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Investors seek more catastrophe risk

Channels: Markets, Corporate

Companies: Nephila Advisors, KKR, Allianz

People: Barney Schauble

The catastrophe risk transfer market is set for further growth, with a range of new products available for investors, says Barney Schauble, managing partner at Nephila Advisors.

 EF: How have recent natural disasters affected the catastrophe risk market?

The purpose of reinsurance, whether from traditional rated companies or “newer” capacity from investment managers that has been introduced to the market starting almost 20 years ago, is to ensure that the financial impact of natural disasters can be borne in an efficient way.  An old Lloyd’s of London expression describes that as “better the shoulders of the many than the heads of the few.” 

All natural disasters tend to increase demand for future coverage – we have seen that since the early 1990s in particular.  Some disasters are dealt with largely by primary insurance companies (localised flood, tornado), and others impact reinsurers and the broader cat risk market (most recently the Tohoko earthquake in Japan and Superstorm Sandy).

EF: How big is the market and how do you see it evolving in future?

The current market sees about $300 billion/year of catastrophe risk transferred in reinsurance (2-3% each via cat bonds, industry-loss warranties (ILWs) and retrocession and the remaining 90% in syndicated or private reinsurance transactions).  That market has grown each year and is not currently in equilibrium: there is more demand even today for peak catastrophe risk than there is supply. 

We expect to continue to see the amount of risk transferred grow, both in the existing peak regions and as economic growth outside the US and Japan mean that new reinsurance is required in places like China, Turkey, and Brazil.

EF: What trends are emerging in different cat risk products – e.g. cat bonds, ILWs, direct reinsurance etc?

The most notable trend is that most buyers of reinsurance have adopted the use of all of these tools, and are structuring risk transfer programs which have components to reach into all of these market sub-segments.  Many providers of risk capacity focus on only one segment – a cat bond fund, or an ILW seller at a reinsurance company – and others (like Nephila) are active in all.  For both buyers of protection and investors/risk capacity providers, the market today offers a much broader range of products and alternatives than it ever has in the past, which we think is an important sign of a vibrant and healthy market.

Barney Schauble: Nephila offers a range of products for the growing cat risk market EF: What is Nephila’s role in the market?

We operate an investment platform that offers institutional investors a range of different products which offer different risk/return profiles that are not correlated with broader financial markets, and offers buyers of protection a range of risk capacity alternatives across all segments of the reinsurance market.  As a firm, and as individuals, we have been in this market since its inception, and we strive to apply our advantages in experience, analytical expertise, and capital scale to offer the best products to both constituencies.  

EF: Has your approach to the market changed since KKR invested in the business?

Our approach has not changed.  KKR have been a fantastic strategic partner, and allow us access to much deeper resources around the globe than we have within our relatively small firm.  They have a very strong culture of partnership, and the two firms share similar long-term approaches and have similar philosophies.  So, while we have not changed our basic approach, we certainly appreciate being able to augment that approach with the help of a team which has had extraordinary success.

EF: What kinds of investors are currently active in the cat risk market?

The market is primarily institutional investors: pension funds, foundations, endowments, sovereign wealth funds, life insurers, and from all corners of the globe.  More recently, we have seen greater interest on behalf of high-net-worth individuals, but there are few products available that allow them to access the market efficiently.

EF: Weather risk affects more businesses that catastrophe risk but remains a smaller market. Why is this, and do you expect it to grow?

Reinsurance is over 150 years old as a product, and is required of insurance companies to protect their operations against peak exposures.  Property insurance for homes and businesses is typically required for operation, but protecting against weather risk is not. 

The market for weather risk transfer products is barely 15 years old, and suffered some growing pains in its early stages, which is one reason for its relatively small size.  The other factor is that, surprisingly, it is still acceptable for business to blame poor weather – low rainfall, high snowfall, unexpected temperatures, low wind for a wind-farm generator – for a deviation from results.  It is no longer acceptable to blame changes in exchange rates or commodity prices or other variables outside the control of a business for negative impacts on earnings.  We expect that over time, given increasing weather variability worldwide, that will become the case for weather as well.

EF: What products and services does Nephila offer to deal with weather risk?

We have managed investment vehicles dedicated to weather risk since 2005, so are in our tenth year of having dedicated weather risk capacity.  We offer protection against any weather variable globally, directly and indirectly (through our strategic partnership with Allianz); in some cases an additional component of commodity price protection is also included.  We have worked with most re/insurance brokers, banks, and other intermediaries and would welcome future inquiries as this asset class continues to grow.