![]() The reinsurance market was valued at $560 billion as of the end of 2022. The demand for alternative capital is large enough to fit investors’ needs. When losses are low, the value of the contract declines.ĭerivatives allow for cat bonds and ILWs to be traded. When losses are high, the value of the contract increases. Sidecars are co-investments in which an SPV contains third-party capital and traditional reinsurance capital.įronting arrangements refer to third-party capital provided through the infrastructure of a carrier with a credit rating.Ĭatastrophe futures are indexed to parameters associated with events covered in parametric insurance, and they are publicly traded. They can be defined for a single peril or multiple perils and are conveyed in a securitized special-purpose vehicle (SPV).Ĭollateralized reinsurance refers to nonsecuritized private transactions that allow entities without credit ratings to participate in the market. Industry loss warranties (ILWs) are securitized contracts indexed on industry-wide losses arising from an event.Ĭatastrophe bonds (cat bonds) are risk-linked securities. And because ILS returns are typically uncorrelated with equity market returns, ILS are an appealing source of diversification (Exhibit 1). 3 Eurekahedge ILS Advisers Index, accessed MaMSCI AC World Index, returns 2008–22, FactSet, accessed March 4, 2023. ILS returned 4 percent per year from 2005 to 2022, compared with 3 percent per year from equities in the same period. Investors are attracted to ILS because they have better risk-adjusted returns than global equities. For investors: Diversification and managed risk In return, insurers can receive capital at better terms. ILS help investors diversify their portfolios and manage and refine the kinds of risks they take on. Within an appropriately structured relationship, investors that provide alternative capital and insurers both benefit. Advantages for both investors and insurers Insurers should consider making alternative capital a core part of their capital management strategy. This market is dynamic, and we believe it will grow beyond catastrophe classes and see the evolution of platforms for insurance-linked securities (ILS) as well as new investors, new business models, and regulatory reform. Although total reinsurance capital declined 11 percent from 2021 to 2022, alternative capital stayed constant at about $95 billion. Our analysis shows that alternative capital deployed into reinsurance grew significantly from 2010 to 2020, by 15 percent per year, and has consistently contributed 13 to 18 percent of total reinsurance capital since 2015. ![]() 2 For more, see Kevin Bradicich, Ari Chester, Peter Hahn, and Giambattista Taglioni, Could third-party capital transform the reinsurance markets?, McKinsey, September 11, 2013. This was already happening in 2013, when McKinsey outlined three scenarios for how alternative capital in insurance could evolve (see sidebar “Recap of 2013 insights: How the reinsurance market could evolve”). Alternative capital from sources outside of traditional reinsurance has surged and embedded itself into P&C insurers’ capital structure. Because their large balance sheets can absorb volatility in the comparatively smaller reinsurance market, major investors that take large positions in the market could create this dislocation.īut there is good news. We wrote that alternative capital could reach or exceed 40 percent of the reinsurance market’s capacity since the global value of managed assets dwarfs that of the property catastrophe reinsurance market. ![]() We predicted that alternative capital could grow to become 25 to 35 percent of the market’s capacity if insurers became more comfortable with alternative-capital instruments and if investors were attracted by uncorrelated yields and became more comfortable with the risks of participating in the reinsurance market.ĭislocation. ![]() Insurance carriers could also favor traditional reinsurers if they believed investors lacked long-term commitment to reinsurance.ĭisruption. We wrote that developments such as a large catastrophic event that erodes a principal investment or rising yields in standard markets could dampen investors’ appetite for involvement with the reinsurance market. In 2013, alternative capital was 15 to 20 percent of the reinsurance market. 1 For the full report, see Kevin Bradicich, Ari Chester, Peter Hahn, and Giambattista Taglioni, Could third-party capital transform the reinsurance markets?, McKinsey, September 11, 2013. ![]() In that report, we sketched out three scenarios for how the reinsurance market could evolve in the future. We published a report about global alternative capital in 2013. ![]()
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