ILS capacity tightening to influence June renewals: A.M. Best

An expected tightening of third-party reinsurance capital from insurance-linked securities (ILS) funds and structures is likely to influence pricing at the upcoming mid-year reinsurance renewals, according to A.M. Best.

The rating agency explained that while the reinsurance market is adapting to operating under Covid-19 coronavirus pandemic conditions, the fact ILS capacity may become a little less abundant at the renewals could become a factor in accelerating the firming of rates.

On top of this, the impacts of the coronavirus pandemic in the financial markets and on asset prices will pressure traditional reinsurance company balance-sheets, which we believe could also add further pressure to firm rates faster at the June and July renewals this year.

In fact, EIOPA, the European regulator has provided new guidance yesterday calling for reinsurers to halt all dividends which analysts from Morgan Stanley said could raise the sector’s cost-of-capital and noted that even a 200bps increase there could dent market cap by around 15%.

So there’s a lot going on right now, in the financial markets and in regulatory circles that could all impact available traditional reinsurance capital and the ability of the market to provide capacity at the June and July 2020 renewals, not just a potential dip or slowing of ILS capacity availability.

The reason for the potential tightening of ILS capital is down to the end-investors.

As we’ve noted repeatedly, there are some redemption requests being made of ILS funds right now and other investors of the multi-strat or more generalist variety have been selling down their catastrophe bond portfolios and may look to exit other ILS structures in their ongoing search for cash.

The reason for the selling off of cat bonds and some redemption requests being seen for ILS funds or structures, is that major investors are looking to the sector as a stable source of cash, where they can liquidate assets at close to full values, when the majority of other more correlated assets have suffered heavy declines.

It isn’t every ILS investor, the majority are longer-term and happy to hold a performing asset at this time. But if your portfolio has been severely dented by the coronavirus related financial contagion, then selling an asset that wasn’t affected is a natural step to take.

Rating agency A.M. Best says that “the upcoming April and June renewals should proceed as usual” from an operational perspective.

Noting also that, despite the hit to reinsurance company balance-sheets and the unrealised investment losses they almost all expect to take, they are “well positioned to take advantage of the potential rebound in business activity once the social and economic impacts of the pandemic subside.”

At this stage though, it looks unlikely that the social and economic impacts of the pandemic will subside by June 1st, at which time the world may still be largely under lock-down.

So that will certainly add extra upwards impetus to reinsurers price ambitions at the mid-year renewals this year.

“The industry was already under considerable pressure to increase rates following three consecutive years of losses,” A.M. Best also explains.

This pressure to increase rates is now undoubtedly higher, with the coronavirus pandemic ongoing.

“Pricing during the upcoming renewals, particularly in June, could also be influenced by capacity tightening from third-party capital, as investors are pressured by collateral and margin requirements owing to the suddenly volatile markets,” the rating agency said.

It’s not just the immediate tightening due to any redemption requests and investor withdrawals, but there are also going to be some opportunistic investors (for who ILS is likely less core) that could cycle out at this time.

A.M. Best says there is also a chance that, “Capital may flow out of third-party facilities to take advantage of opportunities in other asset classes that suddenly become more interesting.”

On the traditional side of the market, “Depressed investment returns, which are now under greater pressure from central bank actions in response to the pandemic and increased investment volatility, only exacerbate the need for better underwriting discipline across the board,” the rating agency continued.

While on the positive side, but also a factor in rates, “Demand for reinsurance could increase, as depleted balance sheets from cat losses and, now, investment volatility seek more surplus relief through a transitional period.”

If capacity is tighter, while rate ambitions are higher, but demand also increases, we could see even more firming movements across reinsurance at the mid-year renewal seasons.

While April renewals followed the expected pricing pattern despite the coronavirus, aside from some discussions over exclusions and the withdrawal of some ILS capacity, the June renewals are far enough away that the market may reset its expectations entirely as they approach.

Which will make the coming weeks very interesting, as the market moves from initial reactionary responses to the pandemic, to a new normal or resetting of expectations.