Big test of ILS needs much higher losses than 2017: Ludolphs, Hannover Re

Despite the large losses experienced in 2017 as a result of a series of major catastrophe events, much higher losses are needed to really test the expanding insurance-linked securities (ILS) market, according to Henning Ludolphs, Managing Director of Retrocessions & Capital Markets at Hannover Re.

The ILS market showed its commitment to the risk transfer space following the large level of losses experienced in the second-half of last year, reloading and actually expanding in time for the January renewals despite numerous funds and investors experiencing losses.

The impressive reaction of the sector underlined the permanence of both the investor and sponsor base, as well as the increased sophistication and maturity of a marketplace that continues to claim an increasingly larger slice of the overall reinsurance market pie.

“ILS investors paid for hurricane losses in accordance with agreed documentation and they had sufficient funds and capacity available to offer renewals. They were indeed here to stay. Investors, however, will have to learn that losses may further creep up even after almost a year. In particular, losses from Hurricane Irma are growing,” said Ludolphs.

But despite the initial losses and the ongoing loss creep from Irma, “last year’s losses did not shy investors’ money away. They rather saw them as a new opportunity and even more money came in,” explained Ludolphs.

Some in the insurance, reinsurance, and alternative reinsurance capital space have described 2017 as the first major test for the ILS sector. However, according to Hannover Re’s Ludolphs, while the ILS market passed an “important test in 2017”, it wasn’t the big test everyone had been talking about.

“The big test will come once losses will be much higher than what we saw in 2017,” said Ludolphs.

The ILS market has continued to expand in 2018, now accounting for an estimated 16%, or $95 billion of total, dedicated global reinsurance capital, according to recent estimates. And Ludolphs expects this growth to continue through the remainder of the year.

“Currently, the estimated size of the ILS market is close to USD 100 billion. The majority of that is collateralised reinsurance but we expect that the issuance volume of new catastrophe bonds will also mark a new high in 2018. Supply from investors still exceeds demand from reinsurance buyers,” said Ludolphs.

The catastrophe bond market broke issuance records in the first-quarter, and after a very impressive second-quarter and continued issuance has already surpassed records at over $13 billion, as shown by the Artemis Deal Directory.

And, with more deals reportedly in the pipeline, it seems very likely that full-year 2018 issuance will be the strongest ever, beating the $12.6 billion brought to market in 2017.

With loss creep from Irma continuing, it might still be sometime before the overall industry loss from the three hurricanes is fully understood. Add to this the impacts of the California wildfires in the fourth-quarter of 2017 and the two powerful Mexico earthquakes, both of which impacted ILS market players, and it’s clear that the ILS market has passed an “important” test.

However, and as noted by Ludolphs, in order for the marketplace to really be tested, losses will need to much higher than those experienced last year, with 2017 already being discussed as one of, if not the costliest year on record for global insurers, reinsurers, and ILS players.

The 2018 aggregated catastrophe loss activity, including the recent wildfires, while not as high as the prior year may provide a different kind of test, being the first time that some ILS strategies have faced losses in consecutive years.

It will be interesting to see if and how the market dynamic changes as a result.