How new sources of capital are changing (re)insurance

Back in July 2004, I wrote an article for Canadian Underwriter called ‘Our own worst enemy,’ about the mechanics of the insurance cycle.

The piece explained “cyclical rate peaks and valleys in (re)insurance [i.e., primary insurance and reinsurance] markets almost always come as a result of issues surrounding supply, rather than demand. In the risk transfer business, the supply in question is that of capital — essentially, capacity.

“In essence, the financial position of (re)insurers governs the cycle, as industry players tend to increase prices and pull back on capacity when growth of surplus is flat or negative, investment returns are sour and catastrophic losses high, and lower prices and increase capacity when surplus is growing, investment returns are high and claims costs are manageable.”

In the distant past, (re)insurance capacity was provided strictly by (re)insurers.

But more recently, as ‘outside capital’ viewed reinsurance as an attractive investment, other capital providers (like hedge funds and other sources of venture capital, often called ‘naïve capital’ because of the lack of expertise in (re)insurance) began to pump huge sums of capital into world (re)insurance markets.

This may have started in the immediate aftermath of 1992’s Hurricane Andrew, when the Bermuda (re)insurance market popped up almost overnight, but it’s hard to say.

Awash in capital

This massive and nearly unbroken influx of capital played havoc with international (re)insurance markets, and essentially ended the traditional insurance cycle as we knew it.

The once inevitable pricing peaks and valleys of the past led to at least a decade-and-a-half-long valley, as the prior average seven-year insurance cycle gave way to a prolonged period of below-cost-of-capital pricing and less restrictive contract wordings due to competition.

So much capital existed in world markets that huge loss events like Hurricanes Harvey (August 2017) and Maria (September 2017) and some of the large fires in California hardly made a dent in available capital. In the past, such events would likely have driven an almost-overnight re-underwriting of NatCat risks.

But recent uncertainty and instability in international capital markets — possibly initiated by COVID-19 and exacerbated by supply chain disturbances; high inflation and resulting rapid interest rate increases; concerns about the international banking system; and the war in Ukraine among other things — led to a perfect storm. For the past while, investors have been sitting on capital, opting not to deploy it, even for investments that proved quite lucrative in recent years.

Enter the hard market

This has led to an unprecedented hard market in virtually all lines, property and liability.

Companies underwriting the risks almost solely control the capital, which is generally no longer available from fly-by-night sources looking for a quick buck. Oddly, as (re)insurers finally ‘get rate,’ sources of naïve capital are not able to take advantage of that by pouring capital into the market.

Historically, our industry would have seen that it was finally ‘getting rate’ and responded by increasing capacity, beginning the back-slide to a soft market. But not this time.

It’s quite possible that when we begin to see the general international investment market open back up again — i.e., when we begin to see more businesses of all kinds issue new shares and debt; see more initial public offerings and leveraged buyouts; and more share buybacks and so on — this could be a signal naïve capital is again poised to enter the (re)insurance realm.

Time will tell.

Glenn McGillivray is managing director of the Institute for Catastrophic Loss Reduction. This article is excerpted from one that appeared in the June-July print edition of Canadian Underwriter. Feature image courtesy of iStock.com/ZargonDesign