The rise of alternative capital market solutions could constitute one of the defining elements of the long-term future of both life and non-life insurers and reinsurers, says Fitch Ratings.

In a special report issued today, Fitch says the convergence of the capital markets and the insurance marketplace is showing no sign of abating. Insurance securitisation is a key aspect of this convergence, which includes the increased use of derivatives.

“From an insurer’s credit perspective, the development of insurance securitisation is a positive factor,” says Franz Lathuillerie from Fitch’s Insurance team. “It has the potential to improve capital management practices within a company and in certain cases enables the company to better manage the risks assumed, by shifting risk away to the capital markets.”

The insurance securitisation market has developed slower than expected, the rating agency says. “It has suffered from a lack of enthusiasm from insurance originators, regulatory hurdles, deal complexity, an insufficient investor base and high transaction costs. However, issuance volumes have grown strongly in 2005 and 2006, driven by external factors such as hurricane Katrina, regulatory changes, a widening investor base, and increasing awareness of securitisation tools from insurance and reinsurance companies,” it explains.

Fitch says that insurance securitisation represents a largely untapped source of financing and risk mitigation, which has a positive impact on liquidity, risk management, financial flexibility, regulatory and economic capital. It can also enable companies to optimise capital efficiency and Fitch views that in an increasingly competitive market sophisticated insurers will be able to gain an advantage from the use of securitisation just as the banks have done.

However, insurance securitisations have many forms and fit different purposes, it cautions. Fitch says it analyses each transaction on a case by case basis to determine the credit implications for the sponsoring entity. Securitisations can often be time consuming and expensive to structure for the issuing companies, it notes. Fitch also says that their success depends on aligning investors’ interest with that of the originating companies, and that one of the key challenges is to find structures that appeal to both parties.

Although insurance securitisation represents one of the most obvious connections between the insurance industry and the capital markets, Fitch notes that it is not the sole product of this convergence, as highlighted by the recent developments in the use of derivatives by life insurers, the development of the hybrid debt markets, or the rise of ‘side car’ solutions.