Consider alternative capital a core part of capital management, McKinsey urges

Participants in the global insurance and reinsurance industry need to consider alternative capital and insurance-linked securities (ILS) as a “core part of their capital management strategy” to deliver on promises of plugging protection gaps, enhance relevance to clients and make their reinsurance purchases more efficient, consultants at McKinsey have said.

In a recent paper, McKinsey’s consultants note that the good news is, “Alternative capital from sources outside of traditional reinsurance has surged and embedded itself into P&C insurers’ capital structure.”

But there are additional benefits to embracing alternative capital even more fully, according to the consultants, with further growth of the insurance-linked securities (ILS) market and expanding remit of alternative reinsurance capital good for both the investors in the instruments and the insurers utilising them.

Growth further outside of catastrophe classes of business is anticipated, with significant opportunities to use alternative forms of reinsurance capital to plug gaps in capacity available for classes such as cyber, McKinsey notes.

While re/insurance carriers will also benefit from attracting more investors into the market, which could help them as they look to negotiate better terms with the reinsurance market.

ILS and alternative reinsurance capital “offer a lower cost of capital than traditional reinsurance, particularly in a context of increased industry losses and rising costs of equity and debt raising,” McKinsey’s consultants said.

They can also benefit carriers through the multi-year nature of ILS coverage, as well as by reducing counterparty risk as the funds are locked away in trust for when they may be needed to pay claims.

There is also the potential to earn additional income from alternative capital, by fully-integrating it and earning fees through its management, which the consultants note can also “increase insurers’ franchise value.”

“The predictable stream of income from investors who subscribe to the franchise can also offset volatility from underwriting results, all of which are regarded positively in the capital markets,” they explained.

There are specific opportunities in expanding the ILS asset class to cover other P&C insurance classes, on which insurers can assist by helping investors with exit mechanisms, while benefiting from efficient capacity in market segments that have been lacking.

There’s also a chance to disintermediate, through direct transactions with investors, meaning reinsurance can be sourced from capital market investors and the traditional market be bypassed, McKinsey also points out.

But, key to all of this, is insurers positioning themselves in such a way as to increase investor confidence, while also catering to an increasingly diverse set of investor appetites as well.

Transparency and certainty on offerings, simplified structures and contract language, diversified opportunities, and having the right talent, are all areas insurers can focus so they can maximise their relationship with alternative capital providers, McKinsey believes.

“As part of insurers’ core capital management strategy, alternative capital can help drive returns and plug the P&C insurance gap,” the consultants said.