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The use of insurance-linked securities (ILS) structures and access to third-party capital are essential requirements now for a reinsurance company to remain competitive in the evolving and challenging marketplace, according to analysts.
Mergers and acquisitions (M&A) in reinsurance has clearly evidenced the appetite of major insurance and reinsurance players to embed the access to alternative capital within their traditional business models.
ILS expertise is now seen as a key requirement, as evidenced by a number of hires over recent years where we’ve seen expertise in the capital markets side of reinsurance brought into some very traditional re/insurance companies.
Analysts at JMP Securities said that they expect we will see more M&A transactions that evidence this desire to bring ILS capabilities in-house.
They cite transactions such as Markel’s acquisition of ILS fund specialist Nephila Capital, which showed one traditional companies burgeoning appetite to become a leader in the collateralized space.
As well as examples where major global players, such as AIG and AXA, have acquired specialty and reinsurance focused units that also have their own ILS and third-party capital management expertise, Validus and XL Catlin.
“We do not see signs of it stopping, but rather believe that it will continue, due to market conditions,” the analysts explained.
“Against the backdrop of top-line and expense pressures and limited areas of growth, acquiring growth/scale or handing the keys over to another entity will likely continue to be chosen routes for some,” they continued.
They said that the Nephila acquisition by Markel will likely be the, “first of what we believe could be several ILS managers to be bought by “traditional” insurers/reinsurers.”
As traditional insurance and reinsurance firms get increasingly used to the fact that ILS is a permanent form of capacity and unlikely to dry up, they now understand it can give them an edge in terms of efficiency and a lower cost-of-capital, compared to utilising traditional reinsurance and retrocession.
They are also learning that by bringing it in-house you not only benefit from the cost-of-capital advantages, but also from the ability to earn fee income by managing and underwriting for the capital investors.
“With a property cat pricing cycle likely requiring a needle-in-a-haystack event to trigger material pricing improvement, they need to find a way to remain competitive in the increasingly commoditized market,” the JMP analysts said.
“One way to do this is to better match risk with capital, which is, in effect, what ILS does.”
The analysts believe that the hybrid model so well demonstrated by the likes of RenaissanceRe is a model for the future.
“We now believe it is required to remain competitive in the market,” the analysts concluded, adding “If a reinsurer does not have an alternative/ILS capital operation of reasonable scale, in our view, it should reconsider its place in the market.”
Of course we’d support that view, believing that access to the most efficient forms of capital is key and that reinsurers are destined to operate multiple balance-sheets, capitalised by different sources, as they continue to adjust to the new reinsurance market environment.
From the investors point of view though, there remains a demand for independent ILS investment managers as well and reinsurers need to be careful to manage their conflicts of interest or a venture into ILS could turn out a negative experience for them.