Courting the capital markets

The transfer of peak catastrophe risk to the capital markets has hit an all-time high in 2013. But what does ‘convergence’ mean for insurance buyers?

A significant change has been taking place in the property catastrophe (re)insurance market over the past decade, one that has been ramped up since 2008. In the low interest rate environment capital market investors, pension funds and institutional investors have increasingly been turning their attention to insurance. Among the risk transfer solutions they have been backing are fully collateralised reinsurers, catastrophe bonds and industry loss warranties (ILWs).

An estimated $42bn of these insurance linked securities (ILS) will be in force by the end of this year, according to Willis Re. The influx of non-traditional capital on the sector was felt at the mid-year US property catastrophe renewals, with pricing for traditional reinsurance dropping as a result of the competition. Non-traditional capacity now makes up an estimated 14% of global property catastrophe limit, with much of it (more than 70%) focused on US peak risk, such as Florida windstorm and US earthquake. This could grow to 30% within three to four years, says Willis Re.

But what does this mean for commercial insurance buyers? There is anticipation there will be a further influx of up to $100bn of additional ILS capital over the next five years. This could have a profound impact on the insurance industry, with a ripple effect that is likely to affect classes of business outside of property catastrophe. The ‘fungible’ nature of the capital, which can move far more quickly in and out of the insurance industry, is also expected to remove the peaks and troughs from the insurance cycle.

“As Airmic and as insurance buyers we like to think that the big fluctuations in premium rates is not something we’ll confront in the future,” says Airmic technical director Paul Hopkin. “That is substantially driven by the fact there is significant capital available to provide insurance and other risk financing mechanisms.”

The growth in ILS also means the insurance industry will be forced to respond and potentially become more innovative. “Insurance products have to remain relevant to organisations,” says Hopkin. “Otherwise they run the risk that other funding mechanisms put themselves forward and are considered to be more relevant by people who are currently insurance buyers.”

In the future buyers could enjoy softer pricing for many classes of business, as excess capital is spread around the sector exerting competitive downward pressure on rates. Willis Re predicts between $30bn and $40bn of traditional property catastrophe reinsurance capacity could be displaced by the new money coming in. While some of this will be returned to shareholders, some of it will be redeployed into other parts of the business, including commercial insurance.

Going direct

There is also the option for some insurance buyers to directly tap the capital markets for capacity. This year’s MetroCat Re cat bond is a good example. Worth $200m and issued on 30 July, it was sponsored by First Mutual Transportation Assurance Company, the New York based captive insurer of the Metropolitan Transportation Authority (MTA). It was the first cat bond to solely cover storm surge risk.

The MetroCat deal was deemed attractive in the aftermath of Superstorm Sandy, which inundated parts of New York’s Manhattan Island in October 2012, including the Brooklyn-Battery tunnel and seven subway stations. “The traditional avenues we use for insurance and reinsurance contracted dramatically, making it exceedingly difficult for the MTA to obtain insurance,” said MTA chairman and chief executive Thomas Prendergast. “We anticipate that this deal represents the start of a long-term alternative reinsurance option that diversifies MTA’s risk management strategy.”

And according to Guy Carpenter vice chairman David Priebe, there are similar deals in the pipeline. Its ILS advisory, GC Securities, acted as bookrunner, joint structuring agent and lead manager on the cat bond. “MetroCat Re is not a one-off ,” he says. “We are seeing real demand and interest from corporate insureds to access the capital markets as a way to secure additional capacity.”

“The insurance market continues to be the solution provider of choice, as it provides tailored coverage on a very cost effective basis,” continues Priebe. “However, large corporate buyers are looking to access the capital markets for increased capacity beyond what is available from the general insurance market and the capital markets are poised to offer solutions.

The area of greatest focus is towards protecting assets and earning streams that are highly exposed to natural catastrophes.”

With ILS costs and barriers coming down the option of tapping into capital market capacity will become more feasible for insurance buyers. ILS pricing has reduced by between 25% and 70% for peak US risk transactions, and this non-traditional capacity is increasingly branching out into other areas. Cat bonds to cover workers’ compensation, motor and terrorism have been structured in the past and aviation cat bonds have been mooted.

The launch of two cat bond platforms this year could help broaden the scope of cat bond perils. The Tokio Tensai Platform (created by a subsidiary of Tokio Millennium Re and GC Securities) and more recently, Kane SAC’s private cat bond platform, have been launched to facilitate smaller cat bond transactions.

Cell companies are increasingly being used to access capital market capacity, according to Justin Wallen, managing director of Guernsey-based Hexagon PCC Group at Robus Group. “I have seen a large influx of business into the three PCCs that we set up specifically in 2012 to provide transformer cell facilities to ILS Funds wanting to access returns available from ILS type transactions,” he says.

“In the main, our cells enter into fully collateralised reinsurance contracts, although we have also facilitated a few fully collateralised ISDA [swaps and derivatives] contracts as an alternative way of taking on these risks,” he explains. “We work with three different ILS Fund Managers and have set up 25 different cells to date during 2013, primarily to conclude collateralised reinsurance and with approximately $300m on risk.

“I have been responsible for these types of transactions since 2007 and the main difference I have noted in 2013 compared with prior years is the move away from the more traditional property catastrophe coverage to a broader cross-section of risks, including marine and energy, crop, personal accident, premium reinstatement and even prize indemnity,” he continues. “This is a diversification strategy for the ILS Funds being driven by two key components. First of all it is a risk mitigation strategy and secondly the fall in pricing for some of the more generic US windstorm, EU windstorm and Japanese/US quake covers is leading the ILS Funds to seek new markets to continue to be able to produce higher than average returns.”