Ring Of Truth

The Ring of Truth: A State of Effervescence in Reinsurance?

In Michael Chrichton's Jurassic Park novel, the real star was not the dinosaur. As deadly as the T-Rex and the Velociraptors were, one of the most important characters of the book was Dr Ian Malcolm, the sarcastic philosopher who insisted from the beginning of the story that the dinosaur park was a disaster; an accident waiting to happen. He used the Chaos Theory to predict that "Life always found a way" and that the park would collapse. He believed that the park was an unsustainable structure that had no place in the world today. No matter how much we try to control and predict complex situations, it will never be enough to be 100% sure that everything is under control. At its heart

But lately the multibillion reinsurance industry looks under threat, as insurers are increasingly bypassing reinsurers and discharging their risk directly to the capital markets instead.

Insurers have been increasingly transferring risks through complex “bundled” reinsurance arrangements. Many have been gradually turning to pension funds and other capital markets investors – by issuing securities such as catastrophe bonds – as a substitute to traditional reinsurance. Bundled deals make the underlying risks, on which they are based, opaque. Such shifts in the underlying basis of a deal bear resemblance to changes those were associated with the subprime mortgage crisis.

In a book titled ‘Making a Market for Acts of God’, the author, Paula Jarzabkowski, professor of Strategic Management at Cass Business School, has argued that the market is moving from coverage of acts of God to one that covers commoditized risks. During their three-year research on the book, Jarzabkowski and her co-authors Rebecca Bednarek and Paul Spee discovered that the reinsurance market that has worked very well over the years is beginning to evolve into a commodity

While the current state might not be as reflective, with tranches of securitized mortgage debt and Collateralized Loan Obligations (CLOs), but catastrophe bonds and Insurance-Linked Securities (ILS). The buyers remain same, though. Pension funds, sovereign wealth funds, hedge funds and other institutional capital infatuated with the idea of uncorrelated returns in higher yielding instruments.

A long-standing industry is born afresh with innovative financial products attracting huge amounts of fresh capital in pursuit of incremental yield. The parallels between the two seemingly incongruent episodes in financial history lead us to ask: Is it a state of effervescence in reinsurance, and if so, what will the impact of the eventual wind down look like?

According to Aon Benfield, the alternative reinsurance capital growth rate experienced in 2014 suggests that the ILS, collateralized reinsurance and catastrophe bond space will scale $150 billion of capital by 2018. Alternative capital in the sector registered a growth of 28% in 2014, jumping from $50 billion at the end of 2013 to $64 billion at the end of last