ILS capital inflows tempered again, but deployment opportunities to emerge

It’s apparent that some insurance-linked securities (ILS) fund managers turned down new capital allocations around the January reinsurance renewals as they were not convinced they could deploy it all at acceptable return levels, or in certain cases deploy the entire volume of funds they could potentially have raised at all.

The more we speak with ILS market end-investors and also interested investors not yet allocated to the ILS space this year, the more apparent it becomes that there could have been a significant flood of new capital into the reinsurance market from alternative sources around the January 2021 reinsurance renewals, had the opportunities for deployment been available.

A number of investors have told us that, if they could have, they would have deployed twice as much capital into collateralizing reinsurance renewals business at 1/1 2021, or into catastrophe bonds, had they been able to find the ILS fund managers that could support this deployment ambition.

On the new investor yet to deploy into ILS side of things, we’ve also heard from a number who are struggling to find entry points to the market that can support the level of investment they wanted to make, which in one case saw a large institutional investor pivot in the fourth-quarter of 2020, from a more targeted collateralized reinsurance, ILS structure deployment, to allocate its capital to a traditional reinsurance start-up and equities in established reinsurers instead.

It’s another sign of how attractive insurance-linked securities (ILS) continue to be, especially in the current economic and financial market environment.

We understand that the catastrophe bond market, in particular, would have been overloaded with capital around the end of the year, had ILS fund managers accepted all the inflows that might have been available.

But, investors are not saying they are disappointed by the outcome, not being able to deploy the capital they would have liked into the ILS asset class.

They appreciate the disciplined approach by ILS fund managers and those managing collateralized reinsurance assets, as clearly they have learned that flooding the market with capital does not help in achieving the risk commensurate returns they seek.

However, the fact that the ILS market has not grown substantially in recent years is seen in some quarters as becoming a bit challenging, given the deployment ambitions of certain large investors.

The ILS deployment opportunity has not grown significantly over the last few years, which of course is partly due to the challenges faced with catastrophe losses, loss creep, trapped ILS collateral and more recently the pandemic.

But the availability of capital looking at the ILS asset class favourably, either already invested and keen to allocate more, or on the outside wanting to enter the ILS asset class for the first time, shows that a renewed focus on originating new deployment opportunities will be time well spent, among reinsurance brokers and ILS fund managers.

Of course, the fact the ILS market cannot always accommodate all of the investment capital that might like to be deployed within in should not be seen as negative.

It’s actually a healthy feature of the ILS market, as the reinsurance market as a whole continue to be constrained in size, meaning that naturally the ILS market is too.

It’s better to hold back at this time, when everyone in the market (on both traditional and alternative sides) are keen to generate better returns, than flood the market with capital, suppressing rates for everyone else.

The real source of growth for ILS deployment opportunities, that can unlock the ILS asset class for the very large investors who want to deploy larger sums to it, does not come from just taking share from the traditional reinsurance side, it comes from expanding the overall insurance and risk transfer pie, moving ILS to different areas of the chain, in particular the large corporate risk transfer world, while continuing to pick off new perils as well, and continuing to take a reasonable slice of that enlarged marketplace opportunity set.

There are numerous promising signs on this, with the catastrophe bond market one area that looks primed for further growth and expansion to a growing range of cedents.

So too are areas of innovative insurance, or reinsurance, related risk transfer, or even pure hedging, where the capital markets can provide risk transfer product capacity, that the ILS market is well-suited to being the capital vehicle for.

There is also great opportunity in areas like climate risk and it may just take all the stars to align and catalysts to cause sponsors of municipal bonds to seek to hedge the climate related risks embedded in their securities, for new opportunities requiring deep pools of capacity to become available.

Timing is not always kind though and this recent renewal season was not one where demand for reinsurance and retrocession soared. Hence, deploying bundles of fresh capital was never going to be an easy ask of the ILS fund market and its managers.

Investors should continue watching the ILS market develop, as the opportunities look set to come in time and all the while they can learn about the managers (in particular watching their discipline as they manage capital to the deployment opportunity) and current opportunity set, while making sure they are informed on the ILS opportunity set of the future.

Over the last year, the ILS market and its fund managers have struck up new relationships with these investors that target larger deployments into ILS.

This should stand many of them in good stead to capitalise on the appetite to deploy more capital going forwards, as opportunities for ILS capital deployment are expanded, new ones developed and entirely new ways to access insurance and reinsurance linked returns become available.

We’re also bullish on risk transfer and insurance in general, strongly believing that the pandemic will stimulate uptake in hedging and protection buying, as well as the development of new categories of products that ILS capital can be a backer for.

Sometimes it pays to be patient and anyone watching the ILS fund market knows that managers have been so over the last few years, as they worked through the major catastrophe events the market has faced, all the while maintaining their market shares and key role within reinsurance.

Now, ILS seems primed for growth, the opportunity allowing.

But we believe the ILS managers and those managing reinsurance assets in ILS structures, have laid a solid footing for the next decade. As a result of which, investors should find increasing opportunities to access the asset class, to the benefit of insurers, reinsurers and ultimately those in need of insurance and risk transfer protection.