Third-party capital is expected to continue growing and to remain an important way for reinsurers to reduce natural catastrophe risk, according to S&P analysts.
According to a recent S&P report the risk level of natural catastrophes – influenced by climate change, urbanisation, and inflation – is high, a trend that will remain unchanged for the next twelve months.
Higher losses come with elevated nat cat, driving primary insurers to try to cede more of this risk to reinsurers, which have in turn raised rates and reduced capacity for coverage that protects against loss frequency, analysts highlighted.
One way for reinsurers to manage nat cat exposure is through the use of alternative capital, which has been growing significantly since 2006.
“Nat cat exposure is attractive to third-party capital providers–such as sovereign funds, private equity, and hedge funds, among others–because it’s a source of portfolio diversification that isn’t correlated with factors such as interest rates, and it offered promising returns while interest rates were low,” analysts explain.
Adding: “As interest rates have climbed, third-party capital providers have maintained their appetite for the uncorrelated risk that nat cat offers while becoming more selective about the insurers and reinsurers they work with–especially in terms of underwriting, profitability, and enterprise risk management.
Cat bonds will continue to be favoured by investors over other insurance-linked securities, S&P believes.
This is mainly due to the cat bonds having a better structure, clearer coverage, and more liquidity compared with other forms of insurance-linked securities.
“We expect third-party capital to continue to grow and to remain an important way for reinsurers to effectively manage and reduce their exposure to catastrophe risk, helping them to meet strong demand for coverage,” S&P analysts stated.
“Moreover, the use of third-party capital has been expanding into other lines, such as cyber and mortgage insurance. Our median rating for the reinsurance sector is ‘A+,’ and we expect strong demand to sustain the industry’s pricing momentum through the upcoming 2024 renewals,” they concluded.
Other top risks for reinsurers, according to S&P’s report, include geopolitical tension, which can affect both sides of the balance sheet; social and economic inflation and potential effects on claims cost and reserve adequacy; and rising cyber exposure, including concentration and aggregation risks.
All the above risks are considered high by S&P analysts. The social and economic inflation risk is to remain unchanged in the next twelve months, while the rest are to be monitored.
