The credit crunch may dull appetite for complex tools reinsurers issue to share catastrophe and other risks, chipping away at the sector's growth prospects after it first looked to have largely escaped the crisis.
Trendy new securitisation paper such as natural catastrophe bonds use similar Special Purpose Vehicles (SPVs) as those at the heart of the credit turmoil, and indiscriminate investors may shun both even though they are not correlated.
"The market turmoil from sub-prime is focusing investors on thinking okay, there's a reason why we're getting high returns on this," reinsurance specialist Mark Rouck at Fitch Ratings said at an industry event this week.
Insurance-linked securities (ILS), the market for which could reach $350 billion a year within nine years according to one leading player, protect reinsurers and insurers against certain predefined peak risks such as hurricanes and earthquakes.
If such events happen the issuer does not pay out to holders of the bond. In return, the paper pays a high yield to investors and market spreads between catastrophe bonds and other ILS tools and spreads can go up to 40 percent, though they typically are between 8 and 10 percent.
But with investors fleeing into safe paper on the back of the credit crisis - which has predominantly hit asset-backed securities with a similar structure as ILS - the appetite for such hefty returns may falter.
"The main short-term impact would manifest itself through a slowdown of new issuance," said Timour Boudkeev, an insurance analyst at rating agency Moody's. A slump in ILS would have no major impact on profits of reinsurers, which get fee income when issuing ILS for their insurance clients, as it is still a niche business.
But it could cloud their growth outlook. Swiss Re, the world's largest reinsurer and by far the largest issuer of such paper, sees ILS as a key long-term growth driver.
Swiss Re says world-wide ILS is now among the world's five largest providers of catastrophe cover, meaning the market has overtaken most individual companies in size.
ILS volumes have mushroomed over the last few years. The total volume was $23 billion at the end of last year, up from $6 billion in 2001. In 1998 it almost did not exist. By 2016, the volume could reach between $150 billion and $350 billion, Swiss Re says.
Reinsurers at an annual round of price-talks in Monaco put on a brave face on the state of the market, saying appetite had not soured and that spreads on some of the tools had even narrowed, possibly indicating higher demand from investors. "In terms of non-correlation with other fixed-income categories, and as had been expected from a theoretical standpoint ... the spreads have actually tightened," Swiss Re Chief Executive Jacques Aigrain said this week.
ILS is sold as attractive for investors looking for returns that are not correlated to economic swings. Performance is largely determined by the occurrence of hurricanes, earthquakes and other risks underlying the paper.