Greater availability & use of leverage is increasing ILS limits: WCMA

Historically, investors in the insurance-linked securities (ILS) marketplace had little leverage to take advantage of, but in today’s market environment leverage presents itself in various forms, ultimately helping to increase ILS limits, according to Willis Capital Markets & Advisory (WCMA).

During 2016 ILS capital reached an impressive $75 billion but the additional leverage available in the ILS sector in today’s marketplace means that $75 billion in assets under management (AuM) no longer means $75 billion in limit, says WCMA in its Q4 2016 ILS Market Update.

In the past, explains WCMA, the size of the ILS market was determined by the ILS AuM, annual catastrophe bond issuance, and the volume of outstanding catastrophe bonds. But the evolution of the asset class in more recent times has seen its remit expand, and increasingly, ILS structures and arrangements provide additional leverage.

“Many sidecar arrangements cap the supported limit at a modeled return period (e.g., 250 years). Sidecar and reinsurance premiums provide additional leverage, as do excess of loss fronting arrangements. Ideally we need to filter the AUM growth metric by leverage and by product form to better understand the changing impact of ILS,” says WCMA.

Sidecars, fronting arrangements, and also some collateralised reinsurance agreements, now the fastest growing and largest sub-sector of the ILS space, have in the past, and are increasingly providing leverage with the inclusion of diversifying risks such as marine and energy, for example.

In 2017 WCMA expects ILS AuM to grow at a similar pace as in 2016, which suggests the market could reach or surpass $80 billion.

“Nonetheless, leverage will grow more rapidly as investors use fronting and similar techniques to enter insurance and reinsurance. This could mean more capacity and more competition even if AUM grows more modestly,” said WCMA.

The evolution of the risk transfer landscape combined with the increased sophistication of the ILS space has seen investors and funds look to get closer to the original source of risk. This trend is expected to continue as ILS looks to increase its efficiency and expand into new business lines and geographies in the coming months and years.

“As with rated reinsurers, ILS investors enjoy maximum leverage for perils that are not peak perils. If investors need leverage to be more competitive with a specific peril, fewer diversifying cat bonds will occur relative to ILS investments with more accessible leverage. As such, nonpeak perils are actually more prominent than the cat bond figures would suggest,” explains WCMA.

The dynamics and reshaping of the global reinsurance industry and the expanding ILS sector suggests that market convergence continues to deepen. The availability of leverage in the ILS space looks set to boost the underwriting ability of the marketplace, and it will be interesting to see how this materialises throughout 2017.

“Our 2017 expectation is that assets under management will continue to grow at roughly the same pace as in 2016. Leverage and diversity will also increase, led by a greater level of sophistication amongst the established investor base. At the same time, newer investors will continue to seek the greater liquidity that the traditional cat bond product offers,” said Bill Dubinsky, Head of ILS, WCMA.