General Insurance Article - Fitch reviews impact of alternative forms of risk transfer


 Fitch Ratings says in a newly published report that alternative forms of risk transfer are a permanent market fixture, having gained acceptance by both cedents and most traditional reinsurance providers as a structural change to the reinsurance sector, particularly for property catastrophe risk.

 Fitch views the growth and acceptance of alternative reinsurance as a strain on the credit quality of reinsurers, especially for smaller, stand-alone property catastrophe providers. While there are some positives for individual companies, the added competition and increased supply of capacity from the capital markets has resulted in a deteriorating profitability profile for the reinsurance sector.

 Third-party capital continues to focus on model-driven property risks. As a result, returns on property catastrophe business, while still profitable, have been pushed down into the high single digits. This is below the 10%-15% level many traditional reinsurers consider adequate for the volatility risk, but in line with the 6%-10% returns that reflect capital market providers lower cost of capital.

 Watford Re Ltd.'s entry into the non-traditional reinsurance market is causing concerns, as its focus is on multi-line casualty risk, rather than the customary property risk. Fitch expects that the amount of alternative capital dedicated to casualty business will no doubt grow. However, growth will be constrained to a limited group of capital market participants that are willing to accept longer tailed, generally un-modelled risks in a more permanent vehicle.

 One area of uncertainty is how investors would react to an environment of less favourable catastrophe risk spreads or a large unexpected catastrophe loss, either of which could cause capital to retreat. Fitch considers a significant portion of capital market investor funds to remain as permanent, given the nature of catastrophe risk as providing a very valuable portfolio diversification benefit and institutional investors longer term investment horizon.

 Growth in the catastrophe bond market has been considerable in the first half of 2014 as the market produced over $5.7bn of new issuance and is on track to produce a record amount of catastrophe bond issuance for the full year. Demand has remained very strong in the marketplace as repeat sponsors have been eager to replace maturing cat bond issues and take advantage of favourable market conditions. Nevertheless, there have been signs that market pricing may be reaching a floor.

 The report: 'Alternative Reinsurance 2014 Market Update' is available at www.fitchratings.com

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