Alternative capital’s return to growth may be slow to develop: RBC analysts

The alternative reinsurance capital and insurance-linked securities (ILS) sector may return to growth in 2021, but it may be slower than some expect, according to analysts at RBC Capital Markets.

The analysts believe that losses suffered in 2o20 may be sufficient to hold back further significant growth of the ILS market and alternative capital levels in the industry for a while longer.

We’d agree, when looking across the market in its entirety, growth is likely to be relatively limited and with a significant amount of it based on the demand seen for catastrophe bond coverage at this time.

However, taking a more detailed look at where institutional money flows to in reinsurance and ILS, shows that inflows are continuing to numerous alternative reinsurance capital vehicles and funds, something that is likely to continue through 2021, we believe.

In fact, we would forecast outright growth for the ILS market and alternative capital in reinsurance, based on the current environment (major loss events aside of course).

The analysts from RBC are anticipating “widespread hardening across the reinsurance market across nearly all geographies.”

However, as we explained recently, hardening is not at the rate envisaged only a few weeks ago, as capital inflows and ramping up competition as the January renewals approach has once again served to dampen rate increases a little.

The analysts believe that demand for reinsurance is still outstripping the sector’s capital growth.

This has been one of the drivers of the catastrophe bond market this year as well, as sponsors have returned and new sponsors emerged, which also has something to do with relative pricing and the availability of other collateralised reinsurance and retrocession coverages at this time as well.

The supply-demand equation is said to be more in favour of traditional reinsurance companies right now, by the analysts, while alternative capital continues to retrench and adjust to the reality of recent years.

We believe this retrenching is much further along than many acknowledge though, with a significant number of investors becoming increasingly keen to allocate more capital to the sector, but performing lengthy diligence on opportunities available to them.

The virtualisation of the due-diligence process has been another factor, as investors and managers come to terms with operating under pandemic conditions.

RBC’s analysts expect a continued pause from alternative capital as a whole, for the moment, which as we said we’d agree with when looking across the market as a whole.

But there are a number of ILS fund managers who will reach record, or near-record levels of assets under management after 1/1, we understand and trapped collateral is increasingly set to be freed up as we move into 2021, our sources suggest.

At the same time, there are reinsurers who are also set to increase their alternative capital under management quite significantly.

Plus there are alternative forms of capital seeping more broadly into insurance and reinsurance, in less typical ways as well.

There is unlikely to be significant growth in alternative reinsurance or insurance-linked securities (ILS) capital for now, but that pause could be a little more short-lived than many expect, as the rate environment is also helping to raise the profile of ILS as an asset class more than it has been for a number of years now.

Of course, capital inflows do depend on there being space for them and with reinsurance still very well-capitalised, something will have to give if ILS inflows do begin again in earnest.

Another point the RBC Analysts make that is worth highlighting, is the fact ILS players are taking their time to re-price risk, in some cases.

We understand this is resulting in some pull-back, in certain areas of the market, where ILS funds no longer find rates covering loss costs and in particular anywhere that they feel climate change factors are not being adequately priced in.

In addition, AM Best recently said that, “Third-party capital—at current rates at least—does not yet seem to share the same level of enthusiasm for the hardening market that some equity capital investors express.”

This is also true, as some ILS funds are disappointed in rate increases and had been hoping for more.

Given that rate expectations for the renewals are on the decline, this disappointment is only likely to increase.

Which is also set to be a factor in slower overall growth for the alternative capital and ILS sector at this time. But that could be a healthy development, demonstrating discipline among ILS managers and investors, more than any sign of slower interest in the asset class.

As a result of all of this and the other factors we’ve been discussing about the market, such as the capital and competition question, but also the fact ILS return potential is now much higher, it will be particularly interesting to see just how sustainable the firmer rates we’re now seeing are over the rest of 2021 and beyond.

Also read: ILS “more likely to grow” in 2021, as shake out moderates: Credit Suisse analysts.