The collateralised reinsurance market remains the fastest-growing segment of the insurance-linked securities (ILS) industry despite significant investor losses from 2017 and 2018 catastrophe events, according to a new AM Best report.
At year-end 2018, AM Best says market capitalisation of the collateralised reinsurance market was approximately $56 billion out of an approximately $95 billion ILS market.
Meanwhile, heavy cat losses of the last two years have highlighted the issue of trapped collateral in the market.
Of the total $95 billion third-party capital in 2018, AM Best says between 20%-25% was trapped. In 2019, the firm estimates that figure was closer to 15%.
During 2017 and 2018, as loss estimates changed over time, The industry experienced difficulty in determining the ultimate loss amount on catastrophe events and could not release tied up capital until risk-bearing entities’ obligations were satisfied.
AM Best notes that this creates a significant drag on the results of collateralised reinsurance transactions and that this drag on investment returns can run as high as 20%.
As a result, the impact of trapped capital is becoming a more important consideration in the risk pricing of collateralised reinsurance contracts.
In addition, AM Best says collateralised reinsurers are paying closer attention to the quality of cedents with the aim of containing potential loss creep.
Pricing is differentiated based on historical loss experience, the accuracy of prior loss estimates, long-term performance and a willingness to work as partners.
Going forward, AM Best believes high-quality cedents likely are to be rewarded with better pricing, terms and conditions.
Given that ceding companies generally are exposed to the tail risk associated with collateralised reinsurance programs, the growth in volume and value of these transactions undoubtedly will create collateral and credit risks.
AM Best believes that there have been improvements in reducing collateral risk, but it still remains and is a critical component in AM Best’s rating considerations.