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Should Insurers Welcome Their Capital Markets In-Laws?

Posted by Sam Friedman, Insurance research leader, Deloitte Services LP, on April 9, 2014

Insurance buyers are benefitting from the flood of money pouring into the property-casualty business these days outside of normal channels, but some in the industry don't quite seem to know what to make of the new wave of investors seeking diversification, non-correlated risks and better returns.

As Deloitte noted in its recent 2014 Property and Casualty Insurance Industry Outlook, insurance-linked securities, such as catastrophe bonds, are being scooped up at record levels by individual and institutional investors. Meanwhile, hedge funds are financing reinsurance companies and managing their reserve funds, figuring they might be able to produce superior margins given their keen investment skills.

This influx of capacity from non-traditional sources has already prompted reinsurers to lower prices and might even spur greater consolidation in the sector before long to relieve overcapacity. And while the focus for now appears to be on property-catastrophe exposures, such capital markets sources are likely to migrate into additional lines of business and not just at the reinsurance level.

For consumers, this is all good. It's the classic law of supply and demand. More money invested in insurance means more capacity to underwrite risks, which means more competition, which means lower prices. The short-lived hardening market for property coverage is already losing steam as a result.

However, while the new breed of investors was one of the hot topics discussed during the industry's annual "family reunion" earlier this year, such capital markets "in-laws" were nowhere to be seen at the festivities. That's unfortunate, in my humble opinion.

These newcomers may have been out of sight, but they were anything but out of mind during the gathering of company and association leaders at the Property and Casualty Insurance Joint Industry Forum, convened this past January in New York.

Hedge funds, pension funds, sovereign wealth funds and other institutional players have a huge pool of assets to invest. Committing even a very small stake from the perspective of these gigantic capital entities could generate a significant ripple effect in terms of insurance capacity and prices. Add to that a deepening pool of individual investors eager to fill out their portfolios with insurance-linked securities and you have a movement on your hands, rather than a passing fad.

Yet some at the Forum shrugged off this trend, dismissing capital markets players as short-term interlopers likely to scatter at the first sign of a major catastrophe or series of disaster losses. Rising interest rates or some other macroeconomic change could also prompt them to move their chips into what's perceived to be safer bets, these skeptics added.

I'm not so sure about that. Given the volatility in the economy right now and compared to the potential returns offered elsewhere, property-casualty insurance may appear to be a pretty intriguing investment to many of these savvy players for quite some time. And even if a major loss occurs, initially that would likely send insurance premiums sharply higher. Such a development could actually draw more alternative market investors rushing in to capitalize on the pricing upswing — at least in the short term.

I liked hearing one Forum panelist opine that additional competition was good for insurers in the long run, in that it might prompt not just greater efficiency but real innovation — the latter not known as one of the industry's strong suits.

Others noted that capital markets aren't "the enemy" here. In fact, they offer a new range of risk-transfer alternatives and financing sources for traditional insurance carriers to tap.

In any case, it wouldn't hurt for insurers to invite the "in-laws" to next year's family reunion. I'd certainly be interested in hearing from the horse's mouth at the next Joint Industry Forum what capital markets investors think in terms of taking on more insurance risks. Wouldn't you?

As used in this document, "Deloitte" means Deloitte LLP [and its subsidiaries]. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

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