Report Asks Why Reinsurance Sector Still Attracts Investors

Capital is still being attracted to the reinsurance industry although the fundamentals are trending in the wrong direction, reports AM Best in its latest report on the sector. The credit ratings agency (CRA) recently revised its outlook for the global reinsurance industry from ‘stable’ to ‘negative’.

The report, entitled
‘Global Reinsurance – How Relevant Is the Underwriting Cycle?’
notes that an emerging trend identified by AM Best two years ago was “the birth of a new breed of reinsurers, sponsored by hedge funds”. The trend towards third party capital is still in motion and apparently accelerating, say the authors.

“Furthermore, the asset strategies of the newly rated vehicles are broadening. Instead of being focused on long/short equity, some vehicles have strategies that place more emphasis on high-yield, fixed income,” the report states.

“While third-party capital increasingly enters the reinsurance sector through catastrophe bonds, sidecars and hedge fund reinsurance companies, the quick exit strategy has always been a focus. For sidecars and catastrophe bonds that focus on property catastrophe business, the exit strategy is baked into the structure itself and the targeted lines of business.

“For hedge fund reinsurance companies, the exit strategy, more times than not, contains an initial public offering (IPO) component. Thus far, equity investors continue to display an appetite for the hedge fund reinsurance model.”

The report notes recent evidence that more hedge fund reinsurers seeking a rating are looking to partner with an existing (re) insurance company rather than go it alone. “An obvious benefit is that it taps an existing underwriting team that has an active book of business with a known track record and well-established relationships,” comment the authors. “This reduces some of the operational risks of assembling a team and developing a book of profitable business.”

The authors also query the insurance and reinsurance industry’s traditional underwriting cycle, driven by supply and demand. “If capacity is lacking, the price of risk goes up. Too much capacity and prices drift down. At some point, the downward drift is too far and balance sheets end up in need of repair.”

However, over the past 20 years the tremendous amount of data available and significant technology that allows much greater speed in decision making should have ended the cycle. “Perhaps there are other factors at work. Despite advancements in technology and access to information, the basic, fundamental, human core emotions have not evolved as rapidly,” the authors suggest.

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