Deployable capital in the insurance-linked securities (ILS) market declined at the end of 2021 as the January 2022 reinsurance renewals approached, which resulted in some ILS investment managers making use of financing arrangements, we’re told.
Overall the reported ILS capital base remained relatively flat, largely thanks to gains in catastrophe bond funds that offset declines in collatertalised reinsurance, retrocession and for instruments such as sidecars.
As we explained earlier this week, overall ILS capital was seen to expand in 2021 by reinsurance broker Guy Carpenter, who recorded a 3.7% increase in alternative reinsurance capital levels to $94 billion.
Broking group Howden meanwhile, cited ILS capital levels at around $92 billion at the end of 2021.
As these are both figures that include trapped capital, or collateral held back for prior period catastrophe loss events or potential exposure related to more recent loss events, it makes it harder to understand the true level of alternative or ILS capital available to support reinsurance contracts at any one point in time.
Guy Carpenter gave some insights into this, by saying that it estimates less than 5% of reinsurance capital was trapped at year-end 2021.
So, that would be less than $26.7 billion, based on the reinsurance brokers estimate of global capital having reached $534 billion at the end of the year.
As said, our sources and research among ILS markets, suggests the trapped capital figure was likely somewhere between $15 billion and $20 billion at year-end, meaning somewhere around $70 billion to $75 billion, or so, was deployable.
As our latest catastrophe bond market report explained, which was published yesterday and you can download a copy of here, the outstanding market of property cat bonds, other 144a cat bonds and private cat bonds was $36 billion in size at the end of 2021.
Which would suggest there was somewhere around $40 billion of deployable ILS capital available, to support existing in-force and renewals of collateralized reinsurance, sidecars, industry-loss warranty (ILW) deals and other private ILS arrangements.
However, it is very hard to have full visibility of this and it could have been a little higher still, as ILS fund managers with financing facilities have also utilised them again to assist in providing continuity to ceding clients, allowing them to provide support to their renewal clients despite having collateral trapped for the previous year’s arrangement.
A number of the larger ILS fund management firms that allocate to private deals and collateralised reinsurance or retrocession, had put in place financing facilities after the 2017 hurricanes and 2018 multi-catastrophe loss years.
These arrangements are typically with lenders or banks and allow an ILS manager to more strategically navigate issues related to trapped collateral.
The idea of a financing facility is to use it when collateral has been trapped or held, so that a deal can be renewed or rolled forwards without having to tap investors for more capital to support it.
Obviously there is a cost attached to these facilities. But with borrowing having been at historically cheap levels in recent years, it has been a cost well worth paying to enable ILS funds to provide continuity to clients, despite their trapped capital issues.
However, we understand there are ILS managers whose financing facilities are already coming with more onerous terms, or less capacity, after having used them in recent years to get through previous renewals after catastrophe losses.
We’re also told by sources that there are cases where financing had been tapped earlier in 2021, meaning less was available towards year-end and drove a further decline in deployable for certain ILS funds.
In fact, our sources suggest that there are cases where capacity was being touted as available during year-end renewal negotiations, but then ended up to be diminished as financing facilities were unable to make up the difference.
Whether this was down to financing facilities already being eroded, or drying up, or rather down to late in the year trapping of additional collateral by cedents, we can’t be certain.
The January 2022 reinsurance renewals have shown up trapping of ILS capital as a negotiation tactic once again, we hear, with some occurring while the renewal negotiations were in full-swing.
We’re also being told that there is a chance of further trapping in the New Year, as market sources suggest we could see some reserve strengthening for hurricane Ida losses, from certain quarters of the re/insurance market, in the coming weeks and that this could drive further ILS fund side pocketing if it proves to be meaningful.
Of course, while financing is helpful for those operating fully-collateralized strategies without a rated front, or where a front retains collateral, there are ILS managers that have set up their own rated balance-sheets or found ways to avoid needing financing at all.
Financing can be extremely useful to ILS fund managers. It isn’t used especially widely, but where it is the facilities have been critical in helping managers renew their portfolios through loss challenged years and renewals.
The key is in finding ways to navigate, negate where possible, the effects and implications of trapped collateral, so as to offer continuity to clients, be able to capitalise on market opportunities and importantly to avoid any erosion of returns due to financing costs.