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Reinsurance market investors search for opportunities beyond U.S.

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Reinsurance market investors search for opportunities beyond U.S.

Falling returns on insurance-linked securities for peak U.S. catastrophe zones is one factor that may prompt specialist funds and other capital providers to diversify into European property catastrophe risks as well as other business lines and territories.

While commentators believe that alternative capital will remain in the insurance and reinsurance sector, the extent to which that capital will seek to diversify depends in large part on the nature of the capital provider and the ability to model the underlying risks, experts say.

While they are declining for certain risks, returns are still attractive to investors, sources said, and offer them a form of diversification as their returns typically are uncorrelated with those in the wider financial sector.

According to sources, catastrophe bond issuance in the second quarter of 2014 reached $4.5 billion.

The first quarter of 2014 saw $1.4 billion of issuance, according to research by Aon Benfield Group Ltd.

“Our view is that capital is going to continue to flow into the sector, and we will continue to see changes to the way that buyers buy reinsurance coverage,” said Paul Schultz, president at Aon Benfield Securities in Chicago.

While it is not possible to say if rates for U.S. property catastrophe coverage in peak zones have reached the bottom, it is likely that Europe and Asia will be areas where ILS funds and other capital providers will show increased interest, Mr. Shultz said.

This year has seen the placement of the first indemnity-based catastrophe bond for European windstorm risks, a $263 million bond providing Trieste, Italy-based Generali Group with per-event coverage for European windstorms over a three-year period.

If buyers see the terms and conditions — as well as the price — of the bonds as favorable, this will aid development of ILS for European risks, said Mr. Schultz.

In addition, he said, cedents have a favorable view of an indemnity trigger.

“U.S. hurricane is always going to be the dominant risk” underwritten by alternative capital providers, said Maren Josefs, a credit analyst at Standard & Poor's Corp. in London.

Risks that are able to be modeled and for which there is plentiful data, such as U.S. windstorm, are deemed the most suited to ILS structures.

While large pension funds allocate a small percentage of their overall investments to insurance and reinsurance as a diversification strategy, specialist ILS funds also are looking for diversification in the perils, risks and geographies they underwrite, Ms. Josefs said.

Aside from peak U.S. property catastrophe zones, reinsurance buyers are exploring using ILS and other alternative capital solutions, notably for European wind coverage, said Ed Hochberg, CEO of Jardine Lloyd Thompson Capital Markets in New York, a unit of London-based brokerage Jardine Lloyd Thompson Group P.L.C.

“At this point, it is probably more exploration than execution, but I would expect that to change over the next 12 to 18 months,” Mr. Hochberg said, as buyers and sellers become more comfortable with covering different risks.

It is clearly advantageous for buyers to have a variety of capital sources and products from which to choose, he said.

In areas where reinstatements are not required, it is easier and less expensive for capital market participants to underwrite coverage.

In the early days of ILS, funds typically were focused on returns, said Mr. Hochberg, while now they are seeking diversification.

In addition, rates-on-line for some coverage outside peak U.S. property catastrophe zones have been low and not hugely attractive to ILS players, Mr. Hochberg said.

But now some funds want more balanced portfolios by, for example, becoming involved in writing less volatile business outside U.S. peak zones, Mr. Hochberg said.

While capital providers likely will seek greater diversification in areas such as European wind risk, such coverage will be modelable and”data-driven,” said Patrick Hartigan, leader of the treaty reinsurance team at Beazley Group P.L.C. in London.

While floods are a huge risk for all buyers, the lack of data on Europe and the difficulty modeling the risk make it a less viable area for capital markets players, he said.

Since catastrophe rates have fallen for high-risk areas such as Florida, with consecutive years of 15% to 20% rate decreases, there is greater impetus for funds to looks outside those peak zones for diversification and profit, Mr. Hochberg said.

Many reinsurance buyers in Europe, especially medium-size buyers, have longstanding relationships with traditional Continental European reinsurers that they want to preserve, he said.

In addition, many European cedents have felt uncomfortable about entering into contracts with unknown counterparties, a contrast to their often long-term relationships with traditional reinsurance providers, said Mr. Hartigan.

This could be one factor that has constrained newer capital providers' ability to underwrite coverage in Europe, Mr. Hochberg said.

But the upcoming Solvency II rules for insurers and reinsurers in Europe, which are slated to go into effect in 2016, will require companies to examine how they handle their credit risks and may result in some considering the use of ILS products to mitigate them, he said.

While Solvency II may not be the principal driver for buyers looking to capital markets for coverage, it may play a part, Mr. Hartigan said.

Solvency II's recommendation that companies have protection up to one-in-200-year levels may prompt some to access capital markets — which can provide that level of coverage — to meet that, he explained.

As well as geographical diversification into Europe, ILS capital providers likely will start to write different lines such as casualty or primary insurance, Mr. Shultz said. For investors in ILS, underwriting classes such as casualty will increase their diversification, while for buyers it will give greater choice, sources explained.

Capital providers also may seek to diversify into liability coverage or aviation lines on which there is good historical loss data to design coverage, Mr. Hochberg said.

While a perceived lack of quality data has held back development of ILS in some areas, recent cat bonds for European and Japanese risks with indemnity triggers suggest that investors are willing to take on those risks, Ms. Josefs said.

But S&P would “sound a note of caution” about the extent to which all investors fully understand those risks, she said.

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