Strong investor demand for alternative reinsurance instruments is set to continue due to the comparatively high potential returns of catastrophe risk through cat bonds and sidecar investments and the lack of correlation between catastrophe losses and returns on other major asset classes, according to a new Fitch Ratings report: 'Alternative Reinsurance 2013 Market Update'.
'The convergence of the reinsurance and capital markets is likely here to stay and should continue to grow in the near term,' says Brian Schneider, co-head of Reinsurance at Fitch Ratings. 'Powerful economic forces have driven increased acceptance and use of capital market alternatives to traditional reinsurance.'
Guy Carpenter & Company estimates that capital from the alternative markets currently totals a meaningful $45 billion, or approximately 14% of the global property catastrophe reinsurance limit, up from only 8% in 2008. Increased investor demand has reduced spreads in many alternative reinsurance products, meaning pricing is very competitive with, and even below, the rate for some traditional reinsurance coverage.
According to Fitch's report, one area of uncertainty is how investors would react to a large unexpected catastrophe loss, or higher risk spreads, either of which could cause investors to pull out of these instruments. Fitch considers this risk to be higher for hedge fund capital, as pension funds tend to have a long-term investment outlook and more diversified risk exposure.
Alternative reinsurance brings mixed benefits to reinsurers' credit ratings and financial strength, in Fitch's view. It can be used to manage reinsurers' exposure and capital and serve as a source of fee income. However, it also represents competition for traditional reinsurers that, in conjunction with the strong overall capitalisation of the reinsurance industry, has noticeably dampened reinsurance pricing.
Fitch Rates more than 65 reinsurers globally and has a stable rating outlook on the reinsurance sector.
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