The great challenge and opportunity facing the reinsurance industry is not the $45 billion of alternative capital that has entered the industry in the last decade. It is in managing the value that can be created through the next $100 billion that will enter the reinsurance business over the next five years.
That is how Bryon Ehrhart, CEO of Aon Benfield Americas, sums up the dynamics of the reinsurance industry. “We estimate that there is $510 billion of capital in the industry right now and that some $100 billion of that—around 20 percent—will be refinanced as a result of this alternative capacity in the next five years,” he said.
"The formation of asset management divisions will allow reinsurers the opportunity to accept asset management mandates from investors."
To incorporate the additional $100 billion of alternative capital flows, reinsurers will engage in three broad categories of transactions with investors: insurance-linked securities (ILS or cat bonds) to lower the cost of underwriting capital supporting peak tail risks; sidecars to lower the cost of underwriting capital across the risk spectrum; and the formation of asset management divisions that will allow reinsurers the opportunity to accept asset management mandates from investors.
Many classes of insurance risk are likely to be interesting to alternative investors—not just catastrophe risks. Traditional reinsurers have a distinct advantage to source these additional risks for investors and to create suitable structures.
“Reinsurers will lead the diversification into new risks—that is inevitable,” Ehrhart said. “People say that investors will not touch ‘unmodelled’ risks but the reinsurance industry has been underwriting these risks with knowledge and consideration of the losses for some time. Investors will be smart to align with experienced reinsurers.”
The new lower-priced catastrophe bond capacity has tempted new issuers into the market. Ehrhart says this is largely due to the more competitive pricing available but he also acknowledges that such first-time users of cat bonds, for example, have had almost 20 years of observing the steady growth of the cat bond market and have become progressively more comfortable with the product and the process.
He now sees the catastrophe reinsurance market as being in a post-convergence phase. “It is clear now that these new lower-cost capital sources need to be incorporated into the reinsurers’ capital structure to allow them to remain competitive,” Ehrhart added.
"Reinsurers have an unprecedented opportunity to lower their cost of underwriting capital."
“A $100 billion refinancing is a huge structural change,” he said. “But it is necessary in a postconvergence world. Reinsurers have a strong value proposition and they will simply learn to package risks that take advantage of what can be a lower cost of underwriting capital for them in many areas. It is only natural that they use this in that way.
“Reinsurers have an unprecedented opportunity to lower their cost of underwriting capital and improve their value proposition to cedants.”
Bryon Ehrhart is CEO of Aon Benfield Americas.
Bryon Erhart, Aon Benfield, alternative capital