The continued and growing appetite of third-party, capital markets investors to access insurance and reinsurance-linked exposures through the features of the insurance-linked securities (ILS) market suggests a flattening of the reinsurance market cycle, according to speakers at the 2016 SIFMA IRLS event.
“I think the industry is changing and yes, we’re probably not going to see the spikes that we’ve seen back in the day,” said Todor Todorov, Senior Investment Consultant, Hedge Fund Research, at Willis Towers Watson.
A view shared by Dr. Dan Bergman, Head of Investment Research & ILS at the Third Swedish National Pension Fund, in a panel discussion on the role and desire of pension funds in the global ILS market.
“I think there are players and much capital that is repositioning itself at the moment to take advantage of the next hard market, and it’s not obvious to me that the next hard market will be very hard,” said Bergman.
Adding, “Whatever triggers it there will be many people ready to step in and try to profit from that.”
Numerous market participants and analysts over the last 12 months have noted the possibility of an end to the re/insurance market cycle, as a wealth of capacity from both traditional and alternative sources is expected to result in a flatter underwriting cycle in future years.
Whether continued, tough market conditions means the end of the traditional reinsurance cycle entirely, or just a more compressed one remains unclear, but the impacts of the challenging re/insurance industry are also being felt in the ILS space.
Discussions between Bergman, Todorov, and also Jonathan Malawer, Managing Director, Senior Investment Analyst at K2 Advisors and Howard Bruch, Managing Director at Willis Capital Markets & Advisory, reveal that strong investor appetite for ILS is, and will continue to contribute to the smoothing of the ILS market cycle.
Bergman implies that whatever triggers the next turn in the market, and whenever this happens, is unlikely to result in a particularly hard market, at least compared to previous hard market cycles in the space, as there is a wealth of institutional investors sat on the side-lines waiting to deploy capital into the sector.
Furthermore, the majority of pension funds already in the space typically allocate around 2% of their entire risk portfolio to ILS, which is extremely diversified and largely un-correlated with the rest of their investment portfolio and has been returning positively when other alternative assets have been hindered by financial market volatility.
With this in mind, it wouldn’t be surprising were the sophisticated third-party investors already interested in the space to continue to deploy capital into the asset class even after the next loss event, as it has provided them with a steady, reliable income stream, and that their allocation is typically limited when compared to their overall investment portfolio.
For the new investors that are looking to enter the space after the next large loss event, Malawer explained that sitting on the side-lines isn’t the best approach to allocating in the space.
Despite the benign loss environment the next event will happen at some point, but Malawer notes that even after hurricane Sandy the market didn’t substantially re-price itself, “and you’re still getting paid positive margin in this environment.”
“I think you’re going to have your view of risk and how much you want to take, but this asset class has really benefited investors over that period of time, and for you to sit on the side-lines and wait, whether that’s six months, tomorrow or ten years from now, I think that is the wrong point of view,” said Malawer.
Further highlighting the diversified and un-correlated, steady returns the ILS market has provided investors over the last ten years absent a large loss event, and also during more recent times underlined by a softening reinsurance market.
The challenge then, says Malawer is to continue to educate new investors so that they understand the risk and return parameters of the ILS market, something that could lead to further investor sophistication and market maturity, and ultimately the continued expansion of ILS in the overall reinsurance landscape.
Moderator of the panel, Howard Bruch, commented on the permanence of institutional investors in the ILS space.
“This asset class actually happens to be very unique, it’s the only alternative risk that is not synthetically created, and when you think about it in that context I think it makes the players who come to the space, it makes them a little bit more sticky in the long run.
“Should they pull-back on alternative risk, I don’t think this would be the first one they would choose to pull-back from because of the unique nature of the risk,” said Bruch.
The higher returns investors in the ILS space were used to previously might well be a thing of the past, as the wealth of capacity already in the space, coupled with that sat on the side-lines waiting to come in, is likely to compress future market cycles.
The steady income stream capital markets investors have benefited from via the ILS market has helped to build a sophisticated, strong and growing investor-base, that shows signs of expanding further into new risks and regions in the coming months.