The insurance-linked securities (ILS) market is facing a more comprehensive test after higher returns did not appear after the 2017 catastrophe losses and now rate increases have failed to materialise at the January 2019 reinsurance renewals, according to Willis Re.
Broker Willis Re reports that the reinsurance renewals saw rates broadly flat to a little down in some areas, a disappointing result for some that had hoped for increases after the impacts of fresh catastrophe losses in the second-half of 2018 and ongoing loss creep from 2017’s hurricanes.
The broker notes a gap emerging, in terms of pricing though, with accounts heavily loaded with peak peril exposures and those that have been loss-affected seeing the largest rate increases, while at the same time reinsurers were placing a greater emphasis on the quality of client counterparties at the renewal.
This drove a “two-track trend” at the renewal, as worse performing accounts and counterparties paid more for their reinsurance and retrocession, but more broadly the market has been reported as mostly flat, with property catastrophe reinsurance rates declining once again.
James Kent, Global CEO, Willis Re, commented, “In the immediate aftermath of the 2017 catastrophe losses, many observers felt the measured reaction of the reinsurance market was a clear sign of a changing structure and maturity. Others more cautiously suggested time was needed to properly assess the impact of 2017 events. In the wake of the high loss activity during the second half of 2018, early renewal negotiations have proved prudent, while pricing in the primary market has given reinsurers some cause for optimism in light of the increased pro rata cessions from clients.”
While some demand increases have been seen, helping to satisfy the appetite for capital deployment for some, the lack of rate increases has pushed others to hold back and new capital raises have either been challenging for some ILS funds, or not required for others who saw the market opportunity at 1/1 as no better than the prior year.
Willis Re says that, “The ILS market faces a more comprehensive test in the absence of a major pricing uptick following significant loss erosion for some funds in both 2017 and 2018.”
As a result, the broker notes that some ILS funds are currently facing difficulty in attracting new investors, given the two successive years of poor returns.
However, those ILS funds with longer and more successful track records, consistent and well-respected management teams, as well as offering cedants more flexible trust language, rated paper, or fronted capacity, are the ILS funds the broker feels are “best equipped for success.”
Within the ILS market the performance has been split, depending on where in terms of products and perils ILS funds and their managers have deployed capital.
“Some ILS products, most noticeably aggregate catastrophe and retro covers, have performed poorly for investors, thereby resulting in less available capital— although this is balanced by other ILS products that have continued to deliver acceptable returns,” explained James Kent.
Also noting, “The variation of individual ILS funds’ exposures to different product types is starting to impact the ability of many funds to attract new investors.”
However, the effects of this may not be felt for long in the ILS market, Kent explained, “As the long-term interest in ILS, particularly from pension fund managers seeking diversification, remains robust.”
Willis Re believes that the ILS product needs to keep evolving, to meet customer needs and also in response to the challenging environment that the successive years of catastrophe losses have created.
In particular Kent highlights that, “The trust language supporting collateral will need to continue to evolve to match client expectations on the “promise to pay” as well as supporting a developing ILS product demand.”
There have been attempts to push the collateral trust language at this renewal but many have been unsuccessful, resulting in lower demand for some reinsurance sidecars, we understand from our sources. So it seems the market has not yet identified the best way to achieve this goal.
Importantly though, Kent notes that, “ILS investor interest remains as the market continues to evolve to match client needs and demand,” as evidenced by recent ILS vehicle launches.
The more comprehensive test of ILS that Willis Re refers to will play out over the rest of this year, as the market recovers from the major losses of the last two years, deals with its trapped collateral and side-pockets and trades forwards.
This could all unwind over 2019, but any further major losses this year may prolong this testing period for some.