Protectionism and more excess capital
Aon Benfield has just published its September Reinsurance Market Outlook report. Mike Van Slooten, head of market analysis–international at Aon Benfield, discusses some of the key findings with Monte Carlo Today.
The Reinsurance Market Outlook report mentions regulatory pressures. What are your key concerns in this area?
When we look at regulation globally, we see some jurisdictions that are beginning to show protectionist trends. This raises a certain amount of concern, as in many ways reinsurance has been the poster child of globalisation—a proven risk transfer mechanism that thrives on the free movement of capital and risk. Some of the regulatory changes that are happening have the potential to hinder that, and I feel that would be a backwards step for the industry.
Why is this important for reinsurers?
There are three key factors that affect pricing in reinsurance: losses, interest rates and market structure. When external forces affect the way the market works then that has an impact on pricing, as anything that restrains the free movement of capital and risk adds costs to the business.
There are a few examples of this trend emerging in Asia, partly spurred by regulatory changes. We generally see risk-based capital regimes as positive frameworks as they ensure that companies understand risk and hold sufficient capital against that risk. But the downside is that they tend to be introduced in a way that can make it more difficult for external capital to enter the market. Making it difficult to trade across borders adds costs to an industry that really does not need that right now.
On a more positive note, the US has verbally agreed to sign the US-EU Covered Agreement, which should create pretty much a level playing field between the two markets.
On the flipside, the US is also considering tax reforms that could affect the provision of offshore capacity.
What other challenges are reinsurers facing?
The basic dynamic is that there remains excess capital in the industry. There has been a resurgence of alternative capital entering the industry this year, which has increased competition. Reinsurers are still making money—just less than before—and in the absence of big losses, we do not anticipate any great shift in market dynamics. We do not think Hurricane Harvey is going to be enough to make much of a difference in this context.
In terms of alternative capital that has entered the industry, the activity in the catastrophe bond sector has stood out. At the start of the year, our firm was one of the most bullish in its projection that around $8 billion of bonds would be issued this year, but this figure was exceeded in the first half of the year alone.
The area that has shown real growth over the past decade has been collateralised reinsurance—around $50 billion of limit is now being purchased in this way.
What has been behind this resurgence in new capital?
There has been a general trend of institutional investors becoming interested in this space for several years, but there is something of a lag effect. It can take pension funds, for instance, up to three years to complete due diligence before investing in a new asset class.
Second, a lot of catastrophe bonds have matured this year. Many investors were keen to invest capital when they were renewed, so some increased in size and that also put pressure on pricing. A big attraction of this asset class is its lack of correlation with other investments.
The growth of this sector has had a knock-on effect to reinsurers writing business in a more traditional way as they look to deploy capital elsewhere. That means the pressure on pricing can also be felt in other lines.
Most of these investors have a long-term horizon and we believe there is a lot more capital waiting on the sidelines for a better market opportunity.
How can reinsurers react to this?
The distinction between traditional and alternative capital has blurred, and most reinsurers have now incorporated it into their own capital structures. Most have sidecars in place and use it for their own retro cover. Doing this allows them to lower their own cost of capital.
The market is making money and has done so pretty much for the past 10 years. But it’s a difficult environment and we sense that the bigger, more diversified players are better equipped to cope.
What other pressures are reinsurers facing?
The economic climate and continued low interest rates. There are now some slightly more positive signs, but we are not expecting any major change in the near-term.
Mike Van Slooten is head of market analysis–international at Aon Benfield. He can be contacted at: mike.vanslooten@aonbenfield.com
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