ILS reaches critical juncture in Q2, death knell for reinsurance? Willis Towers Watson Securities

The insurance-linked securities (ILS) market reached a “critical juncture” in the second-quarter of 2017, with record issuance of new catastrophe bonds, as well as rising assets under management for ILS funds, leaving Willis Towers Watson Securities to conclude that Q2 2017 could be “the death knell of the traditional property cat reinsurance model.”

Willis Towers Watson Securities (WTWS) recorded record issuance of non-life insurance-linked securities in Q2, citing $6.3 billion of issuance which, as it doesn’t include private or club deals, falls a little short of the $7 billion recorded by us in the Artemis Deal Directory and the Artemis Q2 2017 insurance-linked securities (ILS) and catastrophe bond market report.

That record issuance helped WTWS’ figure for the outstanding non-life syndicated cat bond market at $24.7 billion at the end of Q2, which represented impressive growth of 16.5% over the year, which is aligned with the growth Artemis recorded as our figure for outstanding cat bonds and ILS, including private deals, was also up over 16% at $29.3 billion.

ILS assets under management also grew in the quarter and WTWS says that ” fierce competition from investors” was seen in the markets, as ILS looked to secure as much of the mid-year property catastrophe reinsurance renewals as it could.

The impressive issuance, growth of AuM and overall growth of the ILS market came against a backdrop of “the soft market which sees some traditional reinsurers generating reduced equity returns, government yields in Europe and Japan remaining negative and material uncertainties such as Brexit and potential changes to the US tax environment all causing concern to insurers and investors alike,” WTWS explained this morning.

But the combination of these factors leads the firm to suggest that we could be at a tipping point, a critical juncture, where the ILS market manages a larger share of the world’s peak catastrophe risk and now sees opportunities to expand issuance into non-peak catastrophe exposures and more generally across the property, casualty, life and health insurance or reinsurance market.

Bill Dubinsky, Head of ILS at Willis Towers Watson Securities, commented; “The market has possibly never been in such robust health, with record breaking issuance and competition continuing to increase amongst ILS fund managers.

“I believe this will create the conditions for significant innovation and development so that the benefits of the ILS product extend beyond peak property cat, where it may already be the preferred choice, and out across the wider insurance industry.”

We’d concur with Dubinsky here entirely, ILS is at a point in its growth cycle where opportunities are beginning to seem much more abundant and innovation will drive expansion and growth, as the traditional re/insurance market embraces the efficiency of capital market structures and risk financing.

In WTWS’ latest quarterly report on the ILS market, Dubinsky likens the growth seen in ILS during Q2 to the “barbarians at the gate” of reinsurance.

“Have the investors successfully stormed the gates without any shots being fired?” the report asks, commenting on the fact that ILS successfully hit new records and expanded its growth even with “stiff headwinds from all directions.”

ILS has work to do, with expansion opportunities presenting themselves all over the market and as ILS managers grow their platforms to include more access to fronting, or rated vehicles, as well as different kinds of leverage, it seems destined for ILS to continue to seek out new avenues for growth.

ILS is by no means in the driver’s seat, in areas outside traditional property catastrophe risks as yet, the report explains, and even in that segment where ILS is becoming increasingly influential “It is possible that certain types of cat events will create differentiation among underwriters, traditional, ILS and otherwise, potentially shifting the balance.”

But WTWS does believe that Q2 2017 may be looked back on as a critical juncture for the growing ILS market and for the insurance or reinsurance market it targets.

“We very well may look back and see Q2 2017 as the death knell of the traditional property cat reinsurance model,” the report suggests.

The response from the reinsurance market has been to target third-party capital and look to technology to shore up its access to risk and distribution of its capacity, but the report suggests that the effects are yet to be realised and that so far “that standing still seems fruitless.”

WTWS saw the expansion of the syndicated and underwritten 144a catastrophe bond market in Q2 2017 as a positive, as cedants were able to access the broadest and most liquid capacity from the ILS market.

“A few larger ILS investors fought tooth and nail to prevent these syndicated deals and more generally squeeze out smaller investors, keep more for themselves and foist higher rates on ceding companies,” WTWS’ report explains.

But, “Well- informed intermediaries helped cedants resist the temptation of the “riskless” private deal and save money through syndication.”

The company explains of private deals, which of course it does also structure and assist ceding companies with itself; “Of course it is only “riskless” until the capacity disappears at a future renewal or until the cedant’s competitors have a lower cost structure achieved with broad placement.”

WTWS clearly shows a preference for the syndicated catastrophe bond issuance, as a way for the risks to be dispersed broadly among the investor base and for cedants likely to access the most competitive pricing as well.

Looking ahead, WTWS expects that a “civil war among investors will return as brokers and cedants bring 1/1s to the market.”

While the company expects that Q4 ILS issuance will be muted by comparison to the bumper Q2 we’ve just seen, WTWS does expect it will by no means be quiet, with ILS issuance remaining high and 2017 destined to be a record year.

In fact WTWS also suggests that 2018 may bring more of the same, which is an encouraging outlook for ILS investors who will be hoping that recent brisk activity continues.