ILS market at inflection point, poised for future growth

Following hurricane Katrina “the utility of the catastrophe bond capacity became a replacement for insurance” as firms struggled to find sufficient reinsurance capacity, and now the market’s at another inflection point, according to GC Securities Managing Director, Chi Hum.

Speaking to A.M. Best at the SIFMA event in New York earlier this month, reinsurance and insurance-linked securities (ILS) industry experts discussed the future of a market that’s poised for growth and change.

“What we think is another inflection point that we are starting to go through, is that we can be a replacement for insurance,” explained Hum, using the $200 million MetroCat Ltd. (Series 2013-1) catastrophe bond as an example, which saw GC Securities act as bookrunner, lead manager and joint structuring agent.

Hum explained that after hurricane Sandy the Metropolitan Transportation Authority, a buyer of insurance for the Manhattan infrastructure requirements, discovered a deficit in their renewal programme, which was subsequently filled by the MetroCat transaction.

Hum noted that, “When you consider that we’re replacing the insurance purchase, that takes us out of the $300 billion (rough size of the global reinsurance market) bubble and into a much larger arena.

“And I think on a 3-5 year going forward basis, I think we’re sitting at a point where that growth can happen and really lift our market into a much bigger arena.”

Since Katrina the catastrophe bond and ILS market has gone from strength to strength with issuance in 2014 amounting to a record $8.718 billion, leaving the outstanding market volume at a lifetime high of $25 billion, according to data from the Artemis Deal Directory.

But some in the industry feel the growth of the ILS market over recent years coupled with benign catastrophe loss periods has added more pressure than opportunity for players within the traditional reinsurance space, as competition intensifies and pricing softens.

But absent a single large, or several significant loss events the abundance of capital from traditional and alternative sources is likely to become an increasingly permanent feature of the insurance and reinsurance space.

And while there’s no denying the current pressures that traditional reinsurers are facing, A.M. Best’s Vice President, Robert DeRose says that they aren’t the only ones.

“The alternative capacity that’s in there, whether it be in the form of collateralized market or ILS, they’re really facing the same pressures that the traditional market is facing, I mean pricing is coming down.

“Possibly the only advantage that they may have over the traditional players is that their cost-of-capital might be lower, which really allows them to price more competitively.

“But ultimately they’re facing the same deterioration of returns that the traditional players are. I guess the question is who is going to be left standing in the space when the market bottoms out,” confirmed DeRose.

An interesting point, so much discussion surrounding the effect ILS is having on traditional reinsurers has taken place in recent months, and it’s certainly worth remembering that the new players entering the space are subject to the same impacts of a challenging environment.

“If you look at the sidecars, look at the cat bonds and you also look at the collateralized reinsurance companies, we’re actually seeing a few more of those collateral re’s setting up,” Bermuda Business Development Agency’s Ross Webber told A.M. Best.

Insurance-linked asset managers and ILS funds are increasingly familiar names in the industry, but as alternative forms of risk financing tools become more widely accepted, a growing number of companies are looking to work more closely with leading reinsurers to establish collateralized or similar, reinsurance structures.

“So we’re seeing capital come in from a wide variety of sources and using different tools to deploy,” noted Webber.

One thing seems certain then, the growth of the alternative and traditional market looks set to continue.

And many feel this should be seen as an opportunity for traditional players to embrace the ILS capacity in all its forms, utilising it’s benefits to offer innovative solutions and build solid, valuable client relationships.

In fact that is beginning to happen already and not just in terms of direct corporate catastrophe bonds or collateralized covers. Examples include initiatives such as large, primary U.S. focused insurance firms leveraging third-party sources of capital and also asset management (or hedge fund) type techniques. This is seen as a way to retain greater profits from the business underwritten, while leveraging lower-cost capital and higher asset returns to outperform.

Alongside efforts of ILS managers to access primary insurance risks, by becoming risk capital providers to fronting insurers, or with facilities where they follow the fortunes of other underwriters via a broker’s book, all of these latest initiatives serve to reduce the amount of business available to traditional reinsurers.

It feels like the next inflection point is underway and developing rapidly. It’s testament to the ongoing sophistication and maturity of the ILS market and set to change the insurance landscape increasingly rapidly over the coming months and years.