The growth of insurance-linked securities and other alternative forms of reinsurance capital is responsible for the softness of reinsurance rates, according to “Trends in Reinsurance and Alternative Forms of Capital,” a survey of CFOs at P&C insurers by Towers Watson, a global professional services company. According to 55 percent of those surveyed, the property reinsurance market is softer than the primary market, and 34 percent said the same is true for the casualty business.

“The opportunities in the risk transfer market are just starting to be realized,” said Stuart Hayes, senior consultant, Towers Watson. “Many fresh sources of capital are seeking investments that are uncorrelated to their existing investment holdings. With risk transfer arrangements continuing to evolve, we anticipate P&C insurers hastening their participation in various structures across the risk transfer spectrum, thus complementing their traditional reinsurance programs.”

According to Towers Watson, 21 percent of CFOs said there is a need for consolidation among reinsurers, despite the threat of overcapacity in a softening market; 24 percent said consolidation will happen in the next two years; 52 said prolonged soft market conditions could drive reinsurance market consolidation in the future, and 48 percent said competing alternative capital sources could have the same effect.

Highlights form the report:

  • 90 percent said they have seen or expect to see decreasing prices due to alternative forms of reinsurance
  • 88 percent said the top benefit of alternative reinsurance options is the lower cost of capital
  • 69 percent said the complexity of the contract or deal structure is a limitation of alternative vehicles
  • 62 percent said the ambiguity related to contract triggers is a limitation of alternative vehicles

“Reinsurers need to be aware of the near-term realities of a relatively soft reinsurance market and the longer-term potential of the alternative risk transfer market,” said Matthew Ball, director, Towers Watson. “Given the increase in reinsurance and alternative capital supply, reinsurers are faced with a property catastrophe market that is likely to soften unless there are major catastrophic events with very large losses. Reinsurers may face a classic economic example of reduced demand and increased supply that drives prices lower.”
Of those surveyed, 97 percent said they use traditional reinsurance, but are not using alternative forms of capital to protect their business, Towers Watson said; 59 percent purchase reinsurance from collateralized reinsurers or would consider such a purchase; 27 percent use or “look favorably” on insurance-linked securities, such as catastrophe bonds, and hedge fund-owned reinsurers.

“The new market realities are requiring the reinsurance market to adapt and operate more efficiently. Reinsurers that realize the efficacies of alternative capital, while maintaining the relationships and platforms already built around traditional reinsurance solutions, will distinguish themselves by providing primary P&C insurers the best risk transfer solutions,” Ball said.

Less than a third, 31 percent, have been prompted to buy more catastrophe reinsurance coverage by enterprise risk management processes, but more than three-quarters haven’t changed reinsurance purchasing across various structures, Towers Watson said. “ERM programs are becoming more sophisticated, helping insurers gain an even better understanding of previously hidden risks. The resulting analyses should change reinsurance purchasing decisions,” Hayes said

Regulatory and accounting changes likely will not change reinsurance structures, either; 10 percent said they likely would make changes to accommodate the Own Risk and Solvency Assessment regulations, International Financial Reporting Standards and proposals from the International Accounting Standards Board and the U.S. Financial Accounting Standards Board.

But, pending regulatory and accounting changes could result in increased use of reinsurance, and/or its different structures; 48 percent said they expect to increase their use of catastrophe reinsurance; 38 percent expect to increase their use of aggregate loss covers; and 31 percent expect to increase their use of quota share structures. Less than 15 expect to decrease their use of aggregate loss covers and aggregate risk transfer structures.

“Once these pending changes take effect and their impact on capital requirements are better understood, more significant changes in reinsurance purchasing decisions might occur,” Hayes said.

The sixth “North American P&C CFO Survey” examines trends in the P&C reinsurance market, assesses the impact alternative capital as well as drivers and consequences of current market conditions, the company said. It includes responses from 29 CFO participants, including 31 percent commercial lines; 24 percent personal and commercial insurance; and 21 percent P&C insurance and reinsurance.

Also see Commercial Rates Increase 5% in Q4 '12

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