ILS growth hinges on ability to recover from recent losses: Grimes, Fitch Ratings

Insurance-linked securities (ILS) market growth over the coming years hinges on the ability of ILS funds and managers to demonstrate they can recover from recent catastrophe losses and adapt their business models to better cope with future ones.

Speaking with Artemis, Chris Grimes, Director, Insurance at Fitch Ratings, said that ILS continues to challenge traditional reinsurance business models, even after the losses.

On reinsurers he explained, “Companies are also very mindful of the current challenges they face in producing an adequate return above their cost of capital and the competition they face from lower cost alternative markets.”

But after the significant impacts and loss creep from hurricane Irma and typhoon Jebi, ILS fund managers and collateralized reinsurance vehicles still have some work to do in demonstrating how they have responded, adapted and traded forwards to better handle future loss events.

That’s not necessarily in being better protected against them, it’s also about having better and more transparent processes in place to communicate impacts to investments when the worst happens.

“The alternative players, in particular, have likely learned the value that investors place on transparency, conservatism and open communication in the process of loss estimation,” Grimes said.

Adding, “Markets that have done this better than others in the last two years will likely be in a stronger position to attract fresh capital and expand their business in the marketplace.”

Elaborating on ILS fund performance over the last two years, Grimes explained, “Alternative capital providers have generally had a strong long term record of results to display, but the events of 2017/2018 and associated loss creep and trapped collateral demonstrate that challenges still remain in this business model and growth will somewhat hinge on the industry’s ability to improve in these areas.”

Part of this is demonstrating an ability to recover and trade forwards, while communicating openly and transparently, traits that any investor is looking for from an asset manager, particularly in a less well-understood and complex alternative asset class like ILS and reinsurance.

This could mean a bifurcation of the success of the ILS fund market, as larger and more established players, or those with greater resource and long-standing processes, could find it easier to demonstrate their recovery.

Meaning, “We expect that a flight to quality is an inevitable occurrence with the ILS market and the major ILS funds will continue to grow and become a larger presence in the placement of reinsurance coverage,” Grimes said.

As a result, Grimes explained that at Fitch, “We expect investors to be more discerning in ILS investments, with investors likely to be searching for higher returns to offset any perceived increases in risk following 2017/2018.”

But he warns that, “This could slow the development of the ILS market and reduce its pricing advantage relative to the traditional reinsurance business model.”

Which could help reinsurers to increase their competitiveness somewhat, although at the same time they are expected to continue growing their third-party capital activities and reinsurer managed ILS vehicles.

“We expect that traditional (re)insurers will continue to expand their alternative capital relationships and utilizing the associated lower cost of capital for their own benefit,” Grimes said.

But the overriding need right now is for ILS funds to demonstrate their businesses ability to manage ongoing loss creep and trapped collateral, while recovering, building new portfolios that meet investor’s needs and delivering returns, with future prospects for growth at some ILS funds hinging on their ability to demonstrate this.