Smaller players will increasingly use ILS

One of the hottest topics at Monte Carlo this year will undoubtedly be the growing influx of third party capital into the collateralised reinsurance market and the many challenges this presents for traditional reinsurers.

That is the view of William Pollett, president and chief executive of Blue Capital Management, the investment management company specialising in reinsurance-linked investment products which has a partnership with Montpelier Re and owned by Montpelier Group.

And he argues that the most important change occurring in this market is around the fact that smaller players are also increasingly using such markets.

“Although many of the top 30 global buy- ers of catastrophe reinsurance, who typically purchase more than one billion dollars of limit per event, have been trading with alternative markets for over a decade, we are now seeing smaller insurance groups, who in the past would not have sought collateralised protection, also considering such markets in order to reduce the credit risk in their reinsurance programmes,” he said.

He says there are a couple of trends underpinning this trend: a greater desire for diversity in credit risk and a fear of the consequences of unforeseen systemic risk.

“An explanation for this trend involves two important lessons that risk managers learned from the 2008 financial crisis: first, that ten ‘A’ rated counterparties provide a better credit risk profile than two ‘AAA’ rated counterpar- ties and, secondly, that there is the potential for systemic or contagion risk across all rated counterparties in the most extreme scenarios,” Pollett said.

“This accelerating trend leaves traditional reinsurers who lack a collateralised product offering for their clients at risk of missing significant business opportunities.”

He adds that a gap is emerging around the expertise companies have in this area. While large multinational insurers are already comfortable dealing directly with alternative capital markets through products such as catastrophe bonds, ILWs and collateralised reinsurance, many of the smaller players are still uncomfortable trading with products and counterparties with which they are unfamiliar.

“They are often concerned about the counterparty’s long-term commitment to the space, an important consideration for smaller insur- ance companies who rely on reinsurance to enable them to trade forward following a significant catastrophe event,” Pollett said.

“Past experience has shown that alternative capital markets can disappear as quickly as they appear, often due to circumstances unrelated to underwriting performance, including investor redemptions. In addition, the basis risk that index triggered instruments introduce is often unacceptable to smaller buyers.”

He says that for Blue Capital, the top 30 global reinsurance buyers are not its primary target. “Instead, we focus on trading with smaller insurers; typically regional companies in the US and other developed reinsurance markets who write business in a localised geographic area.

“As these companies seek to diversify their reinsurance credit risk with indemnity-based collateralised protection, Blue Capital is able to meet this new demand while allowing them to trade with a counterparty they have known and trusted for years.”

Blue Capital seeks to develop long-term relationships with these cedants, he says, resulting in a portfolio that will renew a significant portion of its business each year.

“As a specialist property-catastrophe reinsurer, Montpelier is committed to the space and has a strong track record of paying claims promptly. As part of the Montpelier Group, Blue Capital, unlike the majority of collateralised markets, is set-up to provide a full quoting service on traditional indemnity based reinsurance placements.

“Importantly, our brokers and clients also understand that ‘not all collateral is created equally’, and recognise the value of the capi- tal against which we underwrite, such as Blue Capital Global Reinsurance Fund’s permanent capital base, which is not subject to investor redemption.”