How capacity is heading to the specialty markets

The impact of the veritable ocean of capacity in the reinsurance markets is profound and much of it could go into the direct insurance market, according to Willis natural resources industry head Alistair Rivers.

The specialty markets are particularly attractive for this capacity, Rivers added.

Speaking to StrategicRISK, Rivers said that reinsurance and collateralised capacity is having a major impact on the direct insurance market for oil and gas companies.

“With no obvious alternative investment opportunities emerging, and with interest rates around the world still low in relative terms, capital providers are likely to maintain their funds in the (re)insurance markets where they are currently deployed – at least for the short term,” he says.

“Energy market capacity is therefore likely to continue to be available, even if the sector falls into unprofitability.”

The difficulty with predicting how market conditions will turn out in the next few years is that this is the first time we have seen capital deployed in the insurance markets that is unlikely to be put off by short-term underwriting unprofitability, Rivers suggests.

“In previous market eras, we have always found that a major catastrophe or series of losses – for example, Piper Alpha, 9/11 and the 2005 Gulf of Mexico hurricanes – has led to a withdrawal of capacity and harder market conditions,” he says.

“But now we think it will take more than a headline-grabbing loss to precipitate a withdrawal.

“Capital providers would have to find an alternative haven for their money if they are to withdraw from the insurance arena.”

In the April 1 issue of Willis Re 1st View, Peter C. Hearn (chairman) and John Cavanagh (CEO) of Willis Re make it quite clear that the current reinsurance market favours the buyer.

“The cost of reinsurance is falling much faster than original rates in many classes and territories,” the report states.

“Comfortable though this situation may be for many buyers, the nagging concern remains as to timing. When will a lower cost of reinsurance feed through in lower original rates and put primary companies’ margins back under pressure?”

Aon Benfield Analytics estimates that global reinsurer capital totalled $540 billion at the end of 2013, an increase of 7% over the year. The latest edition of the Aon Benfield Aggregate (ABA) report, which was released last week, states that capital reported by the ABA group of 31 leading reinsurers increased by 6% ($20 billion) to $337 billion, driven primarily by $34 billion of net income.

Speaking at last year’s Monte Carlo Rendezvous, head of Willis Re John Cavanagh indicated that the influx of third-party capital into the reinsurance market could displace up to $40 billion of traditional equity capital, which could either be returned to shareholders or redeployed elsewhere in the re/insurance market.

“Discussions so far have centred on the effect third party capital is having on rates and the competition it is producing in the property catastrophe reinsurance market,” Cavanagh said at the time.

“A future influx of $100 billion would, however, have a number of profound consequences.

“As third party capital enters the property cat reinsurance market, it is going to crowd out conventional equity capital. That equity capital has to go somewhere.”

Cavanagh added that if $100 billion of third party capital entered the reinsurance market, then even allowing for significant returns of capital to shareholders, there could be as much as $20 billion excess equity capital to be deployed.

“You could think of this as being the equivalent of 10 well capitalised start-up companies, and the effect on the market place would be profound,” he said.

“If capital is redeployed, much of it could go into direct insurance businesses. Many of the hybrid specialty reinsurers are already implicitly going down this path.”

The influx of third party capital, coupled with changes to reinsurance buying patterns and regulatory complexity, is leading to growing complexity in the reinsurance market, Cavanagh said.

“Solid analytical advice and market knowledge through intermediation is needed now more than ever,” he added.