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Capital markets can hurdle traditional stumbling blocks

Traditional reinsurers are failing to offer capacity efficiently and the trend for them to outsource peak risk to capital market providers is likely to continue, Nephila Capital co-founder Frank Majors said at the Baden Baden conference last week.

The New Zealand earthquake showed how unevenly the reinsurance industry is distributing its capital, Majors said, speaking at a Guy Carpenter symposium.

Antipodean insurers had incredibly high reinsurance recovery rates on their losses from the disaster, while areas such as California were still significantly under-insured to face a major earthquake.

Reinsurers' risk appetite was starting to look more and more like that of insurers as they came under pressure from ratings agencies and other external influences, Majors said. "I think that as an industry we perhaps aren't allocating capital as efficiently as we should be."

This is where capital markets providers such as Nephila can fit into the market, Majors said, by offering more cost-effective cover to insurers for protection against peak risks.

Nephila is a fund manager that invests in cat bonds and other insurance-linked instruments and also writes collateralised reinsurance.

Majors explained that a fund such as Nephila had a lower cost of capital than traditional listed reinsurers - because the institutional investors backing ILS funds have shown willingness to accept lower absolute returns than the double-digit returns investors expect from listed reinsurers.

This is due to the diversification investors gain in their portfolios from investing in a private fund that isn't linked to equity risk and which offers a purer exposure to property catastrophe risk.

This factor overcomes the fact that a provider like Nephila must set aside the full capital sum backing a contract it writes while a rated reinsurer can employ its capital two or three times over.

"The argument has been accepted by institutional investors," Majors said. "This is an asset class that is here to stay."

Majors encouraged the audience to embrace the convergence sector and said it offered an opportunity for all in the market.

Companies that outsourced the financing of peak risks by partnering with providers such as Nephila would gain a "huge competitive advantage" over their peers, Majors argued.

"That would do the best job of unlocking what we think will be a lower cost of capital for the insurance industry."

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