Reinsurance Capital Capacity: New Sources Could Be Required

More capacity on reinsurance could be needed in the future and Bloomberg Intelligence has been doing some thinking about that. Here’s the word;

Alternative-reinsurance vehicles, which compete with rated-reinsurers and thereby hurt pricing, could continue to be the primary source of new capacity in 2024, according to a new report from Bloomberg Intelligence (BI). In 2023, there was essentially no balance-sheet reinsurance capacity added, excluding a capital raise at Everest, notes BI. Catastrophe-bond issuance hit a record high of $16.4 billion last year and expected returns remain above historical averages, it adds.

Matthew Palazola, BI Senior Insurance Analyst, said:

 “Total reinsurance capacity could continue to grow as historically high alternative-capital returns fuel further issuance and draw demand. Alternatives to rated reinsurer balance sheets can come in many forms, such as cat bonds, insurance linked securities (ILS) and sidecars. Alternative reinsurance capital dates back to the mid-1990s and has risen to about 16% of the market from 10% in 2014. Smoother capital-market transactions have made it easier for funding to enter the industry, which has limited price gains after large catastrophes.

“Despite major price increases in 2023-24, there was essentially no balance-sheet reinsurance capacity added aside from a capital raise at Everest. In prior strong markets, new companies were formed, such as the “classes” of 2001 and 2005.”

In 2023, catastrophe bonds drew over $16 billion in issuances, up from 2022’s $10 billion and $14 billion in 2021, notes BI. Cat bonds could see further growth as higher pricing, along with increased money-market rates which hold the collateral, boosts yields and provide a greater expected return. Higher attachment points and retentions among primary carriers may boost interest in such securities.

Cat Bonds Inflows Abound

The combination of lower capacity in traditional reinsurance markets and higher prices could entice capital inflows to the insurance-linked securities (ILS) market, believes BI. Public 144a cat bond issuance hit $16.4 billion in 2023, and investor demand for property/catastrophe-related exposure jumped following Hurricane Ian, as prices increased 37% globally at Jan. 1, 2023 renewals, according to Howden. Higher pricing boosts yields on top of money-market returns, acting as dual tailwinds. For cedents, catastrophe bonds provide additional capital capacity, allowing insurers to take on more exposure.

Investor appetite may be cautious as ILS structure allows cedents to extend maturities. Capital has been trapped several times, including in 2022 due to Hurricane Ian, as cedents lock collateral post maturity while potential losses develop.

Matthew Palazola added: Expected returns on cat bonds — the coupon less expected loss (excluding money-market fund returns — appear to be at their highest since 2012. The current catastrophe-bond multiple, as measured by Artemis.bm, is at around 4.54x, 34% higher than 2022’s 3.38x and 144% better than 2017. Multiples compressed in the 2010s as capital entered both the ILS and traditional reinsurance market, creating a supply-demand imbalance and dampening pricing across reinsurance products. Coupon rates in 2023 averaged 8.9%, the highest since 2012, and expected losses fell to 1.8%, the lowest since 2014’s 1.6%.”