition to this, their investment in the reinsurance market represents a very small allocation of assets within their wider alternative asset mix.
"As brokers, it is our duty to balance third party capital with tried and tested sustainable traditional reinsurance capacity while providing product innovation."
Naturally third party capital investors are reactive to circumstance, and circumstances could change if there were a series of catastrophic events or ‘shock losses’ that were not necessarily costly but were not considered when underwriting the portfolio. The more likely negative circumstance, however, is a change in the credit markets that will lead to institutional investors allocating assets away from reinsurance to more familiar asset classes with perceived superior risk:return characteristics.
Because of this, and as brokers, it is our duty to balance third party capital with tried and tested sustainable traditional reinsurance capacity while providing product innovation and taking an intelligent perspective on the merits and challenges of different providers of capital.
Taking a balanced view, however, third party capital potentially offers the market a source of flexible and relatively liquid capital which could prove valuable, in addition to the more permanent capital structures managed by reinsurers.
Henry Kingham is executive director at Willis Re Bermuda. For more information visit www.willisre.com
ILS: an opportunity
The current changing market dynamics present our clients with an exciting range of opportunities.
For our clients, competition in the reinsurance market is driving informed innovation in product and solution design. A good example—largely influenced by the rise of collateralised reinsurers—is the increased presence of more multi-year structures and aggregate covers.
This improvement is enabling clients to buy solutions that are more closely aligned to their needs than the ‘off-the-shelf’ products they have often been offered in the past.
Reinsurance is used either to provide capital preservation or to protect earnings. The trade-off between reduced potential upside and downside protection is always a complex one—so this increase in innovation by reinsurers is a positive characteristic of the capital influx. The improved product mix and the fact the reinsurance is cheaper and can be better tailored to the buyer should in turn drive demand for reinsurance.
Bermuda, third party capital, Willis Re