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Alternative Capital:Impacts on Global Insurance and
Reinsurance MarketsAnnual Circle of Chief Economists
Paris, France25 March 2015
Download at www.iii.org/presentations
Robert P. Hartwig, Ph.D., CPCU, President & EconomistInsurance Information Institute 110 William Street New York, NY 10038
Tel: 212.346.5520 Cell: 917.453.1885 [email protected] www.iii.org
2
A World of Low Yields
2
Capital Will Seek Its Highest (Risk-Adjusted) Return
3
U.S. Treasury Security Yields:A Long Downward Trend, 1990–2015*
*Monthly, constant maturity, nominal rates, through Feb. 2015.Sources: Federal Reserve Bank at http://www.federalreserve.gov/releases/h15/data.htm. National Bureau of Economic Research (recession dates); Insurance Information Institute.
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15
Recession2-Yr Yield10-Yr Yield
Yields on 10-Year U.S. Treasury Notes have been essentially below 5% for a full decade.
Since roughly 80% of P/C bond/cash investments are in 10-year or shorter durations, most P/C insurer portfolios will have low-yielding bonds for years to come.
U.S. Treasury yields plunged to historic lows in 2013. Longer-
term yields rebounded then sank fell again.
3
European Central Bank Benchmark Rate, 2000 – 2015*
4*As of 20 March 2015.Source: European Central Bank from www.tradingeconomics.com; Insurance Information Institute.
Interest Rates Have Been Slashed by Most Major Central Banks, Igniting a Global Quest for Yield. Reinsurance Is Just One of
Many New Areas “Discovered” by Large Institutional Investors
ECB’s cut its key rate to 0.05% on 4 Sept. 2014
where it remains in March 2015
Book Yield on Property/Casualty Insurance Invested Assets, 2007–2016F
4.42
4.19
3.95
3.71
3.283.20
3.13
3.74
3.523.38
3.0
3.2
3.4
3.6
3.8
4.0
4.2
4.4
4.6
07 08 09 10 11 12 13 14E 15F 16F
The yield on invested assets continues to decline as returns on maturing bonds generally still exceed new money yields. The end of the Fed’s QE program in Oct. 2014 should allow some increase
in longer maturities while short term interest rate increases are unlikely until mid-to-late 2015
Sources: Conning.
(Percent)
Book yield in 2014 is down 114 BP from pre-crisis levels
6
A World Awash in Capital
6
Too Much of a Good Thing?The Global Glut of Capital is Not
Unique to (Re)Insurance
Hedge Fund Industry: Assets Under Management: 1997–2014:Q41
$118
.2
$143
.1
$188
.9
$236
.6
$1,2
29.0
$1,3
60.7
$1,7
13.1 $2
,136
.8
$1,4
57.9
$1,5
54.1
$1,6
93.9
$1,7
10.0
$1,7
98.7
$2,1
56.7
$2,4
78.6
$321
.9
$505
.5 $825
.6
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14:Q4
Yield Hungry Pension Funds Have Grown Rapidly Since the Financial Crisis, Deploying Oceans of Capital in Industries Across the Globe—
Including the Global Reinsurance Industry
1 Figures for 2011-2014 are as of Q4 for each year.Sources: BarclayHedge: http://www.barclayhedge.com/research/indices/ghs/mum/Hedge_Fund.html; Insurance Information Institute.
($ Billions)
Assets managed by hedge funds are up 70%
or $1.02 trillion since 2008 to $2.48 trillion
S&P 500 (Excl. Financials):Cash & Short-Term Investments
8Source: Fact Set Fundamentals.
