$10 Billion in New Capital Enters Reinsurance Market

In the past 18 months, an estimated $10 billion of new capital has entered the reinsurance market and changed the nature of the sector's capital structure, according to “Capital Stewardship: Charting the Course to Profitable Growth,” a mid-year market report from Guy Carpenter.

According to the global risk and reinsurance specialist, the surge of “convergence capital,” in the form of catastrophe bonds, structured industry loss warranties (ILWs) and collateralized reinsurance, has resulted in double-digit rate reductions during mid-year renewals, and been driven by institutional investors seeking access to a comparably high-yielding, noncorrelated assets as part of alternative asset-management strategies. This segment of the reinsurance market now accounts for $45 billion of capacity, which is approximately 14 percent of the global property catastrophe limit purchased.

"The changing dynamics of the specialty insurance and global reinsurance markets, coupled with a market characterized by excess capital, a growing investor base, low investment returns and diminishing reserve releases, presents a unique set of challenges and opportunities for our industry," said David Flandro, global head of business intelligence for Guy Carpenter.

ILS catastrophe risk pricing decoupled from price expectations in the traditional reinsurance market as a result, Guy Carpenter said, and for the first time, some ILS products are now offering more competitive pricing than the traditional market. Despite a significant decrease in ILS pricing over the last 12 months, investor demand continues to be robust, Guy Carpenter said, and GC Securities, a provider of investment banking services to the reinsurance industry and affiliate of Guy Carpenter & Company, projected that the catastrophe bond market could reach $23 billion by the end of 2016.

Reinsurers are confronted with soft pricing and must decide how to deploy capital and generate returns to satisfy investors’ and shareholders’ expectations. The options include:

• Maintaining the status quo. Carriers could use excess capital as a buffer against future losses. By maintaining excess capital, carriers can quickly deploy funds following catastrophes, which is less time-consuming, less expensive and more certain than raising capital after such an event. However, holding excess capital can dilute returns on equity and market valuation.

• Return to shareholders. Excess capital should be returned to shareholders in periods of low-return opportunity. In the past eight years, reinsurers have returned capital when the pricing environment has softened. GC Securities said the level of capital returned to shareholders could accelerate in 2013.

• Organic growth. Organic growth is considered a low-risk but difficult strategy in the current economic climate. Excess capital and increased competition from convergence players means 2013 will likely see more risks assumed for the same, if not less, return than last year.

• Mergers and acquisitions. The concentration on growth and competiveness could stimulate more M&A activity, particularly strategic bolt-on transactions, Guy Carpenter said, adding, “The need to adapt business models to respond to these new market dynamics provides the ingredients for an increase in M&A activity.”

“Although the best capital stewards will employ a strategy that encompasses all four of these approaches, the market is increasingly turning to strategic M&A opportunities to achieve scale, global reach and a more diversified product suite in order to remain competitive,” said Des Potter, head of GC Securities, EMEA. “Evaluating the merits of each option and the interplay between them is paramount to realizing your growth objectives, and is where a trusted and informed advisor can help to identify the best route to success.”