ILS capital to expand. Cat bonds to benefit from retro crunch: Guy Carpenter

Insurance-linked securities (ILS) and alternative reinsurance capital are set to continue growing as a piece of the global risk transfer market, as investor appeal for their relatively uncorrelated returns persists, according to Guy Carpenter executives.

Speaking during a virtual briefing held yesterday, executives from the reinsurance broker said that the market as a whole remains resilient and well-capitalised, despite the impacts of COVID-19, although one area picked out as under particular stress is retrocession.

The retrocession capacity crunch has been well-documented over the last two years and the threat of further retro collateral being trapped at year-end means that reinsurers are working to assess their options for protection.

Some reinsurers now face the prospects of their gross to net business models being constrained by the lack of retrocession, with growth perhaps off the agenda for some that have relied on retro to fuel their underwriting over the last few years.

The catastrophe bond market though, could benefit from this market dynamic.

Shiv Kumar, President of GC Securities, the capital markets arm of the reinsurance broker, explained that his firm is seeing “strong momentum in the catastrophe bond market” with a growing number of reinsurers accessing it as a substitute for retrocessional capacity.

That could help to swell cat bond issuance through the end of 2020 and into early 2021, as more reinsurers look to cat bonds, likely in index trigger form, as a way to secure their much-needed retro capacity.

Lara Mowery, Global Head of Distribution at Guy Carpenter, noted that the current situation of heightened uncertainty over the Covid-19 pandemic will also impact renewals in 2021.

She noted “a heightened cautiousness to deploy capacity unless pricing and other terms met specific thresholds,” adding that, “there is an expectation that renewals will be more complicated and that negotiations will take longer than the norm.

“One aspect of this that contributes to the duration of the process is the increased differentiation we have seen in renewal outcomes. We as an industry have continued to become more sophisticated in this respect.”

David Priebe, Chairman of Guy Carpenter, highlighted the resilience of the reinsurance market in all its forms.

“Fortunately, the sector has a strong track record of responding to periods of change,” Priebe said. “Putting capital to work to create new coverages and meet evolving demands will be crucial in securing the reinsurance sector’s long-term relevance. It is important to remember that transformative events have led to product innovation many times before. We expect a similar playbook this time round. Reinsurance will be crucial in supporting insurers in this endeavor, by supporting capital positions and reducing volatility.”

Kumar of GC Securities noted that, while alternative capital and ILS backed capacity has shrunk in recent years, he expects the ILS market to also prove resilient.

“We have seen capital raises in the insurance industry totaling almost $28 billion in the first eight months of the year,” Kumar explained. “A meaningful part of these has come in the form of equity. This capital has come into various subsectors ranging from P&C and life to mortgage and title insurance.”

While on ILS specifically, Kumar said, “We believe strongly that alternative capital will continue to grow over the long term. The reinsurance sector provides diversification and yield, and both are in great demand by pension and sovereign wealth funds. We are already seeing the formation of new funds by highly credible management teams.”