Property catastrophe reinsurance is causing a feeding frenzy for investors as they seem extremely willing to plunk their money into an alternative investment that does not correlate with their other portfolio bets.
The tens of billions of dollars flowing into the reinsurance industry are being funneled into securities including catastrophe bonds and other insurance-linked reinsurance investments. This bountiful capacity augments traditional sources in the venerable reinsurance industry, although even reinsurers are creating the collateralized securities and selling them to investors. For buyers—primary insurance companies the world over—the lines are blurred insofar as who is taking the reinsurance risk.
While some industry observers see the new capacity as a paradigm shift in the fundamental business of reinsurance, others point out that catastrophe bonds have been around since the mid-1990s, not that they represented a sea change. What makes today different from then is the huge interest in this investment alternative, which is predicated, in large part, on the dismally low interest rates offered investors on more traditional investments like bonds.
For personal and commercial buyers of insurance, this vast reinsurance pool promises good sailing ahead, in the form of potentially lower pricing on a range of insurance products. While many other factors come into play in primary insurers’ underwriting processes, the ability for to pass on a portion of these risks to reinsurers at a competitively lower price is sure to have a positive effect on premiums now and into the near future.
Already, the current insurance policy renewal season is seeing this capacity play out to the benefit of risk managers. “Absolutely the competition all this capacity is creating in the reinsurance market is having an effect on pricing,” said Lara Mowery, managing director and head of global property specialties at reinsurance broker Guy Carpenter. “There are a lot of factors that go into what makes up a reasonable, actuarially sound primary insurance price, and the costs to the insurance company to manage its overall risk profile is certainly one of those components. For primary insurers, there is no question that this is a buyer’s heaven,” she said.
Billion Dollar Gambles
Approximately $50 billion is now invested in collateralized reinsurance securities, the lion’s share in property catastrophe reinsurance, according to James Vickers, chairman of reinsurance broker Willis Re International in London. “This all started in the mid-90s, but in the last year or two we’ve really seen a significant influx of capital,” Vickers says.
Bryon Ehrhart, CEO of reinsurance intermediary Aon Benfield of the Americas in the Chicago office, estimates this volume a bit less at about $45 billion, but predicts this capacity is less than a third of what it will become. “Over the next five years, I would estimate that another $100 billion will flow on top of the $45 billion in there today,” he projects.
Virtually all this securitized reinsurance is assembled offshore, capitalized in Bermuda, the Cayman Islands, and other hospitable regulatory climates. The money is secured in collateralized trusts, there for the taking when primary insurers pull in their cessions to address losses as part of their reinsurance treaties.
Roughly 70 percent of the money in collateralized reinsurance comes from pension funds, with the rest a mix of high net worth private investors, life insurance companies and endowments. There’s a sprinkling of hedge fund money and sovereign funds in there, but nothing to sneeze over, the observers contend.
Obviously these developments pose a common sense question—why would anyone invest in the whims of Mother Nature, particularly in the aftermath of such highly-publicized disasters as the Japan earthquake/tsunami, Superstorm Sandy, and the massive floods in Thailand in 2011?
Part of the answer is the protracted low interest rate environment. “Following the financial crisis, interest rates plummeted and have barely budged since, creating not much in the way of investing opportunities,” said Ehrhart. “Pension funds are finding little to do with their money these past four or five years, and this is a sector with $4 trillion in assets. Collateralized reinsurance is simply paying more than fixed income securities are paying.”
Robert Hartwig, president and chief economist at the New York-based Insurance Information Institute, shares this view. “Pension funds and other large pools of investable cash are searching the world over for areas in which to make investments to overcome or compensate for the low-yield environment in traditional investments, such as corporate and government bonds,” Hartwig said. “Collateralized reinsurance is serving that purpose.”
Another factor explaining the robust investor interest is the two-decade history of catastrophe bonds, giving investors peace of mind that this isn’t some newfangled, untested financial concept. “Investors have been experimenting with catastrophe risk since 1993,” said Brad Kading, president of the Association of Bermuda Insurers and Reinsurers, in Hamilton, Bermuda. “Our sense is that the experiment is over and pension funds, in particular, have decided this is definitely a market they want to be in.”
Finally, the lack of any correlation with other investments has made property catastrophe reinsurance a great diversification play for pension funds and other investors. “You can’t get away from the diversifying benefits of this class,” Vickers said. “As an asset class, [collateralized reinsurance] is completely uncorrelated with any other form of investment.”
Hartwig concurs. “Insurance-linked securities are attractive to investors because they lower the volatility of a portfolio, all things being equal,” he says. “Whatever happens to interest rates, equities or other more traditional investments, performance-wise, has nothing to do with whether or not a Class 5 hurricane hits New York.”
True enough, but what if that Class 5 storm does smack into the Big Apple—will the investors stick through thick and thin? Kading is optimistic. “In my view, they’re here to stay,” he said.
He said the recent spate of large-loss natural disasters were the key test in this regard. “Investors lost money on catastrophe bonds that were underwater,” Kading explains. “Whether or not they could live through the loss of their capital, which has now happened on at least two bond issues, and return (to the market) was the test. Obviously, they did.”
Hartwig is less sure the interest will remain high for all investors. “In a worst case scenario, meaning an economic environment where interest rates rose sharply higher and several large scale catastrophe losses triggered numerous securities for payout, were that to happen simultaneously would some of this capital exit the system? Yes. Would it exit completely? No.”
Vickers seems to agree with this stance, but he says the fact this market has matured indicates it is not going away any time soon. “The challenge really is not capacity, but demand,” he said. “Will primary insurers need more reinsurance as time goes by or possibly less? One would think the answer is more, given the expanding need for insurance in many emerging markets. Many governments are privatizing formerly government-owned businesses, which also increases demand.”
These new insurance buyers may get a deal that veteran buyers did not—stable insurance prices immune to the industry’s historic, knee-jerk market cycle. Only time will tell.