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'Alternative' capital closer to mainstream

Insurers embracing ILS, cat bonds

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Rather than diverging, catastrophe bonds and other insurance-linked securities are becoming more like traditional reinsurance.

“The lines are blurring between the alternative capital and traditional reinsurance,” said Taoufik Gharib, a director and reinsurance specialist at Standard & Poor's Corp. in New York.

In a report this month, S&P said the alternative capital markets are converging in terms of coverage and terms and conditions offered by standard reinsurance. Further, it said, the reinsurance sector is adapting by providing innovative solutions and lowering prices.

“The cedents, the primary insurance companies — at least the ones we deal with — are increasingly using more alternative solutions such as catastrophe bonds or collateralized reinsurance in their reinsurance towers,” Mr. Gharib said.

“What's happened over the last five years and really accelerated over the past two is that the wordings between coverages have converged to a point where they're substantially similar,” said Paul Schultz, CEO of Aon Securities in Chicago. 

Citing indemnity cat bonds marketed in the past two years, “the wording is substantially similar or identical to the wording available in the traditional market,” Mr. Schultz said. “At the end of the day, the solutions are starting to look pretty close.”

“A lot of the language is similar because the coverages are quite similar,” said Michael Pinsel, a partner in the insurance and financial services group of Sidley Austin L.L.P. in Chicago and head of its property/casualty alternative risk transfer practice.

“The terms of the coverages provided are quite similar because they often cover similar risk,” Mr. Pinsel said, adding that reinsurers' use of collateral to ensure funds for claims, is a principal difference.

At year-end 2014, alternative capital reached $64 billion, constituting about 18% of the property catastrophe capacity worldwide, up from $59 billion in 2013, Mr. Gharib said.

“Right now, the overall market isn't really growing, so the growth in alternative capital is taking market share” from traditional reinsurance, Mr. Schultz said.

“I definitely think there is more interest and that it is more widely accepted to use alternative structures, especially on the collateralized reinsurance side and private catastrophe bond side,” said Marens Josefs, a director at Standard & Poor's Insurance Ratings in London and one of the authors of the report.

“It seems to be getting more akin to what you can get in the traditional market,” he said.

One recent change in catastrophe bonds has lowered the threshold of coverage to named storms from hurricanes, Ms. Josefs said.

Jennifer Montero, chief financial officer of Citizens Property Insurance Co. in Tallahassee, Florida, said that was the case with its most recent cat bond.

Last year, Citizens issued the largest catastrophe bond ever, Everglades Re, at $1.5 billion covering hurricane losses. When it returned to the market this year for $300 million in cat bond coverage, it was changed to a named storm trigger from a hurricane trigger, she said, which effectively broadened the terms of the cover.

“The catastrophe bond makes up over half of our risk transfer program for 2015,” constituting $2.1 billion of a $3.9 billion program, Ms. Montero said. 

“Accessing both markets provides investor diversification and the competitive pricing, and it's relatively easier to get the multiyear access in the catastrophe bond arena,” she said. “We do have multiyear in our traditional side, but it's two limits over three years.”

“Are people in the industry more comfortable and more accepting of this as part of the industry? Absolutely,” said Bill Dubinsky, head of ILS at Willis Capital Markets & Advisory in New York. “Clearly we're seeing more end investors look at the space.”

Alternative structures, such as sidecars, are easier to wind down than a traditional reinsurer, Mr. Gharib said.

“It's easier to put a sidecar in runoff than a company,” he said.

The S&P report also noted an uptick in private transactions.

“We see a lot more use of private transactions these days than we have in the past,” Ms. Josefs said, citing recent activity to lessen longevity risk for corporate pension sponsors.

“We've seen a lot of deals being done privately in the U.K. and Netherlands,” she said.

“When we have critical scale as far as the size of the sector, that's what gets a lot of these end investors interested,” said Mr. Dubinsky. 

“If you have $100 billion under management, a sector where you can put only $10 million to work is not practical. If you can put $100 million or more to work, which is now the case, then pension funds will look at it,” he said.