Alternative reinsurance capital could be more relevant than ever: S&P

Alternative capital could be “more relevant than ever” in the global reinsurance industry and has a chance to grow, at a time when reinsurers are looking to manage their volatility more tightly and pulling-back in some quarters such as catastrophe risks, according to S&P Global Ratings.

In updating its analysis of the global reinsurance sector, S&P said that its view of the sector remains negative, but it does believe the industry may be turning a corner on profitability, with better earnings and underwriting profits expected.

But the rating agency sees a continuing and also strengthening role for alternative capital markets in reinsurance, with opportunities likely to abound for the insurance-linked securities (ILS) market as a result.

“Reinsurers will continue to struggle to sustainably earn in excess of their cost of capital due to potential heightened natural catastrophe losses, capital market volatility, increasing cost of capital, and high inflation in 2022 and 2023,” S&P explained.

Which we believe will continue to focus reinsurer minds on volatility control, making certain areas of catastrophe risk less appealing, and driving a continued pull-back by some.

S&P said that, “Reinsurers’ strategies diverge on natural catastrophe risk, and we believe alternative capital will remain an important pillar in the reinsurance space.”

So far, alternative capital in reinsurance, so that deployed by insurance-linked securities (ILS) funds, in catastrophe bonds and other ILS or collateralized reinsurance structures, has held firm, despite the flight to quality seen among investors.

Overall, ILS capital levels in reinsurance have been relatively flat at a time when traditional reinsurance capital has shrunk, while areas of the ILS market such as cat bonds have actually been growing.

As we explained yesterday, this has grown the LS market’s share of reinsurance capital, and as such the relevance of alternative or ILS capital is growing too, as it commands an increasing share of natural catastrophe reinsurance underwriting.

The growth in the ILS market is most prominent in catastrophe bonds, S&P notes, with another active year of issuance forecast, as we reported yesterday.

But challenges remain.

“All is not well in the alternative capital space,” S&P said. “The investors in the recent past have been bruised by elevated losses and the resulting trapped capital, which has created doubts in their minds about the sponsors’ (reinsurers) risk-modeling capabilities.

“As a result, there has been a flight to quality, with investors seeking to deploy capital with well-established and sophisticated risk managers.”

Although it is far from all bad at this time, given the growing relevance of ILS capital.

“We believe the role of alternative capital in the global reinsurance marketplace has been growing,” S&P explained.

Adding that, “In an environment where reinsurers are tightly managing their severity exposures, we believe alternative capital could be more relevant than ever.”

Recent loss history is also pushing an expansion of the ILS market, S&P notes, with explorations of areas of non-cat risk accelerating.

“Given the increased loss experience in the property catastrophe lines, we believe alternative capital investors could look to explore the long-tail lines to manage their own volatility exposures,” S&P commented.

But overall, the rating agency said that “the allure of alternative capital remains”, as it continues to prove out its relatively uncorrelated nature as an asset class.