London market insurance and reinsurance firms, including at Lloyd’s, have increased their use of alternative capital and insurance-linked securities in recent years. But while this is seen as supportive of their returns-on-equity and cycle management capabilities, it may also exacerbate rate softening AM Best warns.
In addition, new entrants and startups are bringing more capital to bear as well, while the Lloyd’s marketplace is also becoming increasingly adept at leveraging third-party capital in more efficient ways, utilising insurance-linked securities and third-party reinsurance capital structures.
All of this has accelerated during a time when we have not seen the kind of loss induced capital destruction across insurance and reinsurance that might moderate a softer cycle, so capital influx into London is exacerbating the trend, it seems.
The London market has been seen as one of the most attractive places to deploy capital into insurance and reinsurance businesses.
But how those businesses are funded has also changed, with some investors that previously would have backed equity rounds, or the standing up of brand new businesses, are now more attracted to opportunities that extend the scope and potential of seasoned underwriting businesses.
As a result, sidecar like structures, aligned quota shares, and ILS transactions, have been gaining traction for London market participants.
In a recent report, AM Best notes that London market participants have been using structures such as catastrophe bonds and sidecars to access alternative reinsurance capital from investors, with both property and casualty structures seen.
It’s also worth adding that there are specialty lines ventures in Lloyd’s which are also utilising third-party investor capital, such as Nephila Capital’s Syndicate 2358.
On top of this, the Lloyd’s sponsored insurance-linked securities vehicle and protected cell company London Bridge 2 PCC has continued to gain traction.
London Bridge 2 has now been utilised for catastrophe bond issuance, collateralized reinsurance transactions and also as a route for funding Lloyd’s members in a more efficient version of the traditional model.
“AM Best expects the increasing use of alternate capital to boost return on equity for some London Market companies and support cycle management,” the rating agency said.
But added that, “AM Best notes that the influx of third-party capital and new market entrants coincides with organic capital generation that is at an all-time high after several years of stellar earnings.
“This heightens the risk of further market softening. Underwriting cycle management is therefore expected to become a key consideration for management teams.”
There is a need for the market to manage its capital base and as players in London become increasingly adept at utilising ILS techniques and structures that can source investor capital more directly, it will be important not to saturate the market and accelerate softening of rates to levels where return adequacy suffers.
Of course, a large component of the London market is the capital base of the major re/insurers that have operations there and with some utilising modern capital infrastructure to partner with investors already, they could perhaps divert some of their own capital base to re/insurance opportunities around the rest of the world.
But that might conflict with the London market’s own stated goal of bringing the world’s risk to it, so perhaps the bigger question is can London grow its premium base at a rate sufficient to keep up with and absorb a growing capital base?
