Convergence capital is encouraging traditional reinsurers to consider how to remain relevant and compete with the alternative market’s cost of capital with “renewed vigour”.
That is the word from Kathleen Faries, CEO of Tokio Solution Management, who tells Bermuda:Re that it is difficult to tell whether traditional or alternative players are driving rate declines, but that in all likelihood it is a combination of alternative and traditional market rate pressure that is behind the downward trend.
“It is difficult to tell what is really driving what here”, says Faries.
The issue is set to be further exacerbated by the trend among cedants to reduce the size of their reinsurance panel, says Faries “which will mean increasing competition for signings”.
The competitive dynamic will mean that “margins will get squeezed, but with the operational overheads for rated reinsurers remaining high, and with the ever-changing and expanding regulatory environment, it will be difficult to find ways to cut expenses to the levels that may be required to compete with a lower cost-of-capital platform.”
Faries says that traditional players see their strengths in multi-year, reinstatement coverage, areas of business where collateralised players will struggle to compete.
“Collateralised markets will find it harder and harder to justify writing and collateralising multiple limits and multiple years especially as the margin compresses. These programmes are just not an efficient way to deploy non-leveraged capital,” explains Faries.
She says that there is potential for some margin compression in single shot property cat coverage, but argues that there is little scope for downward movement on reinstatement and multi-year programmes.
“We have spoken to a couple of alternative markets that struggled to find January 1 business that met their return thresholds, and have since turned capital away,” she says. This trend may help to alleviate some of the pressure traditional players are facing.
Faries says that despite these pressures Tokio Solution Management and Tokio Millennium Re have been able to maintain their underwriting discipline, while benefitting from “increased interest in leverage products like ours from investment managers looking to deploy capital into reinstatement programmes more efficiently than they can through a fully collateralised approach.”
Embracing the challenge
Faries says that while traditional reinsurers have sought to respond to the influx of alternative capital by setting up sidecars, investment management vehicles and funds in order to “boost returns through performance fees, ceding commissions, fund management, or more efficient retro buys”, issues nevertheless remain.
“With all the competition for capital and no significant change to the amount of reinsurance that is being purchased, will traditional reinsurers really be able to make up the gulf in the bottom line without significantly reducing the expense side of the equation?”, she asks.
Faries says that the answer will boil down to cost of capital differences between convergee and traditional reinsurance coverage and the ability of rated players to “maintain their return on equity in this new environment.” As to whether they will be able to do so—“the jury is still out”, concludes Faries.
capital, Faries, alternative, reinsurers, Convergence, Tokio, collateralised, Bermuda