There were some significant in-laws missing from the industry's "family reunion" this year—the growing number of investors flooding the property-catastrophe market with alternative sources of capital.
But while these newcomers may have been out of sight, they were anything but out of mind during the annual gathering of company and association leaders at the Property and Casualty Insurance Joint Industry Forum, convened last month in New York.
Indeed, a number of those in attendance addressed the impact of hedge funds, private equity firms, pension funds, and individual investors on the property-cat industry. Many of those at the forum, both among panelists and individuals chatting during the breaks, indicated that such players can no longer be dismissed as short-term interlopers likely to scatter at the first sign of a major catastrophe or series of disaster losses.
As Deloitte noted in its recent 2014 property and casualty outlook report, there has been an influx of capacity from non-traditional sources, with capital market players pouring funds into the reinsurance business in search of higher returns as well as uncorrelated risks for their portfolios.
This additional capacity has increased competition and undermined the ability of established reinsurers to maintain, let alone raise rate levels. The trickle-down effect has been generally good for consumers as primary carriers have been able to lower their own prices—at least for less risky properties—thanks to cheaper reinsurance. There is even talk that the proliferation of alternative capital sources and insurance-linked securities could eventually prompt greater consolidation in the reinsurance sector.
The buzz at the forum was that capital market players are transforming the reinsurance industry and those who depend on that sector for coverage. One panelist went so far as to suggest that alternative capital has the potential to be a game-changer, and not just for property-catastrophe coverage.
Some attendees speculated that when it comes to expanding the role of capital markets into other lines of business, a lot of smart people are probably already working to make that happen. If so, this additional source of capacity might turn out to be a very real phenomenon rather than a passing fancy.
Pension funds, sovereign wealth funds and other institutional players have a huge pool of assets to invest. Even a very small stake from the perspective of these gigantic entities could make a huge impact on the insurance market, generating a ripple effect across the market in terms of capacity and prices.
To mega-investors, insurance is a relatively small risk in the grand scheme of things, because it represents such a minute percentage of their portfolio. Insurance investments could also deliver a very healthy return if there are no major losses, certainly with low interest rates dampening enthusiasm for the bond market, and with the stock markets taking a beating of late.
Of course, the potential for a major event is a big "if" for property-cat insurance investors to take into account. A few at the forum suggested that capital market players who are so gung-ho about insurance—particularly individual investors snapping up catastrophe bonds—may be surprised to learn that insurance can be a risky business. They questioned whether this new breed of insurance investor completely understands the exposure they are hedging against. Coming off a very mild year for disaster claims in 2013, a cat bond may appear to be low-risk, when in fact such investments could evaporate in a hurry if a major event or series of losses occurs.
But I wonder whether a negative development would really scare off the majority of deep-pocketed players, given the investment alternatives. And might the opposite reaction be prompted by a major disaster loss, with many investors perhaps seeing this as not only just a temporary setback, but also as an opportunity to capitalize on the likelihood of higher prices for reinsurance?
There was also talk at the forum about the "fleeting" nature of capital-market investors. Some suggested that rising interest rates or other macroeconomic factors could prompt a number of these players to move their chips from insurance-linked securities or reinsurance entities into what they perceive to be safer bets, especially if a major event takes lots of investors to the cleaners. I'm not so sure about that. Given volatility in the economy right now, insurance may be looking like a pretty conservative investment.
One other thread of conversation involved the reaction of traditional carriers to the wave of new capital coming into the business. One panelist suggested that the additional competition was good for the industry, predicting that it should prompt not just greater efficiency, but innovation—not necessarily known as one of the industry's strong suits.
When pressed for what innovations might be spurred by the rise in capital market engagement, the responses were less than inspiring—speakers cited the increased availability of multi-year policies, coverage enhancements, and higher limits. But others at the forum were critical of these reactions, characterizing them as "same old, same old" defensive measures and anything but innovative. What else might carriers do to fortify their positions against capital market players?
The bottom line is that most reinsurance buyers and their brokers have good reason to love the market right now, and likely welcome any new sources of capacity with open arms. If nothing else, they can wield the availability of alternative capital as a two-by-four to beat down standard reinsurance rates.
I have a strong feeling that capital market players are here to stay, at least in reinsurance and perhaps in additional lines as well. But traditional carriers should still be able to set themselves apart based on their experience, their reliability, and most of all, their staying power—come what may.
Still, it wouldn't hurt to invite the "in-laws" to next year's family reunion. I'd certainly be interested in hearing from the horse's mouth at the next Joint Industry Forum what future capital market investors see when it comes to taking on insurance risks. Wouldn't you be?
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