Reinsurers like Reinsurance Group of America (RGA), Everest Re Group (RE), PartnerRe (PRE), and Montpelier Re (MRH) obtain capital from alternative sources in order to cushion the impact of large losses due to catastrophes or other events. Third-party investors and investors in the capital markets provide capital through financial instruments and investment vehicles issued for the purpose.
The chart above shows that alternative reinsurance capital has been seeing consistent growth in recent years. In 2006, it was at $17 billion and was at $59 billion as of 1H14. Overall, this growth has boosted global reinsurance capital, which also comprises the traditional capital of reinsurance companies. Alternative capital now accounts for more than 10% of total reinsurance capital.
Next, we will look at two popular types of alternative capital sources: catastrophe bonds and collateralized reinsurance.
Catastrophe bonds normally have a term of one to four years. Coupon payments and return of principal for these bonds occur when a certain qualifying event does not take place. Qualifying events include natural perils. For example, a lot of US catastrophe bonds cover financial risks due to hurricanes.
Collateralized reinsurance vehicles cover underwritten risks. This source of capital has grown very quickly in capacity over the last three years. With more than $25 billion in current capacity, collateralized reinsurance is overtaking catastrophe bonds as the biggest source of alternative capital.
If you are interested in gaining exposure to the insurance sector, consider investing in funds like the iShares US Financial ETF (IYF) and the Financial Select Sector SPDR ETF (XLF).
In the next article, we will look at the current scenario of the insurance-linked securities market.