Alternative Capital in Reinsurance

Alternative Capital in Reinsurance

Alternative Capital in Reinsurance

By: KC Cho, Partner

Alternative capital has been, and continues to be, a hot topic in reinsurance, as hedge funds and pension funds have flooded the market with capacity, increasing competition and creating downward pressure on rates (particularly in property catastrophe). According to Aon Benfield, the amount of alternative capital in the reinsurance marketplace increased by 18 percent to reach $59 billion in the first half of 2014, accounting for more than 10 percent of total global reinsurance capital.

Low interest rates have encouraged new participants seeking higher investment returns and hedge fund investors have established reinsurance companies, primarily in Bermuda, to benefit from tax advantages. Many pension funds, which traditionally participated in the equity markets, have invested in insurance-linked securities such as catastrophe bonds. Furthermore, insurers are on stronger financial footing and more capable of retaining risk and, as a result, they are reducing the amount of reinsurance they purchase. The combination of fewer cat losses, increased capacity from the alternative markets and other factors are keeping a cap on reinsurance rates in North America and around the world. This soft reinsurance market environment will require traditional reinsurers to find ways to remain competitive. They will need to be able to spot emerging trends and innovate with regard to product design of new and creative coverages. For example, opportunities are emerging for reinsurers to develop new coverages for risks such as cyber liability, business interruption coverage and terrorism lines.

In addition, reinsurers will need to expand into new markets and address any resulting issues that would affect this growth. Besides product design and development, technology and data/analytics will be a major factor that dictates where larger-scale, traditional reinsurers have a competitive advantage over alternative capital markets backed competitors. Thus, capital modeling and enterprise risk management may be an increasing area of actuarial specialty within reinsurers.

Just because a new entrant in the reinsurance market is backed by a nontraditional source, that does not mean that it cannot behave like a traditional reinsurer. Unique strategies may be employed, such as focusing more on insurance and less on reinsurance, outsourcing underwriting, having a product-oriented strategy or relying on size/scale to offer cheaper coverage. Bart Hedges, Chief Executive Officer for Greenlight Capital Re in the Cayman Islands, recently was quoted in PropertyCasualty360 as saying, “I think what is called alternative capital today could very well be mainstream tomorrow.”

Looking ahead, a recent report by S&P indicates that we should expect to see fewer but larger reinsurers in the future and that these remaining players will leverage capital markets, along with their own capacity, to provide the level of diversification of risk capital that the insurance market requires.

What will this mean for the job market?

For many professionals in the reinsurance space, alternative capital has been the most exciting “next big thing” in years. But it’s not a new concept. What is new is the growing number of players in the market. The returns are just too lucrative. Have we reached the peak, and will the shoe drop any day now? There is a long list of people who are counting on the trend not to come to a halt including Actuaries, Modelers, Underwriters, Traders, Portfolio Managers, Managing Directors and CROs, for example. They are employed by insurance companies, reinsurers, intermediaries, modeling firms, investment banks,asset management funds, large institutions, hedge funds and newly created investment management firms specializing in ils capital management.

Buyer beware that all good things could come to an end as cat bond yields may continue to drop. The newly created roles over the past few years are likely to stay, though, as the latest “alternative” in reinsurance is quickly becoming mainstream—or, dare I say, traditional.

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