Convergence capital set to play a bigger role in market

Recently in the reinsurance market there has been increased talk about convergence capital.

It seems to be the ‘trending topic’ of the moment in press interviews and on panels at industry conferences. 

This increased attention is partly to do with the impact of this capital on last year’s US wind property catastrophe reinsurance renewal season. 

The capital impact was more pronounced than it had been at prior renewal periods and by most accounts this capital is expected to continue to play a larger role in the overall reinsurance market. 

So what is convergence capital? 

It is capital from non-traditional, third party sources that is earmarked to be deployed in the (re)insurance space.

This third party capital is often referred to as alternative capital. Historically, reinsurance companies have been the key players in this market and they are considered the traditional capital.

These (re)insurance companies have minimum returns that they need to achieve when they deploy capital, however, they also have constraints placed on them by rating agencies that impact their return calculations.

Alternative capital markets are not encumbered in the same way as the traditional markets and often may have lower return goals on certain types of business, thus allowing them to write the business at more competitive prices. 

Alternative capital is not new in the reinsurance space. In earlier years when this capital was accessed it was directed at specific areas where there was a need or a demand.

For the most part, in those instances it complemented traditional reinsurers without causing a major disturbance.  

However, this more recent influx of capital into the marketplace has been clashing a bit more and may be forcing traditional reinsurers to adjust their business models and plans.  

Alternative capital

Guy Carpenter estimates that around $10 billion of alternative capital has entered the convergence reinsurance space in the form of catastrophe bonds, sidecars and collateralized reinsurance vehicles over the last 18 months and that influx has had an impact on a marketplace that previously had been dominated by the traditional reinsurers.  As one would expect, this new capital has played into the dynamics of the market cycle.

Reinsurance brokers and clients are gaining a better understanding of the impact of this capital and have become more at ease with putting it to work in programmes that historically may have only employed traditional reinsurance. 

Had that influx not occurred, last year’s renewal periods from April to July would probably have unfolded differently.  

Superstorm Sandy was obviously a significant event in 2012; not a market changer, but a large enough loss to keep prices stable with rate increases on companies that were hit the hardest.

That was the case during the January 2013 renewal season but by April and more so by June, things changed. Florida deals were expected to be under “pricing pressure” because they had another loss-free year, but that downward pressure was increased as a result of this new capital.  

From that point forward more and more attention has been focused on this alternative capital. 

While this new wave of capital is certainly posing a challenge for companies operating with a traditional reinsurance structure,  companies will adapt.

Some reinsurers are expanding or initiating their presence in the capital markets themselves through sidecars and insurance-linked securities.

At the same time, others may be exploring areas outside of property catastrophe reinsurance for growth opportunities.  

The reinsurance market is constantly changing and like many businesses, the reinsurance market cycle is impacted by a number of different factors.  

Traditional reinsurers might consider this alternative capital a threat, while brokers and buyers consider it an opportunity to explore new reinsurance structures and efficiencies.  

Either way, there is a place for both traditional and non-traditional capital in the reinsurance marketplace.

At the moment the focus of this new alternative capital is mostly centred on property catastrophe reinsurance, but that too is likely to change in time. 

Thomas McKevitt, is executive vice president, Bermuda Reinsurance at Allied World.