Discipline will drive ILS investor, reinsurer convergence: Niklaus Hilti

Features of the insurance-linked securities (ILS) asset class have attracted a sophisticated investor base that’s sought to cease margin compression in recent times, and should reinsurers follow suit it would signal true market convergence, according to Niklaus Hilti.

Following persistent margin reductions in the ILS space between 2011 and 2014, spreads have remained relatively stable since the closing months of 2014 through the first-quarter of 2016, explains Hilti, Head of ILS at Credit Suisse.

The growth of the ILS market in recent years has seen it claim an increasingly larger slice of the overall reinsurance market pie, with analysts stating that ILS capacity now accounts for roughly $70 billion of the $427 billion of total reinsurance capital.

Helping the sector expand both its capital base and product set, the institutional/third-party investors that operate in the space, which includes pension funds and hedge funds, have shown a willingness to support sector growth potential.

Capital markets investors’ have sought to increase their understanding of the risks and opportunities of ILS investments in recent times, instead of being just providers of capacity, a trend that has resulted in the ILS community growing in sophistication and becoming more mature and influential as an asset class.

“The key opportunity we see from an investor’s perspective is that ILS has proven to be very low correlated to traditional asset classes over the last 16 years and has delivered uncorrelated attractive returns.

“We see that more and more investors are appreciating this fact and recognise ILS as a true alternative investment strategy,” said Hilti.

Recent stabilisation in catastrophe bond margins, for example, is a reflection of the increased sophistication and discipline of ILS investors, explains Hilti. As this suggests that ILS investors are disciplined enough to resist investing “below a certain minimum margin over expected loss.”

“It will be very interesting to see if reinsurers follow the example of ILS investors and stop the margin compression and not just slow it down. If that happens, it will be a sign that the market has truly converged and does not fall into old reinsurance patterns,” said Hilti.

Rates in the global reinsurance industry have been under pressure for a prolonged period, with ample capacity, the benign loss landscape, and intense competition contributing to a continuation of rate depression.

However, and perhaps a sign that pricing in the sector is increasingly nearing a floor, or possibly a signal that reinsurers are starting to push back and will only allow rates to fall so far, or both, analysts have noted a deceleration in price declines so far in 2016.

Throughout last year Artemis reported the views of certain ILS and re/insurance industry representatives that the distinction between ILS and reinsurance would continue to blur.

And as the lines between reinsurance and ILS have greyed more and more, driven in part by the increased utilisation of ILS capacity by insurers and reinsurers, and the increased sophistication of the ILS investor and marketplace, it appears that true ILS and reinsurance market convergence is drawing nearer.

Gone are the days when discussions surrounding ILS focused on the longevity of the space and permanence of its investors, as the insurance and reinsurance landscape now recognises the potential efficiency and diversification benefits ILS structures can bring to risk portfolios.

As a result, a growing and substantial number of insurers and reinsurers now work with the expanding base of capital markets investors in some form, whether via catastrophe bond issuance, collateralised reinsurance agreements, sidecar ventures, and so on.

Rates in the global insurance and reinsurance industry are expected to continue to decline through 2016, meaning firms will likely find it increasingly difficult to achieve desirable underwriting returns.

And with interest rates around the globe remaining low any revenue on the investment side of the balance sheet will likely be difficult to come by as well.

This could mean greater demand and use for reinsurance protection in the coming months as primary players look to bolster and diversify their catastrophe reinsurance programmes and beyond.

And, with ILS continuing to expand its share of global reinsurance capacity, any upticks in reinsurance demand will likely filter down into the capital markets, resulting in more ILS capacity finding its way onto reinsurance programmes, and driving the growth of the convergence market.

Hilti’s comments are taken from a new report published by Clear Path Analysis, titled ‘Insurance-Linked Securities for institutional Investors 2016‘. The full report can be downloaded by registering your details with Clear Path Analysis here.