OLDWICK, N.J.--(BUSINESS WIRE)--Despite considerable investor losses from the 2017-2018 catastrophe events, the collateralized reinsurance market remains the fastest-growing segment of the insurance-linked securities (ILS) industry, according to the new AM Best report, “Global Reinsurance: Fighting the Last War.”
Growth in the collateralized reinsurance market has been propelled by ILS funds seeking to provide tailored coverage for ceding companies, and coverage for risks that may not be suited for or available from other ILS instruments. At year-end 2018, the market capitalization of the collateralized reinsurance market was approximately $56 billion, out of an approximately $95 billion ILS market.
The catastrophe events of 2017-2018 have highlighted the issue of trapped collateral in the collateralized reinsurance market. While the industry experienced difficultly in determining the ultimate loss amount on catastrophe events, as loss estimates changed over time, investors’ collateral remained tied up, and could not be released until risk-bearing entities’ obligations were satisfied. This creates a significant drag on the results of collateralized reinsurance transactions owing to the opportunity cost of investors’ collateral tied-up in expired contracts. The drag on investment returns from locked-up collateral can run as high as 20%. As a result, the impact of trapped capital is becoming a more important consideration in the risk pricing of collateralized reinsurance contracts.
Collateralized reinsurers also are paying closer attention to the quality of cedents as they enter into reinsurance agreements, with the aim of containing potential loss creep. Pricing is differentiated based on historical loss experience, the accuracy of prior loss estimates, long-term performance and a willingness to work as partners. Going forward, AM Best believes high-quality cedents likely are to be rewarded with better pricing, terms and conditions.
The impending withdrawal of fronting capacity also has created new opportunities for other entities to enter the collateralized reinsurance market. When fronting companies are involved, the collateralized reinsurance cover is transformed into a traditional reinsurance program, meaning that the ceding company relies on the fronting carrier’s claims-paying resources and thus is dependent on the credit risk of the fronting company. The current uncertainty limits the ability of ILS fund managers to engage in fronting arrangements, and they will need to find other (re)insurers to provide fronting services or to seek alternative solutions.
Given that ceding companies generally are exposed to the tail risk associated with collateralized reinsurance programs, the growth in volume and value of these transactions undoubtedly will create collateral and credit risks. AM Best notes that there have been improvements in reducing collateral risk, but it still remains and is a critical component in AM Best’s rating considerations. Collateral and credit risk issues have the potential for creating systemic risk owing to major catastrophic losses or potential financial market distress. AM Best anticipates further regulation in these markets as recourse is usually limited to funds that have been allocated in trust accounts.
The report section, titled “The Changing Landscape of the Collateralized Reinsurance Market,” also outlines the typical structure of a collateralized reinsurance agreement. The full Best’s Market Segment Report on the global reinsurance industry can be found at http://www3.ambest.com/bestweek/purchase.asp?record_code=289149.
AM Best also will host its annual Reinsurance Market Briefing at the 2019 Rendez-Vous de Septembre (Rendez-Vous) on Sunday, Sept. 8, 2019, at the Hermitage Hotel in Monte Carlo, Monaco. The briefing will start at 10:15 a.m. and end at 11:45 a.m. (CEST). To register, please visit www.ambest.com/events/rmbseptembre2019. AM Best will hold a second Reinsurance Market Briefing in Zurich on Wednesday, Sept. 18, 2019, at the FIFA World Football Museum. More information and registration can be found at www.ambest.com/events/rmbzurich2019.
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