Healthy ILS market may have more appeal than reinsurance start-ups: AM Best

The fact the insurance-linked securities (ILS) market is healthy, has resumed growth and delivered attractive returns to its investors, may now be a contributing factor in diminishing investor interest in backing balance-sheet reinsurance startups, according to AM Best.

The rating agency notes that it continues to have a number of business plans from high-profile reinsurance executives under review, but says that have had difficulty raising the necessary funds.

It’s not down to a lack of appetite in the sector, but a number of factors may be putting off commitments to new reinsurers, AM Best believes.

Before we go into AM Best’s reasoning, it might be helpful to highlight something we wrote recently.

In that article we explained that, based on our interaction with investors, such as large private equity players that have backed reinsurers in the past, some of the factors holding back investor interest in new “Class of” reinsurance startups include:

Concern over whether profits can be sustained and the fact the market is not significantly increasing its profitability through structural modernisation and efficiency improvements.
That investors are sceptical whether the reinsurance sector can sustain pricing and remain disciplined.
Concerns over a return to the hyper-competition that drove the soft market and loose terms of the 2010’s.
Also that startup companies require time to make a profit and exit from, where there may now be better ways to play the reinsurance cycle with greater access to liquidity.
As well as the fact many reinsurance start-up business plans are not really offering anything new, in strategy terms and can often turn out to be the same faces with the same business models again.

Read that recent article for more.

Back to AM Best’s latest thinking.

“A class of startup reinsurers usually quickly forms to capitalize on the interruption in the reinsurance demand-supply equilibrium,” explained Dan Hofmeister, associate director, AM Best. “Many of these new reinsurer formations merge or are acquired as the market cycle returns to the soft phase of the cycle.”

But, despite capital depletion in recent years, this hasn’t happened. One additional reason being the fact reinsurance is not short of capital at this time and reinsurer balance-sheets have recovered and grown.

The current hard market is “different” AM Best said, given it was not one large event that impacted the market, rather a combined number of years of poor results, which is in part driven by catastrophes that occurred, but importantly these occurred at the bottom of a soft market when terms were very loose, we’d suggest.

“AM Best has issued a number of preliminary credit assessments on business plans from high profile management teams, which have had similar difficulties in fundraising,” Carlos Wong-Fupuy, senior director, AM Best confirmed. “Many of them note that large, passive capital investors, such as sovereign wealth funds, endowments and pension funds, still have healthy levels of interest in the industry.”

But, AM Best says that “private equity-venture capital investors do not appear to be interested in supporting startup non-life reinsurers.”

Adding, “Primary drivers behind this may also include competitive conditions in the reinsurance market and the availability of insurance-linked securities (ILS) that may have more appeal in a hard reinsurance market given their concentrated nature.”

AM Best has published a report that goes into more detail and states that, “Regardless of the causes and differences with prior hard reinsurance markets, the market has hardened and it will take at least a few years for pricing and conditions to soften. And, yet, no new reinsurers were formed to capitalize on the turning market. This was not for a lack of effort or talented executives, as some high-profile management teams publicly announced their intentions to form new reinsurers, while many more were rumored to be seeking funding. Ultimately, none of the potential entrants have made it past the fundraising stage.”

But also adds, “The insurance-linked securities market may offer more efficient opportunities for new entrants to the reinsurance space.”

Alternative access points, to derive returns efficiently from reinsurance and in a manner where an exit is both clearer and more accessible, is certainly a driver for some investors.

They have also looked more favourably at different points in the market chain to deploy capital, as private equity deals in the distribution and MGA space reflect.

On ILS, AM Best says, “The availability of insurance-linked securities (ILS) makes the current hard reinsurance market a better opportunity for investors than prior hard market cycles. The ILS market offers a concentrated investment opportunity to supplement investments in large reinsurers that write global, well- diversified business and often primary and mortgage insurance, in addition to property catastrophe coverage.”

Adding that, “Over time, ILS products have been fine-tuned to attract investors.

“Investors currently have the opportunity to access exposures to the hard property catastrophe reinsurance market through either established ILS products or large, well-diversified balance sheets of rated companies with proven risk management platforms. These factors have diminished the attractiveness of start-up reinsurance investment opportunities, where capital can be committed for at least a five-year time horizon in an unproven platform, despite high levels of start-up capitalization and experienced management teams.”

While the ILS market itself had gone through a challenging period where raising capital was more challenging, the sector has worked through many of these issues, released much of its legacy trapped collateral, and now stands ready with more optimised and efficient structures at just the right time to capitalise on the hard market and greatly improved terms.

AM Best said, “The existence of a healthy ILS market appears to have diminished the franchise value of property catastrophe business to investors.

“Investors today appear much keener to allocate funds to shorter-term ILS instruments to capitalize on the hardened underwriting conditions, rather than in a rated balance sheet.”

The rating agency appears to believe that this could diminish investor appetite for new rated startups for some time, given the reinsurance sector has a good number of established companies with no lack of capacity and also with an appetite to grow as well.

“As long as these alternative entry points exist, we don’t foresee capital flowing into the new reinsurers to support hardened property rates and conditions,” AM Best states.

The rating agency believes the time horizon to take advantage of the current hard market is also narrowing, especially with catastrophe reinsurance rates being seen to peak recently. That might serve to further put off investor entry and AM Best notes “It will be interesting to see if any experienced management team overcomes these challenges to achieve their desired funding.”

AM Best concludes, “New reinsurer formation likely will decline as the established rated balance sheets and ILS market players reap the rewards of allocating capital to the reinsurance industry, enhancing their own operating returns and capital positions.”

Also read:

– Dearth of reinsurance startups to persist, its different this time: Shea, Gallagher Re.

– Capital to enter via sidecars & collateralized, rather than “Class of” startups: S&P.