Standard & Poor’s have published an article looking at price declines of traditional reinsurance versus price declines of insurance-linked securities and catastrophe bonds. It’s a really interesting piece of analysis and shows many of the differences between and issues with the two competing markets.
S&P observe that pricing trends in traditional reinsurance have tended to be downwards of late and this is putting pressure on the ILS market as new issuers are finding more value in seeking out traditional alternatives. So despite all the market improvements we’ve seen in the past year; improved collateral structures and greater transparency in the market, investors are being attracted to the market but S&P says insurers who are potential issuers are not.
S&P are particularly bearish on the prospects for the ILS market for the rest of this year. They blame a contraction in issuer and investor base over the last few years and say that the market may struggle to hit $4b in 2010. While reinsurance rates continue to soften they say that insurance-linked securities may not recover to the levels seen in 2006 and 2007. It’s true that it is going to take some large catastrophe losses to cause a reversal of the price declines seen in reinsurance but 2010 so far has been a record year for disaster losses so we will have to wait and see how the rest of the year (and the hurricane season) pans out.
S&P’s report contains an interesting table which lays out what they see as the fundamental factors affecting the reinsurance and insurance-linked security market cycles:
| Fundamental Factors Influencing Reinsurance And ILS Cycles | |
|---|---|
| Reinsurance | ILS |
| The reinsurance cycle is generally more volatile, and over time we believe it will demonstrate greater amplitude in pricing than ILS. | ILS pricing seems to be more influenced by the wider capital markets, as competing investments play a tangible role in investor decision making. |
| The size of the reinsurance market means to us that it is generally less exposed to competing products such as contingent capital facilities and sidecars. | Alternative products that offer a source of replacement capital for (re)insurers are seen to pose a greater threat to the catastrophe bond market. |
| (Re)insurers appear to be finding the process of purchasing traditional reinsurance or retrocession much more familiar and therefore faster. | New investors in ILS often seem to find the learning curve is a steep one, in particular if they lack the level of insurance expertise to appropriately assess and price the risk. These investors therefore find they need to invest in expertise, or see an additional spread on risks to compensate for the additional uncertainty. |
Standard & Poor’s highlight that should a major catastrophe event occur it is not certain that it will attract issuers to the catastrophe bond market. They point out that many other alternatives are available to potential issuers looking for risk transfer or financing solutions such as sidecars and contingent capital facilities.
Overall the report is pretty bearish from S&P, very different to reports coming from market participants. Is it time to be concerned for the future of the ILS market? We don’t think so. The reinsurance market is much more cyclical than ILS and pricing fluctuates wildly. Reinsurance is currently proving much less profitable than before so the market is keen to have rates go upwards which would bring them more into line with ILS. There is plenty of interest in ILS and many issuers who are going to continue to play a role in the market, what is really required to take the market forwards is innovation in the way transactions are structured. Perhaps in the future we could see cell companies which issue cat bonds on behalf of a number of insurers who all have the same type of risk, there by reducing the costs and barrier to entry? Who knows; the buzz in the ILS market right now seems to suggest that it is here to stay.
Let us know what you think in the comments below.
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