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Reinsurers embrace growing number of alternative funding methods

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MONTE CARLO, Monaco — With increased alternative reinsurance capacity from financial markets entering the reinsurance sector over the past year, executives at the Rendez-vous de Septembre gathering discussed its effect on the market during last week's meeting in Monte Carlo, Monaco.

The reinsurance industry largely regards the ongoing influx of capital by alternative funding means such as catastrophe bonds, sidecars and collateralized reinsurance as a positive, said Paul Schultz, president of Aon Benfield Securities, a unit of London-based Aon P.L.C.

Once regarded as esoteric and risky, capital raised for insurance-linked securities provides balance to the reinsurance market and likely will not cannibalize traditional reinsurance, Mr. Schultz said.

“More or less, the reinsurance market has embraced this rather than viewing it as a threat,” Mr. Schultz said.

Speaking at a media briefing, Michael D. O'Halleran, executive chairman of reinsurance intermediary Aon Benfield, said alternative capital now constitutes roughly 15% of the reinsurance market.

“It's not alternative capital anymore; it's part of who we are,” Mr. O'Halleran said.

The speed at which alternative capacity can enter the market in the wake of disasters is vital to the industry's ability to absorb large losses, Mr. O'Halleran said. “The traditional reinsurance market would not be able to reload as fast without it,” he said. “We would be in much more dire straights.”

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David Priebe, vice chairman of reinsurance intermediary Guy Carpenter & Co., a unit of New York-based Marsh & McLennan Cos. Inc., said that as of midyear, $34 billion in capacity in reinsurance and retrocessional markets came from nontraditional sources. The growing competition in the nontraditional market also has lowered its price relative to traditional reinsurance, helping blur the once-stark distinction between the two markets among buyers.

“The market has converged,” Mr. Priebe said. “Price differences have narrowed, new markets are more competitive and providing large amounts of capacity, basis risk is better understood, execution of transactions are smoother, quicker and cheaper.”

Steve Hearn, chairman and CEO of Willis Global, which includes most of the reinsurance brokerage operations of London-based Willis Group Holdings P.L.C., said that while the price difference between ILS products and traditional reinsurance has narrowed, traditional reinsurance remains less expensive. He added that while most reinsurance buyers now review the nontraditional reinsurance products as they consider their options, “whether they buy them or not is another matter.”

Moreover, Brian Schneider, a senior director at Fitch Inc. in Chicago, said although alternative reinsurance products have helped hold down pricing of traditional reinsurance this year, cat bonds in particular remain more expensive than traditional coverage.

Nonetheless, Mr. Schneider said alternative reinsurance products are a permanent part of the market.

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Mr. Schultz agreed, noting that the use of insurance-linked securities as a source of capacity is likely to grow as primary insurers look to diversify their reinsurance programs.

Indeed, large buyers now view the whole range of programs that include traditional reinsurance, ILS, sidecars and other nontraditional products as part of core reinsurance or retrocessional coverage, Mr. Priebe said, adding that buyers like the access to large capacity, collateralization of protection and diversification of credit risks that nontraditional reinsurance provides.

Alternative reinsurance pro-viders are a viable option for many reinsurance buyers, said Simon Clutterbuck, a director at BMS Intermediaries Ltd., a unit of broker BMS Group Ltd. in London.

“There was a time when they were only interested in super large clients or tough clients, but we have a lot of regional clients and they are now being much better served by the alternative market,” he said.

However, Mr. Clutterbuck said fear about the permanency of alternative reinsurance vehicles persists among some buyers.

“There's more volatility and probably less longevity in the sidecar market, although, to be fair, some have been around for a long time,” he said. “In general terms, (sidecars) tend to be more interested in one-off deals than the subscription market.”

David Cash, president and CEO of Pembroke, Bermuda-based Endurance Specialty Holdings Ltd., said the difficulty of providing reinstatement provisions, which enable cedents to automatically buy additional coverage if they suffer a large catastrophe loss, is a limitation of alternative reinsurance products.

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“Most of our clients want to buy reinstatements, and it's hard for collateralized players to offer that,” Mr. Cash said. “We don't view them as a serious competitive threat, but they have a role to play in the peak risk areas where clients need to buy a lot of limit but the pricing is high, such as in Florida.”

Likewise, James Few, Bermuda-based CEO of Aspen Reinsurance, a unit of Aspen Insurance Holdings Ltd., said he expects the effect of capital market products to be concentrated in certain lines of business rather than the broader reinsurance market.

“There's a lot of talk about capital coming into the market, but much is coming from life companies and pension funds who are looking for better yields,” Mr. Few said. “They are targeting specific products, typically peak-zone retro business, and looking for a fair return.”

Fitch's Mr. Schneider said that with ample capacity in the reinsurance sector, alternative reinsurance transactions likely will diminish.