Pros and cons of alternative capital

Pros and cons of alternative capital | Insurance Business

Pros and cons of alternative capital
New Zealand insurers considering using alternative capital sources for reinsurance need to weigh up the lack of flexibility associated with them compared to traditional reinsurance offerings, says Pacific Region CEO of Guy Carpenter, Tony Gallagher.

Speaking to delegates at last week’s ICNZ conference, Gallagher said his company believed the alternative capital market would grow to about $64 billion – but despite offering a range of new products which were very good, there were important differences to bear in mind, he said.

“Dealing with a capital market, it’s binary. There’s the capital and there’s a contract and the triggers set are quite clear.

“For example, if a Mercalli’s 7 earthquake occurs they pay you $100,000 million, but if it’s a 6.9 you get nothing.

“With traditional reinsurance there’s an area where the traditional reinsurer may work with you to be able to settle some of the claims – which they don’t have to - based on the relationship and the ongoing relationship within that activity.”

He added: “The benefits of traditional reinsurance is you know where you are, it’s tested and proven and it’s been in the market for a number of years.”

This situation would evolve, he said, and become more useable in the future but capital markets products were essentially a financial contract.

“You have reinsurers who are buying capital markets products and you have capital market products which are becoming more and more like reinsurance, the differentiation is binary.”

He said the growth of the alternative capital market, which is basically supported by pension funds or third party capital entering the market and taking reinsurance risk, had really taken off  after the GFC following the realisation that while share prices and returns dropped, the same thing did not happen in the risk market where the rates remained stable.

The growing pressure this increasing alternative capital was placing on reinsurance was in turn pushing reinsurers towards insurance to grow their returns.

Munich Re, Swiss Re and Hannover Re had all grown their insurance businesses since 2007.

He marvelled at how conglomerate Berkshire Hathaway, which started off as a non-traditional reinsurer, was now backing broker network Steadfast’s move into personal lines, launched that day.

“So reinsurers are becoming insurers, insurers are becoming reinsurers, setting up their own internal reinsurance businesses and retaining more business, and then brokers are becoming insurance companies.

“It’s incredible how quickly it’s occurring. In only 5-10 years going from a brand new market to an intermediary writing insurance, which is very different as well and something I wouldn’t have expected to occur in this market,” Gallagher said.

Another key driver was the rapid technology change occurring, he said, and those companies which figured out what knowledge to use from the vast amounts of data available to be harnessed, and how to use it, would gain the edge.

“I think many of us are still in the data collection phase but whoever gets there first is going to have a tremendous advantage,” he said.

“The way I look at it is it’s like driving down the road and you’re looking in the rear vision mirror. You’re looking backwards which to me is looking at historical data and that’s going to tell you what’s going to happen forwards.

“This phase is you’ve got the backwards information but you’re changing the way you’re going forwards based on the terrain changing.”