While investor appetite for insurance-linked securities (ILS) has been tested by consecutive years of elevated catastrophe losses, the asset class still plays an important role for many allocators and there remains an appetite to invest in new classes of risk, while differentiation is also an important consideration.
Reinsurance broker Gallagher Re highlighted these trends in its recent renewals report, saying that it’s clear that appetite does remain for diversifying within the insurance-linked securities (ILS) space.
In 2021, the headline growth in the ILS market was supplied by the catastrophe bond sector, as this perhaps most established of ILS structures grew in favour among investors, after proving itself more remote from the effects of recent loss heavy years.
The end result of that was the catastrophe bond market experiencing a record year, as documented in our latest market report.
But, other areas of the ILS market have not fared as well in 2021, in particular higher risk collateralized reinsurance or retrocession, as well as certain quota shares and aggregate structures.
But that’s largely on the catastrophe risk focused side of ILS, which remains the vast majority of the marketplace.
So it’s encouraging to hear that broker Gallagher Re feels there is still an appetite for expanding beyond this.
Gallagher Re noted that the “liquidity, transparency and contract certainty” of catastrophe bonds has been a key factor in driving more inflows to that segment of the market.
This influx of catastrophe bond focused capital has helped to deliver the capacity required to support cat bond sponsors needs for protection and as a result we’ve also seen new sponsors come to market.
But it hasn’t been so positive for all of the ILS market in 2021.
Gallagher Re explained, “Whilst the cat bond market has witnessed a record year, the collateralised reinsurance and sidecar markets have stagnated somewhat, hamstrung by broad contract terms and the impact on returns of potential trapping of collateral.”
But, despite this, there is still appetite and already this year we’ve seen a new major pension investor deploy capital to two ILS structures managed by major reinsurers.
Alongside interest from investors, Gallagher Re highlights that new risk opportunities and the ability to diversify within the ILS asset class remain attractive too.
“Transactions this year involving the incorporation of legacy risk into sidecar form has however displayed that appetite remains in the ILS market for new risks and points of differentiation,” the broker explained.
Points of differentiation is a great way to term it, as it’s not all about embracing exotic classes of risk.
Differentiation can also be how you access risk, the types of partners you collaborate with to get there, the products you underwrite or provide capital behind, as well as the structuring techniques used to bring capital closer to risk and enhance efficiency and hopefully returns as well.
There is a lot of opportunity still in reinsurance for investors with an open-minded and innovative approach to accessing insurance-linked returns.
It seems likely that over the next few years we will see quite a lot of experimentation, with new risks, structures, products and ILS business models, as investors look to access the levels of return they want to achieve, while also diversifying within the sector.
While scrutiny increases over areas of the market such as aggregate covers, collateralized retrocession and secondary peril coverage, we expect that in time the industry will find new ways to bring investor capital to those products, but in a manner more appropriately linked to their return ambitions and appetites for volatility.
There will be areas that ILS investors don’t venture back to, some lower-layer covers may not gain support again in their current forms it seems.
But the reinsurance market has a habit of innovating its way out of this type of capacity issue, finding new ways to provide valuable covers, using efficient capital and in a manner more aligned with cedent and capital providers needs.
It’s finding the sweet spot where the needs of both sides are met, while still offering a valuable capital tool, protection, or hedging product, that can be hardest, but demand will drive innovation, so the areas of the capital stack that require protecting are almost certain to see new products and evolved products launched in time.
Alongside this though, continued effort to provide investment opportunities that offer true differentiation within the ILS asset class will also be needed, as the investor base is going to demand a range of opportunities to deploy more capital into the space over time.