Collateralized reinsurance and private ILS growth potential highlighted by AM Best

In a recent report, rating agency AM Best points to the potential for expansion of the collateralized reinsurance and private insurance-linked securities (ILS) space, not least as catastrophe bond risk-adjusted spreads tighten this year.

The catastrophe bond market has been the main driver of overall growth of third-party and alternative reinsurance capacity provided by ILS investors in recent years.

AM best estimates that there is around US $60 billion in alternative capital provided via collateralized reinsurance arrangements, reinsurance sidecars, and industry-loss warranty (ILW) transactions at this time.

Outside of cat bonds ILS capacity has not grown meaningfully in recent years. Although it is important to note that far more of it is now usable and able to be deployed to support new risk opportunities, given the amount of trapped capital has reduced substantially compared to a few years ago.

At the same time, we’d suggest it’s also important to consider how much risk the private ILS component of the market is able to underwrite, as more efficient market infrastructure and leverage is now being utilised.

Which means that even if the collateralized reinsurance component hasn’t grown significantly, it is likely supporting much more in the way of current risk in the market, and so able to derive more in returns for the investors supporting it.

AM Best notes that at recent renewal seasons, “there is some indication of an uptick in collateralized reinsurance capital being deployed in the middle portion of reinsurance towers.”

While this could expose this capital to more in the way of frequency perils and losses, it is worth also remembering that terms and conditions have remained relatively static for the last few years.

Supporting insurers at these levels in their towers has been seen as an opportunity for some in the ILS market.

Investors are seeking out ways to source more diversification for their portfolios, as well as higher-yielding opportunities, especially where the cat bond market is not able to provide similar.

“ILS managers have observed greater investor interest in collateralized reinsurance deals than 12 months ago,” AM Best explained.

Adding that, “Collateralized reinsurance deals can provide investors with exposure to risk that is not widely available in the 144A cat bond market. Furthermore, as risk-adjusted spreads continue to tighten in the catastrophe bond market, the relative return potential of private ILS deals becomes more attractive.”

Which bodes well for continued interest in private ILS fund strategies at this time, while also being positive for those seeking out diversified sources of reinsurance capital to support their growing needs for protection.