Alternative Capital and the New Normal Tom Collett, Managing Director, Guy Carpenter & Company, LLC | Jul 26, 2018

Alternative Capital

Understanding how capital, technology, and business intersect is vital to operating in the new insurance economy. Alternative capital has caused fundamental change in our market, and it would be foolish to ignore its impact. So, whether you see it as a threat or an opportunity, formulating a strategy to adapt is critical.   

The Evolution of Alternative Capital

Alternative capital is relatively new to insurance. In 2001, catastrophe bonds (cat bonds) were a mere four years old. But after the fall of the World Trade Center, a slew of start-up capital providers entered the market, and alternative capital grew more than fivefold to $7.7 billion. In 2010, the market really took off, and today alternative capital hovers around 20% of the total global cat limit.

Alternative capital has brought fundamental change to the market. The flow of capital has become very fluid, and companies increasingly match the “right capital to the right sources of risk”. This has dampened pricing volatility and lowered absolute costs in peak zones like Florida.

Despite its attraction, alternative capital has not displaced reinsurance. In fact, about five years ago, traditional “trapped capital” (i.e. reinsurers) and dedicated ILS fund managers began to embrace elements of each other. Now, it is increasingly hard to distinguish between the two. In fact, out of the $75 billion of alternative capital, over $20 billion is now managed by “traditional reinsurers”.

An Attractive Investment

Two key features make insurance-linked securities (ILS) potentially desirable. They have a payout like high-yield bonds, and they are uncorrelated with traditional bonds and equities. These attributes attract certain institutional investors looking to diversify. As a result, the market has pulled in a range of investor types, including pension funds, hedge funds, dedicated ILS firms, and others.

Catastrophes like those of 2017 should have swayed the investment appetite for ILS. Yet despite an unprecedented $130 billion in losses – from Harvey, Irma, Maria and Nate, and the California wildfires – alternative capital grew by 16%. This makes sense when you consider the investor’s time horizon. An investor in the market for the long term can absorb a single year of cat losses. And the ability to hedge other investments through ILS is still attractive. The question yet to be answered is whether a few years of catastrophic events, back-to-back, will sway future investment.

The New Normal

For agencies, carriers, and the rest of the insurance world, alternative capital has created a “new normal”. The soft market appears to be here for the foreseeable future. And abundant capital should  continue to hold rates down, even in the face of cat losses like those of 2017.

So, is alternative capital a threat or an opportunity for insurers? It depends on your perspective. Some insurers are embracing alternative capital to lay off risks from their books, so they can pursue new business. Others see an opportunity to play a role in the shifting value chain, with fronting carriers as just one example.

The best agencies, carriers and reinsurers will use advances in technology and analytics to segment the market and pursue profitable growth with targeted new products. As with any change, those who learn to adapt will come out on top.

Tom is a Managing Director for Guy Carpenter & Company LLC., working out of the Dallas office. Tom has active account and production responsibilities across the USA covering a wide range of Property and Casualty Insurers and MGA’s. Tom has over 35 years of experience in the Reinsurance business, most recently with Willis Re where he was an Executive Vice President. In addition to his account responsibilities Tom lead the Program Practice during his time at Willis Re. Prior his time with Willis Re Tom spent extensive time with Benfield (EVP and member of the Management Committee), General Re (SVP) and Munich American Re (VP) Tom has a BA in Economics from Lake Forest College.