The returns on aggregate insurance-linked securities (ILS), including catastrophe bonds, are being questioned by some investors, following the significant number of catastrophe loss events that have qualified under some contract terms in the last two years.
Sources said that investors are set to demand a premium for renewing some aggregate ILS arrangements and that the market should expect that any aggregate catastrophe bonds will likely see their pricing increase in 2019.
There is some nervousness among the ILS fund manager and investor base that aggregate catastrophe bond and collateralised reinsurance coverage may have been given away too cheaply in recent years, leading some to call for increases.
In particular, end-investors we’ve discussed this issue with say that aggregate retrocession cat bonds have been failing to factor in the potential for a higher frequency of qualifying loss events to occur, as has now been experienced over the last two years.
This despite the fact no aggregate retro cat bonds have been triggered (so far), of course.
In addition, a number of investors have cited a need for these aggregate structures (cat bond or reinsurance) to adequately compensate them for any climate change related exposure they could hold as well.
Aggregate reinsurance towers stand to pay out for some insurance and reinsurance firms, after the impacts of the wildfires in California.
Some investors are questioning whether those programs have provided good value as investments, given the losses in 2018 have not been anywhere near as large as in 2017.
However, there have been some outsized loss events, including these wildfires, as well as some surprises, such as hurricane Michael intensifying en route to its Florida Panhandle landfall.
So it’s not surprising some aggregate structures are at-risk and it has certainly heightened investors’ awareness of them and whether they have been paying risk commensurate returns.
Of course, that is the main issue here. The question of whether returns for ILS and reinsurance linked assets have been risk commensurate, or not.
The recent loss experience has raised this question to the fore of many investor discussions, which is encouraging for maintaining pricing discipline in the space.
Risk models are also coming into question, as some investors feel the losses of the last year or so were outside of modelled expectations and question the role of risk models in pricing ILS and reinsurance transactions.
On that, it is important to remember that risk model output should be considered a purely directional input to risk appetite, offering significant value by helping in analysing and underwriting a risk. But they aren’t pricing tools and shouldn’t really be providing the final answer on allocating capital.
At the recent Goldman Sachs financials conference, ILS executives discussed pricing trends and the fact investors are likely to be more demanding, mentioning aggregates as one area that price increases are likely to be requested.
In addition they noted that less well-modelled areas of risk are also likely to come under upwards pricing pressure.
It’s another interesting trend developing, as the January reinsurance renewals approach.
It could also go someway to explaining the slowdown in catastrophe bond issuance at year-end, as well as the absence of some of the larger and usually regular sponsors of retro aggregate cat bonds.