Strong investor demand for alternative reinsurance instruments is set to continue due to the comparatively high potential returns of catastrophe risk through cat bonds and sidecar investments and the lack of correlation between catastrophe losses and returns on other major asset classes, according to a new Fitch Ratings report.
“The convergence of the reinsurance and capital markets is likely here to stay and should continue to grow in the near term,” said Brian Schneider, co-head of reinsurance at Fitch Ratings. “Powerful economic forces have driven increased acceptance and use of capital market alternatives to traditional reinsurance.”
Guy Carpenter & Company has estimated that capital from the alternative markets currently totals a meaningful $45 billion, or approximately 14 percent of the global property catastrophe reinsurance limit, up from only eight percent in 2008. Increased investor demand has reduced spreads in many alternative reinsurance products, meaning pricing is very competitive with, and even below, the rate for some traditional reinsurance coverage.
According to Fitch's report, one area of uncertainty is how investors would react to a large unexpected catastrophe loss, or higher risk spreads, either of which could cause investors to pull out of these instruments. Fitch considers this risk to be higher for hedge fund capital, as pension funds tend to have a long term investment outlook and more diversified risk exposure.
Alternative reinsurance brings mixed benefits to reinsurers' credit ratings and financial strength, in Fitch's view. It can be used to manage reinsurers' exposure and capital and serve as a source of fee income. However, it also represents competition for traditional reinsurers that, in conjunction with the strong overall capitalization of the reinsurance industry, has noticeably dampened reinsurance pricing, according to Fitch.
The report, “Alternative Reinsurance 2013 Market Update,” is available at www.fitchratings.com.
Victoria Spears
Victoria Prussen Spears is senior vice president of Meyerowitz Communications Inc., a law firm marketing communications consulting company. A graduate of Sarah Lawrence College and Brooklyn Law School, Ms. Spears was an attorney at a leading New York City law firm before joining Meyerowitz Communications. She may be contacted at [email protected].