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sidecar large Innovation is a constant theme in the reinsurance industry, and it’s always driven by the requirement to service buyers’ needs. The challenge for the industry is to look at the overall capacity requirements, and then help to find the appropriate capital and assess its cost and availability.

The boundary between ‘traditional’ and ‘nontraditional’ reinsurance is not empirically defined, and the arrival of apparently new delivery mechanisms, especially in the realm of property cat exposures, might lead the casual observer to conclude that traditional reinsurance has had its day, particularly at the retrocessional end of the risk transfer chain. However, for the majority, traditional reinsurance still provides the cover that is needed. For others, there has been a systemic change in where and how much capacity is available.

When you peel away the packaging of many new and apparently innovative products, you find underneath a device providing the reinsured with contingent capital in the same way

Traditional reinsurance provides either off balance sheet backing for a reinsured through a proportional treaty, or replacement capital through an excess of loss protection. When you peel away the packaging of many new and apparently innovative products, you find underneath a device providing the reinsured with contingent capital in the same way.

The 90s saw the rapid growth in the use of ‘structured’ products (reinsurance deals with limited downside from capital providers with a different risk appetite to the standard market). These products were normally multi-year, with reducing limit or payback features, to control the extent of risk transfer. However, changing attitudes in the 21st century as a result of 9/11, along with the post-Spitzer market, caused significant slow-down in the use of these products.

Looking at current market conditions, many of the supposedly ‘non traditional’ products that are now available to meet the demand for property catastrophe coverage – sidecars, cat bonds and so forth – are still modern variants of traditional reinsurance.

While often characterised as ‘capital markets’ products, they are simply alternative ways of harnessing capital. Rather than spelling the demise of traditional reinsurance, the current vogue for sidecars etc is rather proof of the adaptability of the traditional reinsurance concept. Most importantly, in today’s world of scarce capacity, it’s proving a popular way of enticing capital providers – although one side effect is that the reinsurers are moving from owning capital 100% to being third party managers. The long term effects of this on the stability of the industry are yet to be seen.

The current vogue for sidecars etc is proof of the adaptability of the traditional reinsurance concept. Most importantly, it’s proving a popular way of enticing capital providers

The first sidecar was set up a decade ago and is still very much the story of the moment – but the less glamorous cat bonds continue to be attractive to other investors. Cat bonds are very much a pre-packaged product, requiring less insurance expertise and offering a smaller minimum investment for the buyer. Sidecars, on the other hand, are usually valued in the hundreds of millions of dollars and are highly personalised, allowing investors to select individual lines of business, negotiate the form of the reinsurance contract and the investment strategy of the collateral held by the ceding company. Both have their pros and cons and it is our job to help the parties understand what problems they can help to solve and how.

A story of supply and demand

So what does the future hold? The law of supply and demand is simple and universal. If the return on capital through vehicles like sidecars delivers on its promises, then the result will undoubtedly be to generate more interest from hedge funds and the like. Experience has taught us, however, that the risks are also high. This more than anything will dictate how long-term this trend might be.

Simon Clutterbuck