ILS outlook for 2021 positive, as yields move higher: Ruoff, Schroder Secquaero

The insurance-linked securities (ILS) market has entered 2021 with a positive outlook, as ILS investment yields have moved to some of the most attractive levels seen in almost a decade, according to Stephan Ruoff, Head of Schroder Secquaero.

Following a number of years where ILS investment returns have been challenged by catastrophe losses, loss creep and for some the emergence of a global pandemic this year, Ruoff sees the outlook for the year-ahead as much improved.

Importantly for the ILS fund marketplace, when it comes to claims related to the COVID-19 coronavirus pandemic, “The impact was generally small. ILS remained, as expected, largely immune from the pandemic,” Ruoff explained.

In general, any pandemic related impacts for the ILS market tended to come through business interruption claims and mortality exposures, although in most cases the mortality impacts were largely mark-to-market in nature.

On business interruption, as we explained last week, issues related to the potential for ILS collateral to be trapped, over the COVID-19 pandemic and its potential losses for the insurance and reinsurance industry, have largely been postponed until after the January renewals, so there is the potential for some downside to emerge for some.

But, the majority of the ILS market reserved for claims expected due to business interruption and while some of this could be trapped or lost, there is also an expectation some of the reserves may flow back as well.

On the natural catastrophe side, Ruoff explained that in 2020, “Despite the addition of a very high number of natural catastrophes, to date the asset class overall performed well and within expectations.”

This has meant that many ILS fund strategies came through 2020 delivering returns within their targeted ranges, so meeting investor expectations.

Now, with reinsurance rates firmer after the important January renewal season, as we’ve documented, the ILS market stands well-positioned for the year ahead.

Ruoff explained that, “The 2021 outlook for ILS is positive. Re-insurance markets globally are undergoing fundamental corrections that we expect to continue in 2021 and beyond.”

While the ILS market and reinsurance in general has faced issued related to loss creep from the catastrophes that struck the globe in 2017 and 2018, Ruoff explained that, “Root causes for the prolonged “loss-creep” were poorly modelled exposures to perils that are most impacted by climate change. This triggered a trend towards improved pricing conditions.”

The ILS market responded to these issues and “These challenges were proactively addressed by the market, through revised terms and structures,” Ruoff said.

Which has led to the most sustained firming of reinsurance rates in some years.

“Rates were increasing as 2020 began, and have continued to rise, due to the additional impacts of the Covid-19 pandemic limiting the availability of capital,” Ruoff explained.

“Weakened balance sheets, through this loss-reserve development, and a lasting low interest rate environment reducing investment income for (re-)insurance companies have resulted in rating agencies taking a negative view on the outlook for the industry.

“This has put even more pressure on insurers to improve returns.”

The upshot is greatly improved return potential in ILS fund and investment strategies, with in some cases less risk having to be assumed, both due to the higher rates available and also the structural changes and adjustments to terms made over the last twelve months or so.

Putting the ILS market on a strong footing for 2021, Ruoff believes.

“With strong actions taken, new capital flowing in and improving underwriting terms, we see ILS moving to the most attractive yield levels in nearly a decade,” he concluded.