Competition between specialist insurance-linked securities (ILS) and reinsurance linked investment fund managers is intensifying, resulting in a need to differentiate the product offering both for investors and cedents, according to WCMA.
Investor demand continues to outstrip supply of risks to the ILS space, Willis Capital Markets & Advisory explains in its latest ILS market report, resulting in increasing competition for access to business between the ILS fund managers.
With the ILS market continuing to see record growth, after another record quarter in Q1 2015, the market is in flux as investor trends look set to fundamentally alter the ILS market, WCMA says.
Bill Dubinsky, Managing Director and Head of ILS at WCMA, commented; “2015 started with a flurry of activity on the deal front following the record-setting 2014 year. This trend should continue even as we migrate towards more stable risk spreads. But the more interesting dynamic to watch in the coming quarters is the intensifying competition among specialist ILS managers.”
In the past competition between ILS managers was more focused on attracting investor capital by extolling the benefits of their asset management strategy, but increasingly it has moved to highlighting the underwriting side. WCMA says that ILS managers are “competing intensely with each other,” as they seek to establish the best access to risks in order to satisfy their capital providers.
WCMA’s report explains; “Previously, the specialist investors driving the market primarily competed for investment mandates primarily on management approaches (e.g., high risk-return vs. low risk-return, active / alpha and relatively illiquid vs. passive / smart beta and liquid, independent vs. reinsurer affiliated, etc.).”
Now, however, the specialist ILS fund managers are competing for investment mandates based more on their access to business, their leverage and the design of their products. These three key areas of the ILS manager product offering are areas where the “market dynamics are set to fundamentally change the ILS market in 2015” WCMA stated.
“No longer able to purely compete for risk on price, investors are now marketing their relationships and their access to reinsurers and brokers to ensure they see more of the risk, receive better allocations where desired as renewal markets, and at the same time prevent their competitors from achieving the same. They are also finding increasingly creative ways to incorporate leverage,” Dubinsky continued.
As a result of these trends “the need for differentiation now dominates the ILS battleground” the report explains. This has been true, of course, ever since the ILS market began, but is increasingly so in the climate of reduced pricing on catastrophe reinsurance rates which has heightened the competition both in traditional and alternative markets.
“The gloves are off” in the competition between ILS managers, according to WCMA, which it notes is resulting in an enhanced product offering for protection buyers, as well as for the investor base. As a result of this renewed innovation “differentiation dominates the battleground.”
Dubinsky explained; “The most promising trend is that investors are becoming more innovative in their offering and starting to compete on product, with investors selling more of what ceding companies actually want as protection. Ultimately, these trends will create a more dynamic market and grow the capital market footprint.”
ILS investors are increasingly seeking to establish stronger relationships with cedents, in order to secure greater access to reinsurance programmes, to see more risk, get larger allocations at renewals and at the same time prevent competitors from accessing those risk layers as easily, WCMA’s report says.
Just because yields and pricing are low does not guarantee ILS fund managers access to risk, the report continues.
WCMA explains; “You have to give something to get something – access is no different. On the one hand, relationships do matter and can create a better understanding of ceding companies’ portfolios, plans etc. On the other hand, the less syndicated the ceding company’s reinsurance program, the higher the rate-on-line, all else equal. Make no mistake about it: many specialists tell end investors that access equals a higher spread for the same risk.
“Ceding companies know this dynamic too and need to maintain a healthy tension between broad syndication (largely in the cat bond market) and more targeted placements with key specialist investors (largely in the collateralized re market). While relationships can bring undoubted benefits for ceding companies, syndication allows true price discovery through competitive forces and gives the ceding side more bargaining power.”
However even the specialist ILS investors have to give up something to gain access to risk, the report says, meaning that they may lose some of their ability to dynamically underwrite risks in return for access to certain programmes.
Added to access, the topic of leverage is increasingly important, the report continues. Investors and investment managers are finding creative ways to incorporate leverage within their offerings, here the report cites reinstatements provided by fronting companies as well as portfolio financings for catastrophe bonds.
In addition the larger ILS investors are trying new ways to access leverage, such as Credit Suisse’s launch of Kelvin Re, providing leverage through a rated balance sheet, without the need for fronting services.
Also highlighted is ILS manager Nephila Capital’s relationship with State National, which WCMA says provides “the highly leveraged approach necessary for the investors to have meaningful penetration of primary insurance markets.”
Perhaps most promising is the continued push towards providing a product that is comparable with traditional reinsurance, says WCMA, with the ongoing shift to indemnity triggered protection that aligns with cedents claims handling and other reinsurance covers continuing.
WCMA sums up by saying that it’s worth keeping an eye on competition between specialist ILS investment managers in the coming months, as these trends play out.
This could help to grow the capital markets overall footprint, not just each individual investors assets, WCMA notes. However the broker warns that ceding companies need to beware of shifting too far away from broadly syndicated distribution, which still provides the diversification benefits that they require.
“This is especially dangerous where yesterday’s start-up specialist investor can be a market leader two or three years later, a quite different dynamic in comparison with the traditionally modest year-to-year market share changes for traditional reinsurers,” WCMA concludes.
You can access the full Q1 ILS market report from Willis Capital Markets & Advisory here (in PDF format).