Alternative sources of reinsurance such as collateralized reinsurance, catastrophe bonds and ILW contracts were not considered a major threat to the traditional reinsurance market in the early days of their development. But today, it is clear that these new forms of capacity are a force to be reckoned with.
This is most clearly demonstrated by the competition for Property Catastrophe reinsurance renewals in June and July 2013. This is the time of year when most of the Florida and Gulf Coast catastrophe programs are renewed. These are also the programs that generate a substantial return for reinsurers because of their high probability of loss from hurricanes.
Growth of the Alternative Reinsurance Market Twenty years ago, these alternative reinsurance products were just a gleam in the eyes of institutional investors and hedge fund managers. By 2012, this market had grown to almost $40 Billion of capacity; most market observers say that halfway through 2013, the market has now exceeded $45 Billion.
Effects on Market Pricing Traditionally, property catastrophe reinsurance underwriters have counted on the rich rates-on-line of the June and July renewals to fill their premium coffers for the year. But now we are in early July 2013, and it is clear that there has been a sea change in market dynamics.
Throughout May and June, reinsurance brokers and their clients saw substantial increased capacity offerings at very competitive prices from these alternative reinsurance providers as these markets competed for market share. The traditional reinsurance underwriters, not be outmaneuvered by these stronger competitors, responded in kind.
The end result saw clients giving firm orders at prices up to 20% below expiring on a risk-adjusted basis, and obtaining full placements at these terms with ease.
What Does the Future Hold? There is a lot of debate among industry insiders as to the long-term effects of this new capacity source. Some of the alternatives being discussed:
- Will this new capacity have the stomach to withstand the losses from a major hurricane in Florida or the Gulf Coast? Many traditionalists are hoping the hedge funds and private equity funds will head for the hills post-loss and lick their wounds. Others believe the fund managers will recognize the profit potential in a post-loss scenario and double down.
- How much bigger can the alternative reinsurance market get? The barriers to entry and exit of the catastrophe reinsurance market are at an all time low. Some observers calculate the alternative reinsurance capacity now represents almost 15% of total worldwide catastrophe capacity. Some estimate that this capacity could grow to 50% of worldwide capacity, and possibly even more.
- Does this new capacity signify the end of the reinsurance pricing/capacity cycles as we know it? Past market cycles have been flatter due to the influx of new reinsurance capacity following every recent major disaster.
- The reinsurance market has become more and more commoditized; some experts predict we may see catastrophe reinsurance traded on electronic exchanges just like equities or commodities. There is no doubt that the personal relationship between a cedant and his reinsurer is no longer as important as it once was.
The answers to these questions will become apparent as this trend plays itself out. I don’t know about you, but I’m looking forward to seeing what happens next.