Money WavePerhaps the good news for U.S. property catastrophe reinsurers is this: the influx of third-party capital to their sector has slowed. The reality remains, however, that its growth continues to outpace traditional reinsurance capital and this continues to affect the broader market, Standard & Poor’s concluded in a new report.

“Third-party capital, also called alternative capital, has made an indelible footprint in the property/casualty reinsurance sector, especially in the property catastrophe reinsurance market,” Standard & Poor’s said.

The ratings agency noted that alternative capital has already doubled its market share in a relatively short period of time. While it was just 5.4 percent of the broader market in 2007, its market share reached 12.8 percent at the end of the 2016 first half.

S&P noted that the shift came, in part, from governments’ soft monetary policy since the 2008 economic crisis that hit the U.S. and markets around the world. One result: more than $10 trillion of outstanding market yields are negative.

Alternative capital still keeps growing in the face of slowdown in total capital, despite an overall slowdown. Total global reinsurer capital experienced a five-year compound annual growth rate of 4.4 percent as of the end of 2015. But as Standard & Poor’s explained, total capital declined in 2015, dipping 1.7 percent versus the previous year to $565 billion.

This trend stems from a 3.5 percent decrease, year-over-year, in traditional capital due in part to share buybacks. At the same time, however, alternative capital grew 12.5 percent over the same period, and total capital reached $585 billion as of the 2016 first half.

Adapt or Risk Being Left Out

If this trend continues, however, reinsurers that offer capacity with no other added value are at risk of being left out.

“Reinsurers that provide capacity with no other added value are at the highest risk of being marginalized and will see their competitive position weaken, which could ultimately have a negative effect on our credit ratings,” the Standard & Poor’s report noted.

One reason why: As Standard & Poor’s stated, third-party capital continues to heighten competition in the reinsurance market. This, in turn, further depresses margins, “making reinsurers’ earnings and potentially their capital more vulnerable to large catastrophe losses than in previous years.”

The key to avoiding marginalization could very well be for insurers to adapt and embrace new market conditions, Standard & Poor’s said. One way might be continued use of sidecars.

“To adapt to the increasing importance of third-party capital, more reinsurers are harnessing this influx of capital through sidecars,” Standard & Poor’s said in its report. “Managed by reinsurer sponsors, sidecars allow investors directly to take on reinsurance risk underwritten by the sponsor through debt or equity in the sidecar vehicle.”

S&P pointed out that the reinsurer sponsor “typically collects management and performance fees for sourcing and underwriting the business placed in sidecars.” But beyond those fees, “sidecars may back product offerings with risk/reward profiles that fit investors’ risk preferences better than the reinsurers'”

As well, Bermudian reinsurers are rethinking their strategies as the alternative capital situation continues to grow. Standard & Poor’s noted that they harnessed the alternative capital sources by creating “third-party capital vehicles of their own.” By doing so, Standard & Poor’s said that companies could grow their market footprint “while earning more fee income.”

But that fee income won’t replace lost underwriting profits. Because of this, reinsurers have seen consolidation, and that trend is likely to continue, Standard & Poor’s said.

Source: Standard & Poor’s