Extending the margins
The number of smaller cedants using alternative risk transfer structures, including insurance-linked securities (ILS), has been growing in recent years. These players are entering the market privately and publicly, largely driven by a desire to diversify and use what can be cost-efficient alternatives.
While the ILS market was originally limited to covering primarily peak perils in the US, Europe and Japan, a growing number of deals are being structured that deal with the risks in other geographies such as the US Mid-West, Turkey and Italy. A broader range of risks and structures is also being covered.
Adam Szakmary, portfolio manager, Blue Capital Management, whose company provides access to a differentiated book of small, geographically discrete cedants in its core investor product offerings, says that activity is increasing for cedants that are sub-$250 million in risk capital.
“The ILS market is gaining traction with smaller cedants—both directly and indirectly, via collateralised reinsurance and quota share access respectively,” says Szakmary. “However, the US is still the largest market by far for direct ILS capacity.”
Szakmary says that cedants ranging in size from $15 million to $250 million are increasingly looking at the ILS space because it has become a very relevant participant in the cat market, offering diversification and cost efficiency.
“The capacity is available to managers to look for non-peak zone risk, and increasingly relevant lately has been the impact of M&A which has forced cedants to look for new partners,” he says.
“Risk management is a strong ethos with these carriers and the need to diversify their panels is a primary risk to them.”
However, Szakmary explains, the smaller insurers and mutuals tend naturally to be more conservative on the investment side of the balance sheet, so macroeconomic conditions don’t significantly change their reinsurance buying when compared to the larger stock companies.
“Smaller cedants will always be heavily regulated and by virtue heavily reinsured,” he says.
“The ILS market is gaining traction with smaller cedants—both directly and indirectly, via collateralised reinsurance and quota share access respectively."
A larger cession can be seen going into the market both directly and on the back end via quota share or sidecar, and Szakmary says that this activity will continue.
“If we look at the quota share space, underwriting partnerships have grown significantly on that side, between many London and Bermuda players,” he says. “Cat reinsurers are quota sharing a significant amount of their cat books into the market currently and there is no reason that those percentage won’t increase further. However, these actions might not be immediately evident to cedants unless companies ramp up their marketing campaigns to advertise that they’re using third party capital partnerships to support traditional underwriting.”
He also says that as more companion vehicles reach the market, those cessions will grow, as will a direct underwriting approach.
“The direct underwriting approach is growing steadily, but strategies moving forward will likely see some form of underwriting leverage as part of portfolio construction,” he adds.
While the market’s size and strength is expected to continue to develop, some consideration must be given to the extent at which this growth will cease.
“First, I don’t believe the factors that affect investor interest differ between the small and large ILS space. If anything I think there is more interest in the smaller space because there are many more primary insurers worldwide,” explains Szakmary.
“Generally, investor interest will depend on the interest rate environment and macro fundamentals. However the most relevant item for ILS will be returns: if they are good we will have interest, if they aren’t, then we won’t.”
Szakmary explains that as an alternative strategy, ILS has proven to be a good option, with historic strong returns to set a precedent, likely to retain interest from participants for a long time.
However, he says, investors are yet to be tested, but stresses that he believes the smaller cedants to be in a secure position.
“Smaller cedants’ performance in comparison to the larger market will be the test for investors and it is our belief that these outperform their market shares and attract further investment to this sector,” he says.
Aligned with Montpelier, Blue Capital has the ability to transact directly with cedants or craft sidecar solutions that benefit from the reinsurer’s preferred market access, which has ultimately assisted the asset manager’s ability to gain business.
“Cedants prefer to place capacity with Blue because of Montpelier’s track record of timely claims payments, strong account service, analytics, and the ability to quote structures and provide real feedback in the quoting process that other standalone asset managers can’t provide,” says Szakmary.
This alliance has helped Blue Capital to reach its current offerings, which Szakmary hopes will continue to grow.
“Our focus will continue to be on constructing portfolios that leverage our preferred access to the traditional reinsurance market, which we believe has proven long-term value. This means creating strategies to support products for both investors and cedants,” he says.
“Our responsibility is to continue to evolve our product offerings so we can support our core market, and create new products to grow the industry.”