June 3rd, 2013

Influx of Convergence Capital Triggers Downward Pressure on Pricing at June 1 Renewals

Posted at 11:00 PM ET

Guy Carpenter & Company reports that the reinsurance sector has witnessed dynamic capital growth in 2012 and 2013, spurred by an influx of capital from alternative sources. In its June 2013 renewal briefing, Guy Carpenter finds that this surge in alternative or “convergence” capital has changed the nature of the sector’s capital structure, as investors grow increasingly comfortable with supplying capacity through a convergence of both traditional and alternative vehicles. This market dynamic has also begun to impact significantly reinsurance pricing for peak property catastrophe risks in the U.S., with surplus capacity and lower target returns driving downward pressure on pricing for June 1 renewals and likely through the remainder of 2013.

“The reinsurance sector has exited the fairly consistent post-Katrina Florida property catastrophe pricing range,” said David Flandro, Global Head of Business Intelligence at Guy Carpenter. “This has been driven by a very real change to the sector’s capital structure and this change is continuing unabated. New sources of capacity are emerging with implications for pricing, availability and structure. Guy Carpenter is well placed to enable clients to capitalize.”

Impact of Convergence on Reinsurance Market 

For the first time, there were several instances of insurance linked securities (ILS) pricing delivering a more cost effective risk transfer solution than traditional vehicles. While traditional reinsurance has certain capital constraints for peak risk zones, such as Florida, the lower cost of capital assumptions afforded to third-party funds gives them the potential opportunity to charge less for peak U.S. wind risks than traditional reinsurers.

“After years of evaluating the catastrophe bond market as a viable risk asset class, investors are now comfortable breaking away, or “decoupling,” from price levels set by the traditional market,” said Lara Mowery, Global Head of Property Specialty at Guy Carpenter. “The impact has been dramatic this year, with robust catastrophe bond, sidecar and collateralized reinsurance activity triggering downward pressure on rates in the traditional market in order to remain competitive.”

Approximately USD10 billion of new capital has entered the market in the form of catastrophe bonds, sidecars and collateralized structures over the last 18 months as a growing number of investors have been attracted to the reinsurance space by higher yields and low correlations. Capital emanating from alternative markets, including catastrophe bonds, collateralized reinsurance, industry loss warranty (ILW) products and retrocessional reinsurance, has grown significantly during this period and now accounts for an estimated USD45 billion, approximately 14 percent of global property limit.

Florida Reinsurance Renewals

Reinsurance pricing has fluctuated moderately over the last two years during the Florida renewals. Expectations going into 2013 were influenced by the significant excess of available capacity and the fact that Florida has been hurricane loss-free for seven consecutive years.

“This year, market expectations going into June renewals were such that pricing would moderate in line with January 1 trends,” said George Carse, Head of the Tampa Office at Guy Carpenter. “During pre-renewal discussions held in February by Guy Carpenter, reinsurers and non-traditional capital providers suggested a later renewal cycle would be more beneficial to our clients. This held true as flexibility in pricing and structure options from both traditional and alternative reinsurance providers, coupled with a divergence of pricing between Florida-specific catastrophe bond transactions and the traditional reinsurance market, resulted in more substantial price decreases on average than originally anticipated.” 

According to Mr. Carse, “Although catastrophe bond pricing had a major impact on the renewal process and several Florida-only bonds were quoted, very few of these transactions went to market, as more traditional products became increasingly competitive.”

Many companies took advantage of the savings on their core reinsurance purchases to expand top end and aggregate coverage, allowing them to enter wind season with significantly strengthened protections.  While companies over the past few years have expressed continued interest in complementary coverages, this has been difficult to achieve within existing reinsurance budgets.

Hurricane Activity 

Elevated hurricane activity is expected to continue this year and the 2013 hurricane season will play an important role in determining loss activity for the remainder of the year. There is a general consensus that 2013 will see activity that meets or exceeds the 1995-2012 average of the current “active period.” In 2012, the destructive landfall of Superstorm Sandy along the Northeast U.S. coast served as a reminder of the loss potential of hurricanes in the Atlantic, even for areas where landfalls are comparatively rare. Carriers will be closely monitoring this year’s Atlantic hurricane season as its outcome could influence the direction of reinsurance pricing into next year’s renewals.

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