The rate of growth in the ILS market has slowed, as investors look to maintain a desirable level of return from reinsurance linked investments, leading James Vickers, Chairman of Willis Re, to highlight greater discipline from capital markets investors compared to some traditional reinsurers.
The investor base of the global insurance-linked securities (ILS) market has increasingly shown market discipline in recent times, underlined by the slowing inflow of capital as participants see margins thinning to a level below what is desirable to meet return requirements.
Alternative capital’s share of the global reinsurance market is estimated to be at around $68 to $70 billion at present. And prior to the entry of third-party capital showing signs of abating somewhat, certain industry analysts and experts predicted it to expand to anywhere from $120 billion to $150 billion by 2018.
“I think that’s unlikely,” said Vickers, referring to the expectation that the ILS market size will almost, or more than double in the next two to three years.
“The rate of growth I think is difficult to judge, there’s no doubt that there is an underlying interest for investors. But actually what we’re noticing is that the capital markets investors tend to be now more disciplined than the traditional reinsurers,” continued Vickers.
The hedge funds, pension funds and other large institutional investors that utilise the capital markets to access catastrophe risks, typically have huge balance sheets, of which just one or two percent of their entire investment portfolio will be allocated to an ILS investment.
So when competition is high, capacity is in excess and investment returns dip due to the continuous decline in interest rates, large, third-party investors will look to deploy capital into a more rewarding, attractive asset class.
Whereas, “The traditional reinsurers are fighting much harder,” says Vickers.
While the investor base of the capital markets can afford to pullback and reallocate capital into different asset classes as rates for catastrophe exposed lines deteriorate, for the traditional reinsurers it’s the core of their business, resulting in the temptation to be less disciplined in their underwriting and transactional workings to try to secure and maintain a certain level of return.
With interest rates remaining low traditional reinsurance companies haven’t been able to rely on investment returns in recent years, and with competition from the capital markets increasingly filtering down into primary business lines too, it’s become ever-more difficult for reinsurers to maintain discipline while continuing to achieve desirable rates.
This can lead to the relaxation of terms and conditions and the inclusion of unmodelled, or extra exposures within a portfolio to add more value to the client, which can in turn result in significant overexposure, leading to large losses and even insolvency.
Niklaus Hilti, Head of Insurance-Linked Strategies at Credit Suisse Asset Management, and another speaker, alongside Vickers at the A.M. Best 2015 Insurance Market Briefing, Europe, held in London recently, also noted the slower pace at which alternative capital is entering the sector.
“Definitely there is a slowing down, and yields are at the minimum now where investors they think maybe there are other opportunities, which are more attractive, and more rewarding from a risk adjusted perspective,” said Hilti.
Hilti also explains that until rates in the ILS space return to 4%+, or somewhere more attractive from a risk-adjusted perspective, it’s likely moving forward that the entry of capital will continue to slow.
As the third-party investors that operate in the space can easily invest elsewhere and have shown that they won’t deploy capital for the sake of it, and are prepared to adjust their exposure limits and lines away from cat exposed lines once rates fall too low, the discipline highlighted by Vickers becomes apparent.
Looking forward, to the long-term, Vickers and Hilti expect the growth trend to be correct, but stress that it’s unlikely to happen in the next two to three years.
“What we are seeing though is that it’s the demand from the original insurance and the reinsurers that is steady lacking, so what we’re seeing is some of the ILS funds are spilling over from reinsurance and dropping down the food chain to actually try to access what they want, which is clear, easily modelled catastrophe risk at a ground level,” concludes Vickers.