Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Even ILS funds finding prices less attractive: A.M. Best


Even the insurance-linked securities (ILS) fund sector has been finding pricing less attractive in many segments of the reinsurance market, according to A.M. Best, which could help to provide a little more stability under renewal pricing in January and beyond.

It’s the first time that a rating agency has commented, in a report issued just prior to the recent Monte Carlo Rendez-vous event, on the soft reinsurance market environment and said that it has heard from ILS funds that are becoming less satisfied with their underwriting returns.

While it’s been evident that ILS funds do not find returns attractive in many of the diversifying peril regions for some time, largely because traditional reinsurers are soaking up risks at discounted rates due to their ability to wield diversification as a competitive tool, prices are perhaps nearing a point where more ILS funds will become less eager to see ongoing declines.

A.M. Best notes that ILS funds have been the fastest-growing recipients of third-party capital in reinsurance, explaining that their investors likely remain very happy with returns due to the benign catastrophe loss environment of the last few years.

However, the market continues to soften and, “Even ILS funds are finding it increasingly difficult to find attractive opportunities, as pricing dynamics deteriorate further and further,” the rating agency explains.

This suggests that the bottom of the market may be even permanent than thought, even after the recent catastrophe losses there has been a continued expectation that following one or two harder renewals the softening could return. But if ILS funds are unwilling to return to the recent low pricing marks, it could help to install a more permanent floor.

A true floor in reinsurance pricing could be found once alternative capital markets lose their appetite for underwriting at ever decreasing returns, as ILS funds have investors to keep happy and cannot afford a market that removes all margin from their business.

While this situation, of a decreasing appetite for underwriting certain risks at the current very low pricing, is a natural occurrence at the latter stage of a soft market, it could also stimulate further innovation in the ILS fund market, as ILS managers look for ways to achieve the assumption of risks they desire but with a better margin.

This could accelerate the trend for ILS fund managers to back primary portfolios of risk directly, working with MGA’s and fronting providers, and to look to cut out layers of intermediation from the risk-to-capital value chain. It could also push ILS funds to search for more opportunities in other lines of business, as ways to augment their returns.

So even if prices remain more stable in future, all of this could actually equate to more negative pressure on traditional reinsurance players, as ILS fund managers expand, innovate and move even closer towards the source of risk in order to add more margin

Of course it could also push some larger institutional investors that are allocating meaningfully to ILS to look for partnerships and ways to access risk with less fees, so there could be some negative dynamics for certain ILS managers to work through as well and fee pressure is always higher when the margins are more pressured on the underlying assets.

While recent catastrophe losses mean that the expectations of further price declines at the January 2018 reinsurance renewals have disappeared, there is no guarantee that significant margin in the business is going to return and so the efficiency of operations and capital will remain vital, both for traditional and alternative underwriters of re/insurance risk.

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