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ILS expansion could stimulate liquidity demand: WCMA


In recent times illiquid insurance-linked securities (ILS) investments, such as collateralised reinsurance, has overtaken the catastrophe bond space as the main source of ILS capacity. But the benefits of a liquid asset class and the expansion of third-party capital could increase demand for liquid ILS, according to WCMA.

Willis Capital Markets & Advisory (WCMA), the capital markets division of Willis Towers Watson (WTW), in its recent Q3 ILS Market Report, has discussed the potential for increased investor demand for liquid ILS solutions, i.e. catastrophe bonds.

Broader insurance and reinsurance market conditions have helped the rise of collateralised reinsurance placements in recent times, according to some in the space, with the ease of process and reduced cost of collateralised reinsurance over a cat bond, for example, stimulating growth.

While the growth in collateralised reinsurance at a time of reduced catastrophe bond issuance has seen the alternative reinsurance capital space maintain growth, albeit at a slower pace than previously, there are benefits to liquid ILS investments, explains WCMA.

“Liquid ILS accesses the broadest most diverse group of ILS investors. Liquid ILS gives the investor greater certainty in valuation as well as the ability to exit positions more readily,” explains WCMA.

Adding, “One can think of a market with a demand for liquid ILS and a supply of liquid ILS. The supply/demand relationship at any point in time will determine the amount of liquid ILS.

“Innovation,” says WCMA, “impacts supply,” while greater interest from investors “who value liquid ILS impacts demand.”

Currently, the majority of ILS and catastrophe bonds focus on the highly competitive and very pressured property catastrophe space, particularly in the U.S., and it’s been noted by some in the space that in order for ILS to grow in the manner it’s been accustomed to in recent times, it needs to access new risks and geographies.

Interestingly, WCMA feels that the growth of ILS into new areas and business lines could result in greater demand from capital markets investors for liquid ILS.

“Increased demand from such investors might happen naturally as the market continues to expand beyond nat cat risk. Covering new perils in the ILS space (e.g., casualty, cyber) may require longer-dated securities.

“In general, liquidity becomes more important the longer the term of the security. Illiquid ILS makes more sense for one year than ten,” says WCMA.

Investor demand for liquid ILS appears to be strong, but market conditions, namely pricing and the need for efficiency, has meant that collateralized reinsurance (illiquid) is, in the current operating landscape, perhaps more attractive to both cedants and investors.

Given the choice, the range of sophisticated and broadening institutional investors that participate in the ILS space would likely prefer a liquid investment that is transparent, easy to trade out of and that still provides a diversified, uncorrelated, and crucially stable return that benefits their overall investment portfolio.

“We have seen continued interest from high net worth investors as end investors both in Europe and the US. Both regulators and these investors demand more liquidity for their investments than for investments by institutions such as pensions,” said WCMA.

“Liquid and illiquid ILS will continue to coexist as the overall ILS market grows. Innovation and more demand for liquid ILS from investors can shift the balance of products towards liquid ILS,” concludes WCMA.

The demand for ILS investments, both liquid and illiquid remains, but it’s clear that liquid investments such as catastrophe bonds have benefits for all parties involved, and also helps to grow the acceptance of the asset class as a viable liquid investment.

While market conditions can influence the utilization of illiquid or liquid ILS, innovation around product development and the expansion into new business lines and regions, both long-tail and short-tail in nature, can also help to boost the demand, efficiency, and effectiveness of liquid ILS.

Hear more about the future of ILS.
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