ILS “more likely to grow” in 2021, as shake out moderates: Credit Suisse analysts

The insurance-linked securities (ILS), or alternative reinsurance capital market, is “more likely to grow than shrink” over the coming year, as the shake out of recent years moderates, according to equity analysts from investment bank Credit Suisse.

After the challenges faced through 2017 to 2019, the insurance-linked securities (ILS) market entered 2020 with much greater positivity.

But the uncertainty posed by the COVID-19 pandemic and business interruption claims has overshadowed 2020 for many in the ILS sector, alongside a high level of smaller catastrophe and severe weather losses, which have pressured returns for some and meant the year has remained a more difficult one than the ILS fund manager community would have hoped for.

Those focused on catastrophe bonds have fared much better, with positive returns and in some cases relatively significant inflows of new capital seen as well.

At the same time, 2020 has seen an ongoing shift in allocations among some investors, particularly in the private ILS and quota share reinsurance investment space, as the so-called flight to quality continued.

Insurance and reinsurance market equity analysts from investment bank Credit Suisse call 2020 more of a headache for the ILS and alternative reinsurance capital industry.

On the pandemic front, ILS market losses are “relatively contained” as they fall in the main to business interruption policies.

As a result, 2020 is shaping up to be “mildly positive” across the ILS market, although we would add that it is verging on very positive for some ILS funds that have not found themselves as exposed to the pandemic BI, as well as to some of the more catastrophe bond focused strategies.

The analysts believe that most ILS managers have not had to trap significant capital yet, due to the business interruption issues.

There appears some differing of opinion on this, with some of our sources suggesting trapping from the end of January 2021 could be much more of an issue as the 2020 contracts unwind.

However, many ILS fund managers have already reserved all of their potential exposures, so in a lot of cases these would have to be related to legal actions that drive BI claims into insurers or reinsurers reinsurance programs which had been unexpected to-date. It seems there’s a lot still to shake out here.

The analysts explain that, “The major question surrounding COVID- 19 is whether cedants are willing to book a full retention loss for a claim they/their legal team are not truly anticipating or don’t view as likely. This is a complicating factor during this renewal season.”

A complicating factor that could itself drive litigation, if unwarranted attempts to trap collateral are made.

But, we also understand that some cedents are electing to allow collateral to be rolled forwards into a renewal, rather than be trapped, as they view continuity and the ability to negotiate on price during a hardening reinsurance market as more beneficial than holding capital they don’t really view themselves as likely to claim on over the longer-term.

Overall though, there’s a lot of uncertainty here still and the pandemic BI and trapped collateral issue looks set to play out over the next 6 to 8 weeks, after which it should be much clearer how impactful this has been.

Positively, the analysts believe the ILS market is likely to return to growth over the next year or so.

Having seen some shrinkage, due to losses and also investor redemptions, ILS fund managers are now attracting new capital and at the same time maintaining discipline on price.

Which bodes well for returns going forwards and should serve as an attraction to investors, it seems. Something being clearly seen in the catastrophe bond fund market right now.

“The alternative reinsurance – dubbed “ILS” – sector shakeout appears to have moderated, and the ILS sector is more likely to grow than shrink in the next 12 months, driven by ILS managers with positive return profiles in both ’19 and ’20,” the analysts explained.

Growth is unlikely to be even across the market, as differentiated, more established and better performing ILS funds are likely to command the lions share of inflows over the next year it seems.

But a return to growth will also be positive to all ILS fund managers, giving them a chance to at least speak to and build relationships with potential new investors at a time of improving returns.