Capital market-based reinsurance options represent an increasingly viable alternative to traditional reinsurance, Fitch said yesterday.
In an Alternative reinsurance market update, the ratings agency highlighted growing use of sources of reinsurance such as catastrophe (cat) bonds, where insurers issue high-risk bonds to raise money in case of a catastrophe such as a hurricane or earthquake. Insurers and reinsurers are also increasingly using collaterised quota-share reinsurance vehicles - sidecars - where investors take on the risk and return of a group of insurance policies.
Fitch warned, however, that the growth and acceptance of these alternative reinsurance vehicles represented a 'dual-edged sword' for reinsurers themselves. On the positive side, reinsurers can use them to manage their exposure and capital and as a source of income from fees for underwriting or managing transactions.
'Negatively, they represent competition for traditional reinsurers that, in conjunction with the strong overall capitalisation of the reinsurance industry, have worked to notably dampen reinsurance pricing momentum in 2012,' it added.
From the perspective of investors, Fitch expects the 'comparatively high potential returns' that can be made on these instruments to make them particularly attractive in the short term.
'Furthermore, the lack of correlation between catastrophe losses and returns on other major asset classes should continue to contribute to strong demand from investors, which include hedge funds, private equity and institutional investors,' it added.
Fitch expects 2012 to see the highest total amount of cat bond issuances since the record year of 2007, but 'structural issues inherent in the market' are likely to keep cat bonds as a niche asset class in the near term.
The agency also said it expects the hardening conditions in the reinsurance market that have seen rates increase to diminish over the next few months. This, combined with plentiful capacity in the reinsurance market, is likely to lead to less overall use of capital market reinsurance alternatives than was the case in 2011/12, it added.