Holdings of Cash and Liquid Asset Holdings Have Soared Across Virtually All Industries Since the Financial Crisis
Cash and ST investments holdings have nearly doubled since 2007
9
8.6% 8.4% 8.0%6.4%
5.5%4.4%
2.3%
9.9%10.1%10.6%11.4%13.3%
14.9%
0%2%4%6%8%
10%12%14%16%
Compound Annual Growth Rate (%)
9
Global Pension Assets Growth,2008 – 2013*
Global pension assets for the top 13 pension
markets reached $31.98 trillion in 2013 (+9.5% from 2012), an
amount equal to 83.4% of these economies
CAGR of pension fund assets in most major pension markets has
been quite strong since the financial crisis
*As of year-end. Source: Towers Watson Global Pensions Asset Study 2014 at: http://www.towerswatson.com/en-US/Insights/IC-Types/Survey-Research-Results/2014/02/Global-Pensions-Asset-Study-2014
Pension Asset Allocation(World’s 7 Largest Pension Markets)
10
Holdings of Cash and Liquid Asset Holdings Have Soared Across Virtually All Industries Since the Financial Crisis
Alternative investment’s
share of assets is up +15 points since 2001 from 5% to
18%
*Australia, Canada, Japan, Netherlands, Switzerland, UK, US. Source: Towers Watson Global Pensions Asset Study 2014 at: http://www.towerswatson.com/en-US/Insights/IC-Types/Survey-Research-Results/2014/02/Global-Pensions-Asset-Study-2014
11
Policyholder Surplus, 2006:Q4–2014:Q3
Sources: ISO, A.M .Best.
($ Billions)$4
87.1
$496
.6
$512
.8
$521
.8
$478
.5
$455
.6
$437
.1 $463
.0 $490
.8 $511
.5 $540
.7
$530
.5
$544
.8
$559
.2
$559
.1
$538
.6
$550
.3
$567
.8
$583
.5
$586
.9 $607
.7
$614
.0
$624
.4 $653
.3
$671
.6
$673
.9
$662
.0
$570
.7
$566
.5
$505
.0
$515
.6
$517
.9
$400
$450
$500
$550
$600
$650
$700
06:Q
4
07:Q
1
07:Q
2
07:Q
3
07:Q
4
08:Q
1
08:Q
2
08:Q
3
08:Q
4
09:Q
1
09:Q
2
09:Q
3
09:Q
4
10:Q
1
10:Q
2
10:Q
3
10:Q
4
11:Q
1
11:Q
2
11:Q
3
11:Q
4
12:Q
1
12:Q
2
12:Q
3
12:Q
4
13:Q
1
13:Q
2
13:Q
3
13:Q
4
14:Q
1
14:Q
2
14:Q
3
2007:Q3Pre-Crisis Peak
Surplus as of 9/30/14 stood at a record high $673.9B
2010:Q1 data includes $22.5B of paid-in capital from a holding company parent for one insurer’s investment in a non-insurance business .
The industry now has $1 of surplus for every $0.73 of NPW,close to the strongest claims-paying status in its history.
Drop due to near-record 2011 CAT losses
The P/C insurance industry entered 2015in very strong financial condition.
$0.50
$0.60
$0.70
$0.80
$0.90
$1.00
$1.10
$1.20
$1.30
$1.40
$1.50
$1.60
$1.70
$1.80
$1.90
$2.00
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14*
Premium-to-Surplus Ratio:1985–2014*
* As of 9/30/14.Source: A.M. Best, ISO, Insurance Information Institute.
The larger surplus is in relation to premiums—the lower the P:S ratio—
and the great the industry’s capacity to handle the risk it has accepted
(Ratio of NWP to PHS)
The Premium-to-Surplus Ratio Stood at $0.75:$1 as of9/30/14, a Record Low (at Least in Recent History)
Surplus as of 9/30/14 was $0.75:$1, a near-record low (at least in modern history)
9/11, Recession & Hard Market
US P/C Insurance Industry Excess Capital Position: 1994–2016E
Source: Barclays Research estimates.
Su
rplu
s R
edu
nd
ancy
(D
efic
ien
cy)
The Industry’s Strong Capital Position Suggests Insurers Are in a Good Position to Increase Risk Appetite, Repurchase Shares
and Pursue Acquisitions
Per
cen
t R
ed
un
dan
cy (
Def
icie
ncy
)
Barclay’s suggests that surplus is approximately
$200B (~30%)
15
Alternative Capital
15
New Investors Continue to Change the Reinsurance Landscape
First I.I.I. White Paper Released inMarch 2015
Global Reinsurance Capital (Traditional and Alternative), 2006 - 2014
2014 data is as of June 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
Total reinsurance capital reached a record $570B in 2013, up 68% from
2008.
But alternative capacity has grown 210% since 2008, to $50B. It has more than doubled in the past three years.
17
Increase in Global Reinsurance Capital, 2008 – 2014:Q4
Source: Insurance Information Institute based on data from Aon Benfield.
Reinsurance capital increased by ~$230 Bill. from 2008 - 2014
Alternative capital’s growth rate was 25% in 2014, 28% in 2013 and 39% in 2012.
