2018 set to be a record year, as ILS replaces lost capital: John Seo, Fermat

2018 is set to be a record year for catastrophe bonds and insurance-linked securities (ILS), according to John Seo of Fermat Capital Management, as the market recovers from recent major catastrophe events, replaces lost capital and its investors show growing interest in allocating to reinsurance linked investments.

Since the major hurricane loss events of 2017 the ILS and reinsurance-linked investments market has experienced a wave of new interest from institutional investors and has also found its processes for dealing with losses and claims have passed their first major test.

As a result, the ILS market now appears ready for further growth and to take greater market-share from traditional reinsurers, something many of the sectors top fund managers are expecting to see, with catastrophe bond issuance also anticipated to remain brisk and the market to grow.

By the end of 2017 the catastrophe bond market had grown to over $31 billion in size, as a record level of issuance of broadly marketed and private cat bond deals helped to satisfy some of the pent-up and growing investor demand.

Further growth is now anticipated and John Seo, Managing Principal at specialist investment firm Fermat Capital Management, forecasts a record year ahead for 2018.

Looking back at the major losses, Seo commented, “In the year just ending, active returns helped offset losses to deliver a net positive return, despite a string of loss events led by hurricanes Harvey, Irma and Maria (HIM).”

Noting that, “The ILS market has not fully come to grips with some fundamental realities, which emanate from the fact that HIM insured losses, though still substantial, will be approximately USD 60 billion, not the USD 100 billion widely assumed.”

We’ve already seen some of the effects of this realisation that losses were lower than anticipated, with a number of ILS funds restating specific monthly returns as losses became clearer and reserves could be released.

There have also been a number of ILW positions and trades which had been expected to face a loss, but have now been deemed safe, which has again helped some ILS fund managers to recover some collateral that had been previously set aside for losses.

The upshot of 2017 losses coming out a little lower than anticipated will also be a greater availability of capital, in some cases, as managers have raised capital to replace that which had been trapped and some has now been released from reserves as well.

How this impacts future renewals remains to be seen, but with the ILS fund managers market now commanding over $85 billion of underwriting capital (according to Artemis data), the sector looks set to increase its influence on reinsurance markets over the rest of 2018.

“In 2018, we expect to adopt a moderately offensive stance in our portfolios by selectively investing in higher yield positions,” Seo continued, suggesting a need for investment managers to remain disciplined as the market recovers from its losses and finds equilibrium again.

But looking ahead, Seo forecasts, “We also expect 2018 catastrophe bond issuance to break all previous records with USD 12 billion in bonds coming to market.”

Having just had the biggest year in its 20 year history, for the catastrophe bond market to continue breaking records in 2018 could be a very big deal as it suggests growing market-share in reinsurance.

As catastrophe bond rates and pricing have come down, while issuance costs and mechanics have become increasingly efficient, the instruments have been gaining greater share and the sponsor-base has been expanding.

The market could now be at a tipping point, post-loss, with the ability and momentum to gather greater pace and take more share of global reinsurance risk and capital flows.

That’s not to mention collateralized reinsurance, which is increasing in sophistication while offering a true alternative to traditional coverage. That is also set to continue apace, with greater market share expected.

Artemis now believes that the ILS, cat bond and alternative reinsurance capital market is more than $100 billion in size, when all sidecars, collateralized reinsurers, direct pension investors and the $85 billion or more of ILS fund capacity are added up.

By the end of 2018 we expect that figure to grow with increased interest from end-investors and increased opportunity for underwriting risks.

Seo doesn’t just forecast increased issuance of cat bonds, he also forecasts better pricing, saying, “In 2018, we expect a 10% increase in risk-adjusted yields in catastrophe bonds and adjacent areas of the insurance-linked securities (ILS) sector.”

That’s an increase on returns for the investor-base, with the amount rates increase in ILS likely to differ across structures, levels of risk underwritten and counterparties, meaning in some areas the opportunity to increase returns will be even greater.

Seo also anticipates the pipeline for new cat bond issuance being strong this quarter and suggests that there may be some deals that have been put on hold at the end of 2017 that could now come to market in Q1 2018.

“Investor interest remains strong, and it appears that much of the ILS capital that was lost due to the 2017 catastrophes has been replaced. 2018 will likely be a record for new issuance, and the pipeline should start strong in the first quarter,” Seo explained.