ILS market expansion continues, but into less liquid products: WCMA

The insurance-linked securities (ILS) market continues to see increasing total insurance and reinsurance linked assets under management, but the growth is at a more steady rate and largely into more illiquid products, notes Willis Capital Markets & Advisory (WCMA).

In the latest quarterly cat bond and ILS market report from WCMA, the investment banking and ILS specialist unit of global insurance and reinsurance broker Willis, it highlights that investor appetite for ILS and reinsurance investments remains strong, but questions whether their appetites are being fed.

WCMA raises an interesting conundrum from one of the trends that has been a feature of recent years. Is the shift into more illiquid ILS products, so think private transactions, cat bond lites and collateralized reinsurance, a new normal or just a reaction to market conditions across the broader insurance and reinsurance space?

Total ILS assets under management continue to grow, the report notes, albeit at a steadier pace than had been seen over the last few years. Higher competition from traditional reinsurers, lower pricing and the abundant availability of reinsurance risk capital are all causes of this slowdown.

However the appetite to assume re/insurance risks among capital market investors remains strong, WCMA state, but the market is not feeding investors with the liquid 144A cat bond products that many want anymore.

“Is this the new future or just a head fake?” WCMA questions.

The report notes that catastrophe bond issuance for the first nine-months of 2015 is down on a year ago, by their numbers, but that if you exclude the two Everglades Re deals, thus removing the huge $1.5 billion 2014 transaction and the smaller 2015 one, issuance is actually up 1% by its figures.

Bill Dubinsky, Head of ILS at WCMA, explains some of the dynamics being seen in the ILS market.

“The insurance-linked securities market is at an inflection point,” Dubinsky states. “Despite the continued downward pressure on reinsurance rates, investor appetite remains strong and we’ve seen net new capital come into the re/insurance arena during 2015. However, the proportion of Rule 144A catastrophe bonds issued compared to other forms of ILS is down as investors have shifted towards more illiquid products, such as private cat bonds and collateralized reinsurance.”

Is this an investor shift, as in end-investor, or an investment manager shift, as in ILS fund managers?

We’d venture that a significant number of end-investors would like to see more liquid 144A cat bonds come to market, particularly the larger pension funds who find liquid assets easier to invest directly in.

However, in the currently challenging reinsurance market, ILS managers have found that their expertise as underwriters enabled them to continue taking increasing amounts of market share away from traditional players, using collateralized reinsurance and private ILS techniques.

On whether the shift towards less liquid ILS investments is a structural shift or a temporary move in reaction to market forces, Dubinsky explains; “There are arguments for and against. To an extent, the shift illustrates increased investor confidence as the market matures. Over time, investors have become more comfortable and knowledgeable about reinsurance risk and are now more receptive to move into more illiquid products with greater confidence.

“However, this shift is also a sign of more immediate changes within the industry as the recent flurry of M&A activity, coupled with changing program design, has put reinsurance needs in a state of flux.

“Whether or not the shift away from 144A catastrophe bonds is permanent or temporary, competitive tension continues to provide ceding companies and investors with ample product choice, both to cede risk and invest,” he concluded.

In reality the ILS investor community contains players both in favour of the shift to less liquid assets and those against it. Those in favour are the investors who prefer to access the asset class through a manager, those against are often the ones who would prefer to manage an allocation more closely, or the multi-asset managers for whom catastrophe bonds represent another liquid fixed income security.

What is really required is growth of both liquid and illiquid ILS assets, which is likely what most ILS fund managers would like to see as well. Without any liquid ILS assets it would become more difficult to diversify and ensure balance in ILS portfolios, meaning that cat bonds now play a vital role by allowing managers to adjust weightings to perils or peril regions at will.

WCMA also notes that as investors have become more comfortable with the less liquid ILS assets, they have found that by venturing into collateralized reinsurance more diversification can be obtained, as there is a greater penetration into global reinsurance markets than cat bonds can provide alone.

The less liquid collateralized reinsurance transactions also suit some cedants better as well, enabling ILS players to simply become part of their reinsurer panel. This suits the current consolidation and rationalisation of reinsurer panels, but it’s very uncertain whether this will remain a trend in years to come, particularly after major losses.

WCMA notes that while there are reasons to understand the shift to less liquid assets, that as the ILS market continues to grow and mature there will likely be a need for greater liquidity in the future. A shifting and expanding investor base will also call for greater liquidity, it is thought, so perhaps the shift to illiquidity is not permanent.

WCMA concludes that it is not permanent; “In the end, we think the latter arguments are more persuasive and the shift is temporary. Still, it may not necessarily matter so much as competitive tension continues to provide ceding companies and investors with ample product choice both to cede risk and invest.”

Further growth in terms of assets under management and risk transferred to the capital market and ILS investors will continue to be seen, WCMA sum up, no matter whether the products involved are liquid or less liquid.

In summary, as the ILS market grows we can likely expect to see an increasing amount of less liquid collateralized reinsurance deals done, as ILS players increasingly become important trading partners for large ceding insurers and reinsurers.

At the same time we would expect to see a continued growth in more liquid cat bonds and other securities, as these serve a valuable purpose for cedants, ILS managers and for certain investors.

All the while there is likely to be a continued innovation of the ILS product set, which should result in greater liquidity being applied to the asset class in years to come, with technology, structures and new products leading the way here.

So it’s perhaps not a case of a shift, but the market seeking to find an equilibrium, between the more liquid securities and less liquid private deals. In the currently competitive reinsurance space the less liquid wins out, but as the ILS market grows and finds its way into new regions, perils and sponsor-types, we’d expect the liquid ILS and cat bond product to continue to thrive.

Artemis’ Q3 2015 Catastrophe Bond & ILS Market Report – A market making steady progress

We’ve now published our Q3 2015 catastrophe bond & ILS market report.

This report reviews the catastrophe bond and insurance-linked securities (ILS) market at the end of the third-quarter of 2015, looking at the $1.093 billion of new risk capital issued and the composition of the cat bond & ILS transactions completed during Q3 2015.

Download your copy here.