Alternative capital’s share of global reinsurance capital has doubled, from 5.9% in 2008 to 12.0% in 2014
This growth has occurred during a period of falling and very low interest rates and, with the exception of 2011, relatively benign global cat activity.
Alternative Capital Growth Facts
17%83%
All Other$192 Bill
Alternative Capital$40 Bill
2014, $Billions
Alternative Capital now accounts for about 17% of global reinsurance capital
Alternative Capital as a Percentage of Traditional Global Reinsurance Capital
2014 data is as of September 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
4.6%
5.7% 5.9% 5.8%5.4%
6.5%
8.4%
10.2%
12.0%
0%
2%
4%
6%
8%
10%
12%
2006 2007 2008 2009 2010 2011 2012 2013 2014
Alternative Capital’s Share of Global Reinsurance Capital Has More Than Doubled Since 2010.
Growth of Alternative Capital Structures, 2002 - 2014
2014 data is as of June 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
Collateralized Re’s Growth Has Accelerated in the Past Three Years.
Collateralized Reinsurance and Catastrophe Bonds Currently Dominate the Alternative Capital Market.
Catastrophe Bond Issuance and Outstanding: 1997-2014
20
Risk Capital Amount ($ Millions)
2014 Has Seen the Largest Cat Bond Ever - $1.5 Billion (Florida Citizens). Bond Issuance Set a Record.
Source: Guy Carpenter.
Largest Sponsors of ILS, Year-End 2014
21
Two of the Largest ILS Issuers Are Government-Sponsored Insurers. Nine Government-Related Insurers Have $4.6 Billion in Outstanding Securities.
Source: Artemis.bm; Insurance Information Institute.
Reinsurance Pricing: Change in Rate on Line for Cat Business
2014 reflects change through June 30 from prior year end. 2015 is for January 1 renewals..Source: Guy Carpenter; Insurance Information Institute.
Catastrophe Reinsurance Prices Fell 11 Percent on January 1 Renewals, Driven by Emergence of New Capital, Mild Catastrophe Losses.
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-20%
-10%
0%
10%
20%
30%
40%
14% 14%
-11%
-6%
76%
-9%
-16%
10%
-12%
-3%
7%
-7%
-17%
-11%
(Change from Previous Year)
Japan, NZ Quakes, US Tornadoes.
2001-02: WTC Losses, Falling
Stock, Bond Prices Dry Up Capital.
2006: Higher Rates After Record Hurri-
canes.
76%Alternative
Capital, Low Levels of
Catastrophe Drive Rates
Down.
U.S. Wind-Exposed Risk Premium* 2010:Q1 to 2014:Q4
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
Q2-14
Q3-14
Q4-14
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
10.9%
8.2%
8.0%
8.0%
7.9%8.2%
8.2%
10.1%10.9%
12.0%
12.0%
11.6%
11.0%
7.6%
7.4%7.2%
6.4%6.2%
6.1%
5.8%
Ris
k S
pre
ad
(c
ou
po
n –
ris
k-f
ree
ra
te)
23
* Trailing 12-month averageSOURCE: Willis Capital Markets, Insurance Information Institute.
Risk spreads dropped to less than half their
mid-2012 levels – equivalent to lower rates –
low cat losses, capital entering
market.
Risk spreads rose in 2011-2012 from cat activity and changes to catastrophe
models.
Non-U.S. Wind-Exposed Risk Premium* 2010:Q1-2014: Q1
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
8.5%
7.2%
6.9%
4.2%
4.2%4.5%
5.7% 5.7%5.7%
5.6%
4.9%
5.4%
4.8%
4.2%
3.6%
2.7%2.6%
Wtd. Avg. Risk Spread
Ris
k S
pre
ad
(c
ou
po
n –
ris
k-f
ree
ra
te)
24
* Trailing 12-month average.SOURCE: Willis Capital Markets, Insurance Information Institute.
Spreads are also falling in non-U.S. wind exposures, but
less sharply and in line with
expected losses
Insurance-Linked Securities:Average Multiples, 1997 – 2014*
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
20132014
0
1
2
3
4
5
6
7
8
6.51
5.675.38
5.90
7.22
5.42
4.33
3.233.70
4.56
3.39
4.29
5.14
3.33
4.154.44
3.142.78
Ris
k S
pre
ad
/Ex
pe
cte
d L
os
s
25
*The ILS Multiple is computed as: (Bond Coupon – Risk Free Yield)/Expected Loss.SOURCE: www.Artemis.bm Deal Directory, Insurance Information Institute.
