Alternative reinsurance capital no longer a ‘naive’ capacity: Moody’s

Alternative capital, once referred to by traditional reinsurers as “naive” capacity, is now extensively used by reinsurers to lower their own total cost of capital, manage peak risk exposures, improve risk-adjusted returns and enhance their overall competitive positioning in the sector, says  Moody’s Investors Service.

The alternative capital market experienced rapid growth between year-end 2011 and year-end 2017, becoming a “firmly embedded and growing” component of reinsurers’ risk and capital management.

According to Moody’s latest report, alternative reinsurance capital, in the form of collateralised reinsurance, catastrophe bonds and reinsurance sidecars, grew from approximately $28 billion at year-end 2011 to around $97 billion at Q2 2021. It now constitutes roughly 15 percent of total reinsurance capital.

This additional supply of risk capacity drove pricing for US property catastrophe reinsurance, which was historically reinsurers’ most profitable line of business, down by more than 30 percent during this period, it noted.

However, in order to mitigate the impact of eroding profit margins, reinsurers' business models evolved to increase their utilisation of retrocessional reinsurance as a way to lower their own total cost of capital, manage their own risks and optimise their risk-adjusted return profiles.

From a credit perspective, Moody's views this increase largely as a positive development, but highlighted a number of significant risks that need to be carefully managed.

The biggest risk is the inability to maintain access to sufficient retro capacity to support clients following very large catastrophe losses or if capital markets seize up, forcing a retrenchment of the business that would disrupt and damage the core reinsurance franchise, it noted.

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