December 11, 2023

Players in the global insurance and reinsurance industry need to consider alternative capital and insurance-linked securities (ILS) as “a core part of their capital management strategy” to deliver on the promise of filling protection gaps, enhancing relevance to clients and purchasing reinsurance Efficiency, say the McKinsey consultants.

Core Currency Apple CapitalIn a recent paper, McKinsey consultants noted that the good news is that “alternative capital from sources other than traditional reinsurance has proliferated and embedded itself in the capital structure of P&C insurers.”

But according to the consultant, there are other benefits to a greater adoption of alternative capital as the insurance-linked securities (ILS) market develops further and the range of alternative reinsurance capital goods expands for vehicle investors and insurers using them.

McKinsey noted that further growth is expected outside of catastrophe business categories, with substantial opportunities to use alternative forms of reinsurance capital to fill gaps in available capacity in categories such as networks.

While reinsurers/insurers will also benefit from attracting more investors into the market, this may help them seek to negotiate better terms with the reinsurance market.

ILS and alternative reinsurance capital “offer a lower cost of capital than traditional reinsurance, especially against a backdrop of rising industry losses and rising equity and debt financing costs,” according to the McKinsey consultants.

They can also benefit carriers through the multi-year nature of ILS coverage and by reducing counterparty risk as funds are locked in trust when claims may need to be paid.

There is also the potential to earn additional revenue from alternative capital by fully integrating it and earning fees on its management, which, the consultant noted, could also “enhance the franchise value of the insurer”.

“The predictable income stream for investors subscribing to the franchise can also offset the volatility of underwriting performance, all of which are considered positive in capital markets,” they explained.

Specific opportunities exist in expanding the ILS asset class to cover other P&C insurance classes, and insurers can help by helping investors build exits while benefiting from effective capabilities in a segment that has been lacking.

McKinsey also noted that there is also an opportunity to disintermediate through direct deals with investors, meaning reinsurance can be obtained from capital market investors, bypassing traditional markets.

But the key to all of this is that insurers are positioning themselves to bolster investor confidence while also catering to an increasingly diverse investor appetite.

According to McKinsey, product transparency and certainty, simplified structures and contract language, opportunities for diversification, and having the right talent on hand are all areas insurers can focus so they can maximize their relationships with alternative capital providers .

“As part of an insurer’s core capital management strategy, alternative capital can help drive returns and fill the P&C insurance gap,” the advisers said.

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