ILS faces battle for diversifying perils, as traditional reinsurers hold on

The insurance-linked securities (ILS) market, of catastrophe bonds and fully-collateralized alternative reinsurance capital structures, faces a battle for access to diversifying perils as traditional reinsurers look set to compete strongly for this segment of the market.

Access to diversification, be that through peril, geography, line of business or attachment layer, is a core need of the reinsurance market. It is also equally as essential for the ILS, cat bond and collateralized reinsurance market, which needs access to diversifying perils in order to allow the overall market to grow.

Without diversification, reinsurers and ILS investors would become over-exposed to certain perils or regions, a dangerous prospect which can result in severe impairment when losses strike. It’s worth noting that not all ILS investors seek diversification though, as some sophisticated investors are now comfortable with a greater level of exposure in return for better profits.

For traditional reinsurers, with large expense balance sheets and shareholders to please, the need to diversify and to maintain that diversification is clear. The traditional reinsurance market wants to hold onto diversifying perils, retaining these valuable risks, rather than release them to the capital markets and ILS. This means we could see particularly strong competition in diversifying areas of the market.

Martin Bisping, Head of Non-Life Risk Transfer at reinsurer Swiss Re, discussed this at a recent media event. He said that while ILS investors would like to gain access to more diversifying perils, ILS, catastrophe bonds and alternative capital are still largely dominated by U.S. wind, bringing broader diversification into the ILS market may not be a rapid process.

Bisping cited the recent example of the New York MTA’s MetroCat storm surge catastrophe bond, saying that while it appears to diversify the risk is actually still correlated with hurricane risk. This gives a certain level of diversification to a portfolio, but is not the real diversification that many ILS investors and funds seek.

Bisping said that the diversification that is really required by the ILS market is also required for reinsurers who are seeking to maintain their diverse portfolios of risk. This means that reinsurers will be reluctant to let this risk slip into the ILS space and are likely to compete strongly for it.

Bisping explained that for U.S. wind, as well as some other peak perils, the capital markets and ILS investors are required as the risks are simply to large for the traditional reinsurance market. However some other peak perils are not so in need of large capital bases to provide risk transfer, at least not yet, generally due to lower exposures and less well-developed reinsurance markets.

Due to the fact that traditional reinsurers want to retain these diversifying risks, the price is sometimes not attractive enough for collateralized markets and ILS issuance, explained Bisping, so we have not, as yet, seen a large amount of issuance of new and/or diversifying perils in ILS markets yet.

Of course, gradually these diversifying perils will find their way into ILS markets and investors hands, perhaps slowly at first. The concern is that stronger competition here, from traditional reinsurers trying to hold onto diversifying perils, could drive down pricing even further on these risks.

If that happens, the question asked has to be, at what point does the pricing become unattractive for ILS investors as well as traditional reinsurers, and who provides the risk transfer then?

Read our other articles from Swiss Re’s recent media day:

– Catastrophe bond market reaches all-time high with 20% growth.

– Alternative reinsurance capacity up by 80% since 2010.