Alternative capital growth to resume with new records to be set: Fitch

The alternative capital market segment of reinsurance, so insurance-linked securities (ILS), catastrophe bonds and the like, will resume growth on the back of firming reinsurance pricing, analysts at Fith Ratings believe.

The alternative reinsurance capital market is currently “in transition” after a number of year’s of challenging catastrophe loss activity.

Fitch points to trapped collateral and says estimates were that as much as 75% of UNL aggregate retrocession capacity was not available at the January 2022 renewals, which has helped to spur catastrophe bond market growth and also turned some reinsurers back to the sidecar market.

“Given the limited capacity and high cost of aggregate retro coverage in the collateralized reinsurance market, reinsurers have turned to catastrophe bonds for retro capacity.

“Since June 2021, reinsurers have obtained more than $2.8 billion of retro capacity through 15 cat bond transactions. Likewise, some reinsurers have been shifting more catastrophe risk exposure to third-party investors in affiliated sidecar and joint venture vehicles,” Fitch Ratings explained.

But in the current higher reinsurance pricing environment and given the clear strategic benefits of ILS market solutions, Fitch says alternative capital looks poised for growth at this time.

“With US property cat reinsurance pricing up more than 50% from the 2017 lows, the market is poised to resume its growth trend,” the rating agency said.

Adding that, “Higher pricing is likely to increase demand from investors, while reinsurers will continue to increase their utilization of alternative capital due to the strategic and financial benefits it provides.”

Fitch believes alternative reinsurance and ILS capital will now move higher to break all previous records.

“With reinsurance pricing continuing to move up, alternative capital capacity is poised to break out above the $100 billion level and resume its growth trend as higher pricing is likely to attract additional capital inflows from institutional investors,” the rating agency explained.

With pricing for natural catastrophe reinsurance much higher, while terms and conditions have also improved and attachments been raised, expected returns on ILS investments are now higher than they were, “making the asset class particularly attractive considering its low correlation to other asset classes,” Fitch said.

On top of this, catastrophe bonds and other ILS backed by collateral investment instruments that will float higher with interest rate rises, stand to deliver even better expected returns.

Fitch also expects the current wave of interest in non-catastrophe risk ILS investment opportunities will help to further grow the alternative capital market in reinsurance.

“Investors remain keen to access reinsurance risk through partnerships with respected underwriters,” the rating agency said.

Summing up, Fitch explained, “Demand for more alternative capital capacity will come from reinsurers themselves.

“Alternative capital is firmly embedded into reinsurers’ risk and capital management frameworks, providing an efficient source of capital that can also provide numerous strategic and financial benefits for reinsurers.

“Given these trends, we think alternative capital will continue to play a key role in enabling reinsurers to reduce their catastrophe exposures, lower their own cost of capital and improve their risk-adjusted returns in the years ahead.”