Interview with Jason McAlpine - Two specialist areas of expertise within Bermuda’s financial services industry, asset management and insurance/reinsurance, are coming together in what has become known as the convergence or insurance-linked assets market, where hedge funds, other asset managers and institutions such as pension funds are becoming primary providers of capital to an insurance or reinsurance platform.
“The (re)insurance market, in part because of the central role of Lloyd’s, has long been a particularly tight-knit, even closed, community with regard to the source of capital, the players and brokerage relationships,” says Jason McAlpine, a partner in the financial services office of Ernst & Young in Bermuda. “But over the past decade, that exclusivity has diminished and non-traditional capital sources, whose previous allocations to this asset class were small and infrequent, have taken a progressively larger role.”
McAlpine highlights various structuring methods for this new capital. One is insurance-linked securities such as ‘cat bonds’, which are similar to traditional bonds except that instead of the credit risk of a company, they involve catastrophe risk. “Other types include mortality bonds and various other derivative products, but cat bonds are the primary insurance-linked security,” he says.
Another sub-segment of the industry consists of insurance managers, who manage underlying (re)insurance risk as opposed to other alternative investment strategies. The capital may be provided by hedge fund and other asset managers, but this area also requires industry specialists, such as actuaries and underwriters, who understand the market.
“Insurance managers create platforms, sometimes as segregated cell companies, sometimes as so-called transformers or sidecars, similar to a master fund,” McAlpine says. “They put money to work for a fee, just as would be the case with a hedge fund.”
The third type of activity in the convergence space involves proprietary platforms established by hedge funds or other providers of capital. The platform may contain an investment vehicle alongside a (re)insurance vehicle, and it underwrites its own risks, whereas in other structures the investors take on risks from the original underwriters.
“The insurance manager structure can involve a combination of taking on risk from others and underwriting in its own right,” McAlpine says. “It’s a highly entrepreneurial market in which investors are looking for new products and new types of structure that serve the market better in some respect than it is at the moment.”
The great advantages of hedge funds in this situation is that they are opportunistic and flexible, able to allocate capital quickly and to focus on where risks and rewards make the most sense, and where supply and demand do not match up properly.
“The convergence phenomenon was first seen as long as 15 years ago, but it has gathered pace over the past decade, to the extent that it has accounted for the vast majority of commercial (re)insurance formations in Bermuda during 2011 and 2012,” McAlpine says.
The new entrants are also seeking to capitalise on what is expected to be an opportune period for the industry from a pricing standpoint. Following various catastrophes in 2011, a considerable rise in premiums was expected. This increase so far has been indeed strong, but varying according to the type of risk. But McAlpine says: “A few more catastrophes this year could drive premiums significantly higher, even at a time when the new capital is adding to competition in the industry.”
Jason McAlpine is a partner in the financial services office of Ernst & Young Ltd., Bermuda