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Insurers Must Adapt to Inclement Weather

Source: Dow Jones

Posted on 23 Aug 2013 by Neilson

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Climate ChangeThe winds of change are blowing in insurance.

Traditionally, reinsurance companies, backed by shareholder funds, stand behind the insurance industry, providing additional coverage for any outsized losses. But alternative sources of capital such as bonds or vehicles backed by hedge funds or institutional investors now account for about 15% of the global property catastrophe reinsurance market, according to brokerage Guy Carpenter. That is up from 8% in 2008.

And money attracted by the prospect of sizable, uncorrelated returns is weighing on pricing. Rates for U.S. catastrophe reinsurance are down 15% on last year.

Many in the industry argue such money is naive - and potentially fickle. True, in a market where capital can be wiped out by the likes of a hurricane, some novices may be taking on underwriting risks they don't fully understand. One big storm could cause unprecedented losses for holders of instruments like catastrophe bonds, prompting even avidly yield- seeking investors to flee the market.

But that seems unlikely: the cloud cast by alternative capital could be here to stay.

Issuance of catastrophe bonds, at $3.8 billion in the first half, is set for a record year. Longer-term investors, like pension funds, have driven much of the recent growth, rather than the hedge funds who have tended to move in and out of the sector depending on the pricing environment. Pension funds now hold perhaps 14% of catastrophe bonds, according to Swiss Re, up from close to zero five years ago. That also doesn't necessarily capture pension money invested through specialist fund managers.

And interest from mainstream investors is likely in its early stages. Were global pension funds to allocate 0.5% of assets to insurance-linked investments, of which cat bonds account for perhaps one third, the overall market could more than triple to $150 billion by 2020, forecasts advisor Willis.

There are also early signs that alternative capital may be willing to bet on a broader range of risks. About 70% of catastrophe bonds outstanding are exposed to U.S. hurricane risk, where prices have come under most pressure. But the second quarter saw bond sales which offered bets on Australian cyclone risk and Turkish earthquakes: both were oversubscribed, notes Willis.

Reinsurance companies are responding to the new competition. Making their underwriting skills available through asset management vehicles is one option: third-party assets under management at Leadenhall, part-owned by London-listed Amlin, have roughly doubled in the past year to $1.4 billion. The insurer is increasingly offering packages of traditional reinsurance and capital-markets cover to big clients.

Competitors are following suit: Bermuda-based Sirius and XL Group have recently launched capital markets businesses, notes industry specialist, while the U.K.'s Lancashire has been bolstering its rebranded investment unit.

That suggests some companies are positioning themselves for a lasting change in the reinsurance industry. The prevailing wind has shifted direction.