Insurance-linked securities (ILS) such as catastrophe bonds and other forms of alternative capital will have a growing role in Latin American reinsurance markets, Fitch Ratings predicts, as long as limitations surrounding data and risk modelling can be overcome.
In a recent report, Fitch highlighted why writing reinsurance in Latin America could be attractive, because of the diversification opportunities, relatively untapped marketplace, growing economies there and improving fundamentals.
But still, ILS markets remain very small players in Latin American reinsurance programs in general, with a small amount of collateralised participation in some program layers.
Meanwhile the catastrophe bond market has been restricted to sovereign cat bond issuances, facilitated by the World Bank, focused on peak catastrophe risks of Mexico and a number of other countries, to-date.
Aside from that, a handful of private ILS deals have been done, such as the innovative AlphaTerra Validus deals, that provide retrocessional reinsurance protection to Terra Brasis Re and are backed by AIG’s ILS specialist unit AlphaCat Managers.
But ILS markets are not making the headway you might expect in this region, despite the high-levels of natural catastrophe exposure there.
One of the main reasons for that is competition from the traditional reinsurance market, as in Latin America the major global reinsurers have a dominant market share in many countries.
In addition, insurance penetration remains very low, in some countries lower than Asia Pacific and in LatAm you do not have a country like Japan, which has been much faster to embrace cat bond and ILS protection that the rest of Asia due to its higher insured values and penetration of coverage.
Meaning Latin America is a big area of potential opportunity for the ILS market and one that could benefit the local insurance sector, by bringing efficient capital market funding to the regions catastrophe risks.
But Fitch highlights the main issue still hindering ILS market expansion into Latin America, the quality of the data and the lack of robust models for some perils and countries.
Fitch explained that, “This is partly because the accurate capture of insurance data is fundamental in ensuring adequate catastrophe protection. This limitation poses partial constraints on the use of alternative capital. Thus, modeling capabilities need to improve and more comprehensive statistics still need to be compiled for alternative capital sources to become more widely used.
“Alternative capital will have a growing role to play in the evolution of the LatAm reinsurance and insurance markets as some of the current limitations improve over time.”
One area ILS market expansion could happen more rapidly in Latin America is Brazil, which as we explained previously now has its own set of formalised ILS rules and regulations.
“With this new regulation, Brazil is now capable of issuing domestic ILS from its re/insurance market, as a possible new alternative to foster its growing re/insurance industry,” Fitch said.
However, this initiative has yet to see its first issuances.
Fitch said, “However, currently there are no new ILS transactions in the Brazilian market. While ILS instruments further develop and enable re/insurers access to lower-cost capital, both locally and from abroad, to support their reinsurance needs, in the end the goal is that the cost savings benefits can reach the whole industry and cascade down to the insurance consumer”