In Early Years, Investor Reluctance Kept Multiples
High in Tiny Market
Range Established
2014: Breaking 2013 Record for Lowest Multiple
Cat Bond Terms Have Also Softened, With Indemnity Triggers (Favored by Insurers) Growing More Common.
Multiple is a Rough Estimate of Risk-Adjusted Return
ILS Issuance by Trigger
Source: Artemis.bm; Insurance Information Institute.
Terms Are Shifting Away From ‘Objective’ Triggers (Favored by Investors) Toward Indemnity Trigger (Favored by Insurers).
U.S. Wind and Quake33%
U.S. Wind25%
Other (incl. U.S. Wind)
9%
Euro Wind9%
U.S. Quake8%
Other (ex. U.S. Wind)
8%
Japanese Perils8%
27
Catastrophe Bonds Outstanding, Q4 2014
Source: Willis Capital Markets, Insurance Information Institute.
Catastrophe Bonds Are Heavily
Concentrated in U.S. Hurricane
Exposures. Two-thirds of
Catastrophe Risks Outstanding Cover U.S. Wind Risks.
How a Catastrophe Bond Works
28
Reinsurer pays interest, returns
principal at end of term.
Reinsurer pays losses.
Counterparty holds capital till needed, guarantees fixed
return.
Reinsurer invests bond proceeds in
swap. Swap Counterparty
Insurer cedes premium.
Investors supply capital.
Reinsurer (Special Purpose Vehicle)
Investors Insurer (Sponsor)
31
Questions Arising from Influence of Alternative Capital What Will Happen When Investors Face Large-Scale
Losses?
What Happens When Interest Rates Rise?
Does ILS Have a Higher Propensity to Litigate?
How Much Lower Will Risk Premiums Shrink/ROLs Fall?
Will Investors Lose Interest as Risk Premia Shrink?
Will There Be Spillover Into Casualty Reinsurance?
Will Alternative Capital Drive Consolidation?
Has the Reinsurance Industry Been Fundamentally and Irrevocably Transformed?
32
Three Possible Scenarios for Alternative Capital (per McKinsey)
Peak At or Near Current Level: Alternative capital could peak at its current level, as spreads fall too low to keep investor interest, or until a major catastrophe drives them off. Insurers would still seek alternative arrangements but would prefer the security traditional reinsurers offer. Reinsurers would continue to partner with alternative investors, but these deals would remain a minor piece of overall capital.
Doubling to 30% of Catastrophe Capital: Alternative investors remain attracted to bonds where risk is uncorrelated with the overall economy and insurers continue to like spreading risk outside a few traditional reinsurers, particularly in structures in which losses are collateralized at the inception of the deal.
Grow Even Larger (>30%): Dislocating the current markets, as investors grow comfortable enough with the arrangements that they begin to offer terms that more closely resemble the traditional reinsurance contract. SOURCE: Insurance Information Institute from McKinsey & Company, Could
Third-Party Capital Transform the Reinsurance Markets?, Sept. 2013.
34
Potential Pros and Cons of Alternative Capital (per McKinsey) PROs
Collateralized deals (in theory) reduce the risk (albeit quite small) that the reinsurer will be unable to fulfill its obligations
Insurers can diversify risk across more markets, rather than being concentrated with just a few reinsurers, many of whom reinsure each other via retrocessional arrangements
Insurers can lock in strictures for several years, which is particularly attractive when yields (rates) are low
CONs: Capital may not be available over the long term. Investors can quickly exit if
reinsurance (ILS) investments become less attractive than alternatives
Alternative agreements do not perfectly replicate traditional reinsurance treaties. Basis risk is one mismatch. Lack of reinstatement provisions in cat bonds is another.
Insurers also frequently benefit from reinsurers’ knowledge of the marketplace. Alternative capital providers often lack this expertise.
SOURCE: Insurance Information Institute from McKinsey & Company, Could Third-Party Capital Transform the Reinsurance Markets?, Sept. 2013.
www.iii.org
Thank you for your timeand your attention!
Twitter: twitter.com/bob_hartwigDownload at www.iii.org/presentations
Insurance Information Institute Online:
35