September 30th, 2013

Capital Growth

Posted at 1:00 AM ET

thumbnail-midGuy Carpenter is pleased to present our mid-year report on the reinsurance market at a time of dynamic capital growth in the sector. The reinsurance marketplace has undergone significant change since early 2012 as investors continue to supply capacity through a convergence of alternative and traditional vehicles. This new supply has changed the nature of the sector’s capital structure. It has also exerted downward pressure on reinsurance pricing, thereby delivering a more cost efficient source of risk transfer.

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

The U.S. property catastrophe reinsurance market has been most affected by the influx of convergence capital, with double digit rate reductions observed during the 2013 mid-year renewals. While the impact was less dramatic elsewhere, general downward rate movements were recorded for property business in several other regions. There was also some evidence that competition was spilling over into other business segments. Market expectations are for these trends to continue for the rest of the year and into the January 1, 2014, renewal should no significant catastrophe loss occur in the second half of 2013. This is a positive development for reinsurance buyers.

In the current environment of soft pricing and excess capital, reinsurers are confronted with the difficulty of having to decide how to deploy this capital to generate returns that satisfy investors’ and/or shareholders’ expectations. The balance of options under consideration will include maintaining the status quo, returning capital to shareholders, pursuing organic growth or seeking merger and acquisition (M&A) opportunities.

Evaluating the merits of each option and the interplay between the options is not an easy assessment, with the best capital stewards often employing a strategy encompassing all four approaches.

Increasingly, the focus for growth and competitiveness in an evolving market is moving towards more M&A activity, particularly strategic bolt-on transactions as the need to adapt business models to achieve scale, global reach and a more diversified product suite increases.

Guy Carpenter is committed to assisting carriers in plotting their path to sustainable profitable growth and becoming their trusted strategic advisor. GC Securities*, a division of MMC Securities Corporation, a U.S. registered broker-dealer and member FINRA/NFA/SIPC, provides an industry-leading M&A advisory business with deep industry experience and a successful track record. The team is committed to advising and assisting Guy Carpenter clients with their M&A strategies to exploit growth opportunities as they arise. In Europe, GC Securities is a division of MMC Securities (Europe) Ltd. (MMCSEL), which is authorized and regulated by the Financial Conduct Authority.

The capital supporting the obligations of the global reinsurance sector has witnessed dynamic growth during the last 18 months. A significant contributor to this growth has been the influx of convergence capital. The surge in this capital has been driven by increased supply from institutional investors seeking access to a comparably high yielding, non-correlating asset as part of an allocation within an alternative asset management strategy. This new supply of what appears to be a permanent allocation to the reinsurance space is changing the nature of the sector’s capital structure as it adds to the competitive environment for reinsurance capacity and comes with an expectation of a relatively lower return per unit of risk.

Convergence capital contributed half of the growth in global deployed reinsurance capital from USD178 billion at the end of 2011 to USD195 billion at the end of the second quarter of 2013. The most tangible evidence of the impact of convergence capital is being seen in the U.S. property catastrophe reinsurance market, with material pricing declines in areas where this capital is seeking to be deployed. General downward rate movements have also been observed in several other regions and across some other classes, including retrocession and casualty business.

Despite the sustained headwinds of low investment yields and diminishing reserve releases, excess capital and the impact of convergence is challenging traditional reinsurers to reduce their price expectations and adapt their business models to remain competitive.

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*Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/NFA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd. (MMCSEL), which is authorized and regulated by the Financial Conduct Authority, main office 25 The North Colonnade, Canary Wharf, London E14 5HS. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product. **GC Analytics is a registered mark with the U.S. Patent and Trademark Office.

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