CHICAGO — Alternative capital sources and convergence of capital markets with the insurance and reinsurance markets have become permanent factors that may affect pricing cycles in the future.
Beginning with Hurricane Andrew in 1992 and through the Sept. 11, 2001, terrorist attacks and Hurricane Katrina in 2005, the pace with which capital comes into the reinsurance market after a catastrophe has accelerated and its diversity has increased, said Edward Torres, director of capital market reinsurance solutions at PartnerRe Ltd. in Greenwich, Conn.
“This is beyond the inflection point of convergence. The alternative capital is going to be the capital,” said Donald M. Callahan, managing principal at Vanbridge L.L.C. in New York
Michael J. Millette, managing director of structured finance at Goldman Sachs & Co. in New York, said traditionally there have been two insurance market cycles: the primary property/casualty hard/soft market cycle and an event-driven cycle in the reinsurance market.
The latter likely resulted from the absence of vehicles that allowed capital to flow easily in and out of the reinsurance markets, Mr. Millette said, something that's changed with the convergence of the capital markets and reinsurance markets. Consequently, he said, that cycle is “probably going to recede.”
As for the primary property/ casualty market cycle, “I don't think the convergence markets have chipped away at that yet, but I think that they could,” Mr. Millette said during a discussion by industry experts at the April 8 “What's Ahead for Insurance M&A and Corporate Finance” conference presented by Chicago-based law firm Mayer Brown L.L.P.
Asked whether the new capital will stick in the insurance and reinsurance market, Mr. Millette said, “We think the pension funds and endowments are a very sticky sector” because those investors are in the market to add assets that are uncorrelated with other investments. The same is mainly true for high-net worth individuals participating in the market, he said.
“This is an exciting and also difficult time for reinsurance companies,” he said, with reinsurers enjoying more variety of markets in which to take on and lay off risk.
“Reinsurers now have a very rich set of instruments,” Mr. Millette said. “We have reinsurers buying interest in hedge funds, and we also have reinsurers creating reinsurance risk to lay on top of hedge funds.”
“But it's disconcerting because it creates a lot of chaos,” he said. “It also draws a lot of lower-cost capital into the industry,” forcing reinsurers to evaluate risks quickly.
Asked about the merger and acquisition implications of alternative market capital, Mr. Callahan said, “It depends on the pool of capital and what they're going after.”
“I think partners who can bring a cheap cost of capital to experts in the insurance space are going to start to link up,” he said. That activity “will start to have an incremental effect” on pricing and capacity in the market, he said.
Meanwhile, the casualty convergence market likely will take time to develop and faces limitations such as the lack of a “quick exit strategy” for investors, Mr. Torres said. “But if there's a long-term view, I think we'll see some.”
For casualty, “the tail is very difficult because most capital market instruments are collateralized,” Mr. Millette said. Since casualty risks can stay open for decades, “that makes it very difficult.”
In addition, “you've got to decide when to sue and when to settle, when to pay slowly and when to pay quickly,” he said. “That's very hard to package into a bond.”