Insurance-linked securities (ILS) funds have been seen to be more aggressive on pricing of reinsurance deals in the second-quarter of 2016, following on from a first-quarter where more discipline had been evident, according to broker Willis Re.
Willis Re, the reinsurance broking arm of Willis Towers Watson, makes the claim in its latest renewals report, insinuating that price competition from the ILS market had been higher in the second-quarter than at the beginning of the year.
“Stand-alone insurance-linked securities (ILS) funds showed discipline through the first quarter of 2016,” Global CEO of Willis Re John Cavanagh explained.
Back in January, Willis Re had highlighted that pricing discipline displayed by the ILS fund market had contributed to the slow-down in reinsurance rate softening and helped the market to hold up prices in the face of excess capacity and high-levels of competition.
However as the year progressed, it seems that Willis Re had noted more competitive pressure coming from the ILS market, resulting in more pricing pressure being applied.
This is interesting, as the anecdotal evidence from ILS fund managers is that they continue to navigate the reinsurance market carefully, deploying capital where returns can support their promised targets to investors and pulling back where these are not possible.
Cavanagh continued, saying that ILS funds “were more aggressive on pricing during the second quarter as spreads declined for liquid reinsurance investments.”
Through the second quarter the liquid ILS space, of catastrophe bonds, has certainly seen some resurgence of pricing pressure, helping many of the second-quarter cat bonds to price below initial guidance levels.
One, perhaps partial, explanation for this is that issuance has failed to keep up with demand, meaning some ILS funds have had capital to put to work in liquid securitised reinsurance instruments, which naturally can result in some additional pricing pressure.
Willis Capital Markets & Advisory (WCMA), the brokers specialist ILS and capital markets unit, explains this further within the renewals report, saying that “Investors have become more eager for liquid paper and secondary spreads have dropped.”
Evidence has also been seen that investors and ILS fund managers, as well as sponsors, are showing increasing appetite for a broader range of risk assets, outside of natural catastrophe risks “as evidenced by recent deals in life VIF, operational risk and mortgage insurance.”
This suggests that the ILS market is not being supplied with enough risk in these liquid forms, hence investors and ILS funds being more aggressive on pricing and looking outside of the peak perils for new investment opportunities.
That shows the continued and perhaps growing opportunity for ceding companies, to take advantage of demand for catastrophe bonds and other liquid ILS securities so as to lock in attractive reinsurance pricing in multi-year deals. With supply of cat bonds not living up to the clear demand, insurers and reinsurers should seriously consider whether now is a good time to enter that market while rates are at lows.
While supply of liquid ILS and cat bonds may currently be lacking, the ILS fund market continues its focus on securing risk through collateralized reinsurance structures.
WCMA explains; “Growth in insurance-linked securities (ILS) placed on an agency basis with either a single investment manager (collateralized re) and with multiple investors in private deals continues to grow.”
Additionally, Cavanagh notes in the Willis Re renewals report that some ILS and collateralized reinsurance structures are being affected by negative interest rates, this has been a factor that affected some Swiss Franc denominated funds throughout recent months.
“Negative interest rates in some currencies are affecting the collateralization of some capital market structures,” Cavanagh said, adding that “This is likely to promote further moves to alternative structures, which are less exposed to interest rate movements.”
ILS investments are often tranched or structured into classes of shares allowing investors to allocate capital in their local, or preferred, denominations. But when interest rates are so volatile this can result in differences in performance, due to hedging costs.
The development of interest rate neutral ILS or collateralized reinsurance structures would be a positive in the current economic climate, particularly post-Brexit now uncertainty has increased once again.
If ILS funds have been more aggressively competing on price at the latest renewals, it is perhaps another sign of the market being at or near its pricing floor. But with return targets to meet, little in the way of leverage and no ability to boost underwriting returns with investments, the ILS market cannot compete as hard on price as traditional players and therefore the end-result may be that the pricing floor becomes firmer more quickly.