Reinsurers continue to face competition from third-party investors: A.M. Best

Reinsurance firms need to get into lines of business other than the property catastrophe business, as competition from third-party capital sources such as cat bonds and sidecars continue, suggests a new report from A.M. Best Company Inc.

“Despite the less than robust market opportunities, capital from third-party investors such as hedge funds and pension funds continues to flood the industry, putting additional pressure on pricing in the overall reinsurance segment,” A.M. Best stated in a report released Nov. 21, titled Stuck In the Middle: Reinsurers Face Converging Capital, Rising Retentions.

“These challenges are exacerbated by primary companies retaining more risk with each passing year, which decreases the pool of risk available to reinsurance companies.”

The report included a chart showing financial data for the first nine months of each year, from 2008 through 2013, for the U.S. and Bermuda reinsurance market.

The five-year average, of net premiums written in non-life for the first nine months, was US$53.2 billion per year. In 2012, NPW year-to-date, as of Q3, was US$56.7 billion. That dropped to US$48.9 billion this year, though the 2013 data does not include Alterra Capital Holdings Ltd., which agreed in December, 2012 to be acquired by Markel Corp.

This year, A.M. Best reported, “the June and July renewals experienced some pressure from excess capacity in the market and the declining demand for reinsurance.”

The ratings firm suggested third-party capital “will likely spread” to lines of business other than property catastrophe risk.

A.M. Best reports that in 2012, US$6.3 billion worth of cat bonds and US$1.7 billion in sidecars were issued in the global reinsurance market. As of the third quarter, US$5.3 billion in cat bonds and $800 million in sidecars had been issued in the global reinsurance market in 2013 alone. NASDAQ defines a sidecar as a way for investors to participate in the risk and return of a specific group of insurance policies but the investors’ risk is limited to the funds of the sidecar.

Last August, A.M Best had reported that “as much as” US$45 billion of “additional capacity entered the market in recent years.” Sources of this money include hedge funds, pension funds, endowments and trusts.

“Managing third-party capital, as many reinsurance companies already do, is one way to gain fee income and maintain control of the business,” according to the report released Nov. 21. “More creativity may be needed in the long term to stay relevant, and reinsurance companies also will have to spread into other lines of business.”

A.M. Best added in many catastrophes, there is a difference between economic and insured losses.

“That gap represents a large set of opportunities that are likely complex and very difficult to underwrite,” according to the report. “(Re)insurance companies with their intellectual capital are in the best position to assess those complex risks and provide innovative products that offer market solutions. The increasing presence of third-party capital may be a considerable driving force of that change.”