...

Panel: New Investment Alternatives and the Effect Over

by user

on
5

views

Report

Comments

Transcript

Panel: New Investment Alternatives and the Effect Over
Panel: New Investment
Alternatives and the Effect Over
Reinsurance Capacity
James Woods
Partner, Co‐Leader of Mayer Brown Global Insurance Industry Group
+1 212 506 2390 [email protected]
3rd Reinsurance Meeting of Rio de Janeiro
April 2014
Alternative Capital and
Insurance-Linked Securities
(ILS) – a Growing Option to
Traditional Reinsurance
2
New Investment Alternatives and the Effect Over Reinsurance Capacity
New Sources of Capital / Alternatives to Traditional
Reinsurance
• Competitive market conditions and need of buyers of coverage for lower cost alternatives has given rise to non‐traditional / alternative approaches
– For example, • California Earthquake Authority (CEA) pays approximately $250 million per year for reinsurance cover • Since its inception in 1996, CEA has paid over $3.6 billion in reinsurance premiums but collected only $250,000 in reinsurance recoveries • CEA has begun issuing catastrophe bonds as a way to access alternatives to traditional reinsurance
3
New Investment Alternatives and the Effect Over Reinsurance Capacity
New Sources of Capital / Alternatives to Traditional
Reinsurance (cont’d)
• New sources of capital – non‐traditional investors in reinsurance:
– Pension funds
– Private equity funds
– Hedge funds
– Other institutional investors
• Examples of alternatives to traditional reinsurance include:
– Catastrophe bonds
– Sidecars
– Industry loss warranties
– Solvency‐ and catastrophe‐ triggered protection for re/insurers
4
New Investment Alternatives and the Effect Over Reinsurance Capacity
Growth in Alternative Capital / ILS
• Record high catastrophe bond issuances in 2013:
– According to a recent Guy Carpenter / GC Securities report:
• Approximately $7.1 billion in new property catastrophe bonds were issued, which was the 2nd highest record year for such issuances ($7.2 billion in 2007)
• Total risk capital outstanding at end of 2013 in cat bonds: $18.58 billion
• Size of outstanding catastrophe bond market accounted for approximately 16% of global property catastrophe limits purchased annually
– Record number of 29 catastrophe bond deal (according to Willis Capital Markets & Advisory (WCMA))
• Primarily in US/North America, but also in Australia, Japan and Europe
5
New Investment Alternatives and the Effect Over Reinsurance Capacity
Dramatic Growth in Catastrophe Bond Issuances
Source: Guy Carpenter / GC Securities – “Catastrophe Bond Update: Fourth Quarter 2013”
6
New Investment Alternatives and the Effect Over Reinsurance Capacity
Record Risk Capital Outstanding in Cat Bonds
Source: Guy Carpenter / GC Securities – “Catastrophe Bond Update: Fourth Quarter 2013”
7
New Investment Alternatives and the Effect Over Reinsurance Capacity
Reasons for Alternative Capital / ILS
• Diversification – lack of correlation of cat loss risk with other capital market risks (cat bonds performed well in recent financial crisis)
• Low interest rate environment – ILS has offered relatively high returns compared to more traditional fixed income investments
• Increasing demand among both primary insurers and reinsurers for risk coverage
• Growth in number of dedicated ILS funds and ILS managers
8
New Investment Alternatives and the Effect Over Reinsurance Capacity
Effects of Alternative Capital / ILS
• Greater number of ILS issuances has led to reduced costs and shorter periods for doing transactions – for instance, cat bonds can now take only approximately 8 weeks for completion
• Effects on traditional reinsurers:
– Pricing pressure on traditional reinsurers
– Certainly in property catastrophe reinsurance, but affecting other areas as well
9
New Investment Alternatives and the Effect Over Reinsurance Capacity
Response from Traditional Reinsurers to the
Competition from Alternative Capital / ILS
• Efforts to stress diverse book and ability to create customized solutions in reinsurance
• Reinsurers themselves take advantage of alternative capital:
– Reinsurers have set up their own alternative reinsurance third party capital management facilities (e.g., Montpelier Re, Validus) managing ILS funds, managed accounts and sidecars
– Reinsurers such as Swiss Re and Munich Re are major sponsors of catastrophe bonds and users of collateralized capacity via sidecars; they also arrange such transactions for clients
10
New Investment Alternatives and the Effect Over Reinsurance Capacity
Response from Traditional Reinsurers (cont’d)
• Inability for publicly traded reinsurers to earn adequate return on equity in soft market has led to excess capital and, in lieu of writing more business, share buybacks and increased dividends:
– E.g., Munich Re will undertake additional share buyback of up to €1 billion over 2014 (approximately 3.7% of Munich Re’s share capital)
– Deploying the additional capital instead of undertaking share buybacks, for instance, would further increase price pressure in the market
11
New Investment Alternatives and the Effect Over Reinsurance Capacity
Further Growth Expected in Alternative Capital / ILS
• According to JLT/Towers Watson’s March 2014 Property & Casualty Insurance CFO Survey:
– Majority of the 41 CFOs of US property & casualty insurance companies surveyed do not use alternative forms of capital currently but look favorably upon use in the future – However, these CFOs recognize that the reinsurance pricing is much softer currently (due, at least in part, to alternative capital)
– A lot of advantages to alternative capital are seen by such CFOs
12
New Investment Alternatives and the Effect Over Reinsurance Capacity
Further Growth Expected in Alternative Capital / ILS
(cont’d)
Source: Towers Watson’s March 2014 Property & Casualty Insurance CFO Survey
13
New Investment Alternatives and the Effect Over Reinsurance Capacity
Further Growth Expected in Alternative Capital / ILS
(cont’d)
Source: Towers Watson’s March 2014 Property & Casualty Insurance CFO Survey
14
New Investment Alternatives and the Effect Over Reinsurance Capacity
Concerns about and Limits of Alternative Capital / ILS
• Thus far, alternative capital and ILS has focused on property catastrophe –
so‐called peak risk perils for which it is easier to define period for investment and how to exit
• Catastrophic covers have been very well modeled (which allows for easier structuring of ILS transactions); may not be as easy to translate into other areas
• Other lines (e.g., casualty) may not be as attractive due to longer tail risks
• Higher interest rates would make other investments more appealing for investors who have looked to alternative capital and ILS for higher returns not available elsewhere
• The traditional market remains significantly larger and will always be more reliant on long term business relationships among participants than capital markets
15
New Investment Alternatives and the Effect Over Reinsurance Capacity
Concerns about and Limits of Alternative Capital / ILS
(cont’d)
• It is unknown how alternative capital sources might respond after a major event – handling and paying claims? will they remain in the market?
• Concerns of regulators – E.g., in its Financial Stability Report for the second half of 2013, European Insurance and Occupational Pensions Authority (EIOPA) expressed concerns about ILS: The significant change in the market has been driven by subdued economic growth and a low yield environment increasing demand from investors who are searching for safe investments uncorrelated with other assets. It is expected that over the next years funding will increasingly come from alternative sources…. Some concerns are that inflows of new capital into ILS, such as catastrophe bonds originate mostly from fixed‐
income investors, such as pension funds who are searching for yield, but not necessarily having the modelling capabilities and experience to fully analyse the underlying risks and complexity of the insurance market. Without adequate supervision, such developments could cause systemic risk.
16
New Investment Alternatives and the Effect Over Reinsurance Capacity
Global Presence Local Strength
17
Fly UP