Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Fitch sees “breakout” potential for ILS, could double by 2030


The insurance-linked securities (ILS) market has “breakout” potential as the sector returns to growth, increasing numbers of new sponsors enter the market, including from outside of insurance and reinsurance, but the real catalysts for future expansion could be climate change and ESG, Fitch Ratings believes.

Breakout potential - insurance linked securities ILSFitch has a particularly bullish outlook for the ILS market and catastrophe bonds, noting a chance of the sector doubling by 2030, if climate change related issues drive risk transfer needs and environmental, social and governance (ESG) factors drive investment appetites towards these structures.

Fitch views the insurance-linked securities sector as “strong and viable” noting that “investors appear committed despite recent losses”.

With new sponsors entering the ILS market each year and new risk perils gradually being transacted in ILS form, Fitch sees positive ILS growth as likely thanks to a growing sponsor-base.

In addition, the rating agency sees ESG-branded catastrophe bonds as a particularly positive catalyst for future market growth.

Fitch notes the evident strong investor demand in 2021, as cat bond deals tend to get oversubscribed and price below guidance.

The cat bond and ILS form of reinsurance protection continues to see expanding use in the insurance marketplace, but so too do ILS and cat bonds as a way to access insurance capital for non-insurance market sponsors.

Importantly, Fitch highlights a trend towards using the catastrophe bond market to source an alternative to “hard to place insurance,” which is likely to be one driver of future growth for the market.

In addition, Fitch notes that mortality risk and reinsurance remains a peril the cat bond market investor-base readily accepts, highlighting the fact a recent deal also includes pandemic coverage for future COVID related deaths.

These transactions demonstrate the ILS market’s ability to provide solutions for hard to place risks, making it a particularly viable source for alternative reinsurance needs.

But the real game-change for the ILS and catastrophe bond market could be climate change, Fitch feels.

“Fitch views the next potential catalyst for alternative reinsurance to be the effect that climate change may have on ESG directives and mandates,” the rating agency explained.

Fitch further said that, “ESG is in its infancy stage with unclear reporting rules, unknown or possibly conflicting regulatory issues, and incomplete risk modeling tools.”

But explained that, “As these items get sorted out, the narrowing of the protection gap between economic and insured losses and sustainability initiatives could propel this market segment to new heights,” with a particularly bullish forecast of the ILS market “potentially doubling by 2030.”

As we explained last week (regular readers will know we often discuss this), the physical climate risks embedded in industries, asset classes and portfolios are a potential source of significant risk transfer capacity requirements in the future.

ESG reporting rules, climate disclosure and reporting, plus increasingly advanced climate risk analytics, are set to heighten awareness of the embedded physical climate risks and also heighten the appetite to transfer some of them, or hedge against them.

A role the ILS market and catastrophe bonds are particularly suited to deliver on, which could drive the need for significant new capacity across insurance, reinsurance and risk markets.

With traditional re/insurers increasingly wary of volatility from weather, climate and catastrophe risk frequency and uncertainty, the ILS market is one venue where coverage can be sourced for some of these harder to place perils and return-periods.

Is a doubling possible by 2030?

Of the catastrophe bond market itself, we’d have to say yes. It is long overdue a breakout opportunity and consistently demonstrates its potential, both to protection buyers and also its investors.

For the rest of ILS, we’d also say yes, but note that structural adjustments may be required to make the more private and collateralized reinsurance forms of ILS assets palatable to a broader range of investors and the risk transfer products to a wider range of protection buyers.

The fully securitized 144a catastrophe bond market’s growth seems assured and a doubling eminently possible by 2030, especially if the structure is embraced for the transfer of physical climate risks to the capital markets.

Breakout potential does seem an apt way to describe ILS at this time, as it becomes increasingly embedded in re/insurance and looks to do the same in global climate risk transfer and financing.

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