Kramer: Economics of reinsurance have changed
Reinsurance industry veteran Don Kramer is seeing an explosion in the insurance-linked securities (ILS) business, as investors opt to put their money into catastrophe bonds and the like, rather than set up new reinsurance companies.
Speaking at the Bermuda Captive Conference yesterday, Mr Kramer explained to delegates how historically low interest rates, volatile markets and low stock valuations of reinsurance companies were driving large investors toward ILS.
He said the economics of the reinsurance industry had changed markedly from the 1990s, when eight catastrophe reinsurers were formed in Bermuda in the aftermath of the 1992 Hurricane Andrew.
Back then, interest rates of around five percent allowed a reinsurer to make healthy investment income, while a hard market in a post-event period meant the opportunity for impressive underwriting margins.
In those days, you could expect to make 17 or 18 percent return on equity, and trade at 120 percent of book, Mr Kramer said.
Reinsurance rates had not risen sufficiently to fill the gap left by the sharp decline in investment income, so these days reinsurers money-making capability was less, while stock market valuations were, in many cases, at 70 or 80 percent of book value.
Mr Kramer also noted that reinsurers with large holdings of US Treasurys were very vulnerable to a rise in interest rates that would occur at some point in the future.
Yields on ten-year US Treasurys are now around the 1.5 percent mark. Should they rise to five percent, the value of reinsurers traditionally large holdings of such bonds would plunge, meaning that the industry would take a fairly big hit to its book value.
From a shareholders point of view, this is not an attractive place to be, Mr Kramer said.
Despite last year producing the second-highest catastrophe losses in history, rates had not spiked as they would have done in the past.
Nobodys starting new companies to be in the catastrophe business at 80 percent of book value, Mr Kramer said. It should bring about a rise in prices, but instead its created a new industry — insurance-linked securities.
Mr Kramer is CEO of ILS Capital Management, a Bermuda-based company he formed last year to capitalise on the ILS trend. The volatile state of the markets and sluggish global growth were boosting the appeal of ILS to investors, he said.
ILS are attractive, because they are not correlated with the markets, with interest rates or with the economy, Mr Kramer added. Securities tied to specified catastrophic events would inevitably suffer loss years when principal could be wiped out, as well as more years in which they would deliver strong returns.
What his company is seeking to do is to use portfolio analytics to offer investors a diversified pool of risks in order to remove much of the volatility and offer more consistent returns.
Pension funds dealing with issues of people living longer and unfunded liabilities growing ever larger in a low-yield environment were already starting to turn to ILS as an attractive alternative investment that could pep up yields, Mr Kramer said.
Although there was potential for catastrophe reinsurers returns to be attractive this year, Mr Kramer added: Im not a bull on the catastrophe companies in the short term, in terms of anything better than 80 to 90 percent of book value.
The differentiation between managers is the key as far as stock valuation is concerned.