Alternative capital on the rise

by Resolve Editor, Kate Tilley

Alternative capital is broadening its appetite for risk because of greater data availability, John Philipsz, Willis Re deputy CEO, told the AILA Qld Insurance Law Intensive.

While total industry capital dropped in 2018, alternative capital continued to grow, up 9% to $US93 billion.

Reinsurers had seen a “relentless decline” in return on equity because of increasing combined ratios. Expenses had increased 3.8% since 2007, which was “devastating” because of the reinsurance market’s tight margins. Regulation had an impact on expenses, as did losses.

Alternative capital started coming into the reinsurance industry in 1998. Insurance-linked securities (ILS) had a 20% growth rate since 2009. “If it continues, it could be a third of the reinsurance market capital within a decade,” Mr Philipsz said.

Most of it was deployed in collateralised reinsurance and some cat bonds, which was a growing market. Investors were moving to ILS funds but, as a $95 billion asset class, they were “a relative minnow, a fraction of the pot, with room to grow”.

ILS funds were supplying the lion’s share of market capacity but sophisticated investors were participating on their own and through investment with specialists.

The market had longevity, with many ILS funds investing in research. Australia’s Future Fund invested in ILS funds, as did many superannuation funds.

Alternative capital’s growth continued, despite 2017 insured losses being the third highest on record. “A lot of investors won’t leave over time, despite global natural catastrophes, which were modelled and expected. The only counter would be a shock loss, something unexpected, like an earthquake in the centre of London – highly unlikely but not impossible.”

Mr Philipsz said there was an analogy with the asset-backed securities market, which fell 50% during the global financial crisis (GFC), but recovered strongly to pre-GFC levels. “That would probably happen in the alternative capital market if a shock loss occurred.”

He said the reinsurance market was adapting to the alternative capital influx and the different models would converge, creating a hybrid of traditional and alternative market capital.

The convergence had started three or four years ago with ILS managers merging and being acquired by traditional reinsurers.

Modelling capabilities were getting very sophisticated. “Insurers can risk-base pricing on granular, complex predictive modelling and build sustainable portfolios.”

Analytical abilities had progressed, including for flood and fire.

Mr Philipsz said reinsurers were fuelling insurtech, but much of it was hyped – “a unicorn farm”. There was a rapid rise of “disruptors”, but they were not profitable. It was “remarkable” that reinsurers were giving them security to write unprofitable business.

Munich Re was the most advanced, with a dedicated investment unit with 21 insurtechs, eg Trove, Drover, Ticker and Buckle. “But they’re yet to prove they are disruptive in the market.”

Mr Philipsz said the pace of technology was driving an industry realignment. “Capital will be more flexibly deployed and risks will be matched to capital pools.”

There would be more innovation products written, using telematics and sea-level information in real time. Wearable technology would impact on life and health products by preventing losses.

“Underwriters can use more than just traditional gut feeling,” Mr Philipsz said.