13 December 2012News

Alternative capital driven by investment environment

The lack of investment returns being achieved by traditional reinsurers combined with the growing demands of regulatory capital are helping drive the rise of alternative capital in the industry. That is the view of John Berger, CEO of Third Point Re, speaking at The Road Ahead, Ernst & Young’s annual review of the property/casualty market held in Hamilton, Bermuda, this week.

Berger was joined on the panel by David Cash, CEO and president of Endurance; Brian O’Hara, former CEO and chairman of XL Capital; and Pete Cangany, partner and insurance sector leader, financial services at Ernst & Young. He said that regulatory measures following the financial crisis and poor investment returns were placing increasing pressure on the industry and encouraging capital into the alternative space. “Sidecars and unrated market-facing cat writers simply don’t obey the same rules,” he said.

Cash added that greater emphasis by regulators on capital management has reached the point that in some instances business decisions are being taken to reflect capital requirements. The connection between underwriting and capital management has grown increasingly close, he said, with underwriters increasingly responsible for both underwriting risk and protecting the underlying balance sheet.

He said that while regulation has brought many benefits to the industry it was increasingly too cumbersome. “There is a certain amount of regulatory and rating agency fatigue at this point.” Regulatory measures that have constrained capital, limited investment returns and encouraged alternative plays into the reinsurance space, are certainly disheartening to rated players, he said.

Cash said that the industry is grappling with regulatory demands on quality of capital and the need to eke out more returns on the asset side of the balance sheet. While typically 90 percent of the assets of a rated reinsurer are in highly-rated fixed income assets, Cash said companies are looking at ways to maximise returns on the remaining 10 percent, which has traditionally been invested in equities, commodities and alternates. He said companies were experimenting with investment strategies and seeking investment managers to satisfy a growing demand for increased investment yield.

But Berger cautioned against more traditional players pursuing aggressive investment strategies, something that Third Point Re – with the backing of New York-based hedge fund Third Point – is itself adopting. He said that considering levels of leverage in the industry, traditional players would find it difficult to do this. Even experimenting with ten percent of the asset side of the balance sheet could prove costly for some, said Berger.

O’Hara concurred that now is a difficult time for the industry on the asset side of the book. As he explained, in today’s zero interest rate environment there is no investment income to be made, with the focus now entirely on underwriting. He suggested that re/insurers explore alternatives, with O’Hara citing direct lending as a potential opportunity as banks have withdrawn post-crisis.