Insurance-linked securities (ILS) and catastrophe bond investment managers and their end-investors have been working hard to increase their market share in 2017, with pricing becoming increasingly efficient and now reports suggesting that terms and conditions of coverage have largely converged.
This is truly the “convergence” of the capital markets and traditional reinsurance that has so often been discussed and signals a chance for further ILS growth and more challenges for traditional reinsurers.
The ILS market growth trend is shifting to become about more than just a convergence of price terms, the convergence of coverage terms is perhaps more important for the future of the ILS market and reinsurers.
In its latest reinsurance market report, broker Willis Re explained that “Terms and conditions on ILS-backed reinsurance have largely converged with reinsurance backed by traditional promise-to-pay reinsurers.”
For years traditional reinsurance players have had a number of standard responses to any discussion of ILS market growth and the potential for it to disrupt their businesses.
These responses typically revolve around permanence, or otherwise, of capital and the breadth of coverage afforded by either traditional or alternative sources of risk transfer capacity.
The longer we go without any sign of the ILS market retreating the more permanent it is generally accepted to be, by traditional companies who could be future cedents to the alternative markets or managers of third-party capital.
Now it seems the arguments over comprehensiveness of coverage are also set to be extinguished, or at the very least dampened somewhat.
In reality, many collateralized reinsurance arrangements have seen terms & conditions parity for some time, but the news that this is expanding is positive for the ILS market’s future growth.
Catastrophe bond coverage continues to expand, with all natural perils (at least those that matter) regularly seen in U.S. multi-peril cat bonds these days. Additionally the covered portfolios of cat bonds increasingly feature the full gamut of property risk exposures, as well as other property related lines such as inland marine.
At the same time we have seen a growing number of ILS transactions covering Gulf of Mexico energy sector assets against wind risks, another area the cat bond market has seen some terms expansion into.
While other efforts to equalise terms involve fronting partnerships, so the collateralized capacity is funneled through a rated reinsurer that can offer reinstatements, providing another example of how the ILS market has been working to gain true parity of protection offered.
So cat bond terms have also become more converged with traditional reinsurance and the record issuance seen in the second-quarter of 2017 and year-to-date are clear evidence that if the pricing is right, a catastrophe bond is seen as an effective replacement for traditional reinsurance coverage now.
When terms converge it makes the job of fitting a cat bond, or other ILS backed reinsurance arrangement, into a renewal program much easier.
In the past a cat bond always required extra effort, in terms of slotting it into the tower and that had ramifications for the traditional reinsurance placement as well.
The simpler it becomes to replace a layer of reinsurance with an ILS solution the greater the uptake will be, especially where there is either price parity or a price advantage. In fact in some cases, a ceding company may value the diversification of risk capital backed by investors enough to even pay a little more for a capital markets slice of reinsurance coverage.
The convergence of terms and conditions between ILS and traditional reinsurance will continue to increase, as the ILS market becomes increasingly accepting of broader coverage, while innovations help to bring features into collateralized coverage that were once the domain of traditional reinsurance only.
This can only mean one thing, an increasing market share for the capital markets as more ceding companies realise that they can get a comparable reinsurance or retrocession product backed by the ILS market and often at a more efficient rate as well.
This convergence of terms has helped ILS fund managers to raise more capital through the last few weeks, as opportunities to deploy capacity are increasing and so the market looks set for another growth spurt.
If we reach true convergence, of terms and the effectiveness of coverage, then price and the efficiency of capital will be raised to the fore once again, amplifying the pressure that the traditional reinsurance market is already feeling.