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Nontraditional, insurance-linked securities give reinsurance buyers more options

Nontraditional, insurance-linked securities markets trigger inventive securitization choices

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Nontraditional, insurance-linked securities give reinsurance buyers more options

An influx of third-party capital and improved comfort with nontraditional forms of reinsurance coverage mean that reinsurance buyers have greater flexibility and choice when putting together their programs.

Reinsurance buyers increasingly are seeking to access alternative forms of capital and using instruments such as catastrophe bonds and industry loss warranties as part of their overall reinsurance programs.

And the availability of third-party capital also is prompting competition in traditional reinsurance markets, enabling buyers to better tailor their coverage, experts say.

Insurance-linked securities markets are now more competitive, particularly for aggregate facilities using products such as cat bonds and structured industry loss warranties, said Des Potter, Europe, Middle East and Africa head at GC Securities, a unit of Guy Carpenter & Co. L.L.C., in London.

For large buyers of reinsurance, alternative forms of reinsurance coverage are attractive because they like “a diversity of risk-transfer tools,” Martyn Street, a director at Fitch Ratings Ltd. in London, said.

In addition, he said, risk-based capital regulation such as the upcoming Solvency II rules for insurers and reinsurers in Europe likely will mean that buyers of reinsurance will show increased interest in different forms of reinsurance, as a means to receive capital relief under their models.

And corporate insurance buyers are monitoring the reinsurance security of their insurance carriers, experts say.

The increased supply of reinsurance vehicles backed by private equity, hedge fund or pension fund capital has meant the pricing for the instruments offered by these vehicles has fallen during the past couple of years, said Simon Buxton, global head of reinsurance for Allianz Global Corporate & Specialty in London.

“Industry loss warranties, cat bonds and insurance-linked securities are becoming more popular,” he said. “This is because this is where prices have fallen the most.”

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Allianz Global Corporate & Specialty buys its catastrophe program from Allianz Re, the dedicated reinsurer of Allianz S.E., which uses instruments such as loss warranties, cat bonds and other insurance-linked securities, he said.

There has been an increase this year in reinsurance buyers seeking to use capital markets instruments, particularly catastrophe bonds, as part of their program, said Dennis Sugrue, a director at Standard & Poor's Corp. in London.

Cat bond issuance is expected to reach about $5 billion to $6 billion this year, he said, which would be the highest level of issuance since Hurricane Katrina struck the U.S. in 2005.

“In 2013, we have undoubtedly witnessed a step change in buyer habits when it comes to making greater use of third-party capital instruments,” said Matt Fitzgerald, managing director of reinsurance at Arthur J. Gallagher & Co. in London.

For example, he said, the $200 million MetroCat Re Ltd. catastrophe bond purchased in July by the New York Metropolitan Transport Authority to cover storm surge risk demonstrates the greater flexibility, availability and affordability of such instruments compared with a few years ago.

“This is the first time the MTA has used the insurance-linked securities markets, which goes to illustrate how the more freely available and considerably cheaper alternative of third-party capital is not only influencing reinsurance but also insurance buying habits,” Mr. Fitzgerald said.

Many reinsurance buyers are tapping alternative sources of capital for their reinsurance coverage, sources said.

For U.S. catastrophe risk, about 40% of buyers “are now buying their reinsurance from nontraditional markets,” Mr. Fitzgerald said.

Capital markets are becoming more inventive in how they create products, Mr. Fitzgerald said, making them more attractive to buyers.

For example, he said, “moves to cover all named storms rather than just hurricanes or the inclusion of variable resets for key factors like attachment points” are making the coverage offered by third-party capital products more flexible and attractive to buyers.

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The risk appetite of buyers and the “strategic purchase of reinsurance is becoming more sophisticated,” said James Vickers, chairman of Willis Re International, a unit of London-based Willis Group Holdings P.L.C.

Once cedents have decided how much capacity they need to buy, the abundance of third-party capital is “giving them more flexibility on how they manage that,” he said.

Specialty underwriters typically are able to be opportunistic about their reinsurance purchases, while larger companies that are concerned about the long-term sustainability of their reinsurance programs generally take longer to alter the makeup of their reinsurance program, he said.

However, such buyers have been able to use the presence of third-party capital as a bargaining tool with traditional reinsurers to achieve more favorable rates or terms and conditions, he said.

This is particularly pronounced for natural catastrophe-based coverages — the area where alternative capital instruments are the most well-established, Gallagher's Mr. Fitzgerald said.

For example, Mr. Vickers said, rates for many buyers fell significantly at the June 1 Florida renewals, in part because of increased competition for traditional reinsurers from nontraditional capacity.

Mark Bernacki, London-based leader of the property team at Dublin-based Beazley P.L.C., said that during recent negotiations for his company's catastrophe reinsurance coverage, it benefitted from increased competition from third-party capital by being able to combine two catastrophe reinsurance towers — one written at Lloyd's of London and one written in the United States — into one.

This resulted in “significant cost savings and provided additional flexibility,” he said.

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