Continued ILS & alternative capital growth expected into 2019

The main rating agencies for the insurance and reinsurance sector all agree that the insurance-linked securities (ILS) market and alternative capital is set to grow in importance, scope and overall in size.

ILS market and alternative reinsurance capital growth has been steady over the last decade, but has accelerated since the losses of 2017, as the market recapitalised rapidly to support client needs and the total amount of capital under management at ILS funds we track at Artemis reached $102.8 billion in recent weeks.

In fact, if you add in all of the alternative capital that we cannot track (all sidecar capital, private quota shares etc), we would estimate the total amount at likely nearing $110 billion, as of this time. Add in the other ways institutional pension investors access insurance linked returns more directly and you could get closer to $150 billion.

The top 10 ILS fund managers in the Artemis Insurance Linked Securities (ILS) Managers & Funds Directory now command almost $70 billion of assets between them.

Our list of ILS fund managers only commanded a total AuM of $80.8 billion as of the start of 2018. This figure has now grown by 27% so far this year to $102.8 billion, a stunning achievement following the losses of 2017 and a clear endorsement of the ILS asset class by the institutional investor base.

The catastrophe bond market has also grown robustly this year, reaching a new record amount outstanding at $36.6 billion as of this time, following $11.88 billion of issuance so far in 2018.

Further growth is expected and the ILS fund market will be looking to extend its remit in global reinsurance at the key January 2019 renewals, where once again excess traditional capital combined with growing efficient ILS capital is likely to pressure rates, despite levels of catastrophe loss activity in recent months.

The rating agencies all point to ongoing ILS market growth, as well as the expansion of the capital markets as a tool for reinsurance firms and insurers looking to earn fees and put efficient capacity to work supporting their underwriting.

Moody’s Investors Service said recently that ILS is likely to take increasing share from traditional reinsurers, “We expect alternative capital to continue to grow, both on a nominal basis and as a percentage of total reinsurance capital, as insurance risk becomes an increasingly important source of diversification for pension funds and other institutional investors, and as the risks covered by alternative capital expand beyond property catastrophe reinsurance.

“The significant growth in reinsurers’ alternative capital under management primarily reflects the rapid expansion of property catastrophe focused collateralized reinsurance vehicles. The next phase of growth will come from an expansion of third-party capital participation in business lines beyond property catastrophe risk. Arch Capital’s Watford Re and AXIS Capital’s Harrington Re are examples of multi-line sidecar vehicles that provide investors with lower-volatility insurance risk while allowing reinsurers to leverage their risk capacity and monetize their underwriting expertise.”

Fitch Ratings also recently highlighted the prospects for ILS market growth, “Fitch expects alternative capacity to continue to grow in 2019 against a backdrop of significant insurance-linked securities (ILS) issuance in 2018 to date, with alternative capital providers replenishing capacity following prior-year losses. Increased competition from ILS capacity puts a further squeeze on margins, particularly in well-modelled markets where collateralised reinsurance has significantly increased.

“There has been a marked increase in alternative capital in recent years and Fitch expects the sector to continue to expand.”

Fitch also noted that investors may have lost money in 2017 on their ILS investments, but that over time their returns are still attractive, helping to encourage further inflows to the ILS fund space.

“Most investors received strong returns on ILS holdings before 2017 and losses for the year fell within expected ranges and therefore did not result in an exodus of capital,” the rating agency explained.

Adding, “New participants have been attracted by the prospect of improved returns in a hardening market and therefore Fitch expects this sector to continue to grow.”

Standard & Poor’s did not explicitly comment directly on the prospects for further growth of ILS and alternative rensurance capital in 2019, but did highlight the asset classes permanence and growing importance to the traditional re/insurer strategy which it expects to continue to increase, which also suggests growth is practically assured.

A.M. Best also noted that it has become a core component of reinsurers strategies and that investor attraction to reinsurance-linked returns remains strong, both of which suggest further and perhaps accelerated market growth ahead.

The future looks bright for ILS markets as a result, given demand from both the investor side and cedant side is anticipated to remain strong and perhaps increase, while for investors it is also positive that increasingly reinsurance and insurance firms see ILS as a core component of their own capital structure and a source of attractive fee income as well.

However, the growth that we see at January 2019 is not likely to be the same as the growth we’ve seen through 2018, as it is clear that ILS fund managers need to moderate their inflows to match market opportunities.

It is the expansion of the scope and remit of ILS capital that could drive more exceptional growth again in future, as ILS managers access new areas of risk, while reinsurers and insurers increasingly bring the capital markets in-house as secondary balance-sheets.