ILW market dynamics offer attractive investment potential

The industry loss warranty (ILW) market offers an attractive investment opportunity at this point in time, as market dynamics have reduced available capacity, meaning fewer coverage providers exist right now and ILW returns are on the rise.

Those ILS markets for which ILWs and other index-linked reinsurance and retrocession products are more of a mainstay though, this also means opportunity, as protection that triggers based on the industry-wide exposure remains in high demand.

As we’ve reported previously, ILW pricing has been on the rise in 2019 with indications suggesting that ILW capacity will be more costly for the core peak peril markets at the upcoming mid-year renewal.

Of course, it’s not just available capacity that drives rising prices in a market such as ILWs. The losses faced by collateralised providers of reinsurance and retrocession have also helped to create upward pressure dynamics.

The most recent visibility of losses due to the rising industry toll from Japanese typhoon Jebi will only exacerbate this as the mid-year fast approaches, which all adds up to making this an opportune time to be providing ILW capacity, as well as attractive investment potential.

In its recent quarterly report on its ILW focused investment fund offering, asset manager City National Rochdale explained that, “Current market dynamics have created a compelling set of opportunities for the Fund. In terms of outlook for 2019, the January renewal period experienced a wide range of industry speculation and headlines regarding the pricing environment for insurance linked securities. With that said, analysts have been optimistic about premium increases that have been seen to this point.”

“In terms of expectations for 2019, due to seemingly very few capacity providers and widespread increase in demand for ILWs, the Fund saw a lot of positive opportunities during the January renewal period and expects more of the same in the upcoming June period, which in City National Rochdale’s opinion is evidence of a healthy market.”

We have heard similar sentiments from other market sources recently, while discussing the current dynamics in the ILW market.

In fact, we’re told that ILW portfolios right now have perhaps the best return potential of any since around 2012, thanks to higher pricing at renewals so far this year.

Right now, the market opportunity in ILW investments across the reinsurance and retrocession space seems very healthy, especially so as indicative ILW rates have risen in advance of the upcoming Florida and U.S. catastrophe reinsurance renewals.

This has been exacerbated by the shrinking availability of capacity for ILW structured risk, which means rates may stay firmer for longer given ILWs play an important role as a hedging tool for traditional reinsurance players, as well as for ILS funds or collateralized vehicles.

We spoke with the Neuberger Berman ILS team, who specialise in strategies that offer ILW and other index or parametric based protections to learn more about the latest ILW market dynamics.

“The scale and diversity of index based reinsurance policies and the number of counterparties using them has never been greater,” Peter DiFiore, Managing Director, Neuberger Berman explained to us.

Adding that, “Growing visibility of and thoughtful innovations in the structuring of high resolution index and parametric products are creating new utility for reinsurers, capital markets participants, primary insurers, and corporates.”

As the usefulness of these strategies increases, thanks to the more granular and abundant level of data available, as well as the advancement of technology that can assist in structuring and measuring triggers, the uptake in the market is bound to increase further as well.

Basis risk has always been a core concern for protection buyers, but more advanced data and analytics are helping ceding companies to better understand how an industry loss or parametric trigger can sit within and complement their reinsurance and retrocession towers.

Cedric Drui, Managing Director, Neuberger Berman, added, “ILWs and index-based risk transfer solutions continue to increase both market depth and capital efficiency, particularly in the aftermath of 2017-2018 which saw large amounts of capital trapped and awaiting resolution. By contrast, transparent and fast settling products allow capital to be re-used which benefits both buyers and sellers.”

This is another good point, as the use of index and parametric triggers does help to remove some of the latency over claims and their payment, enabling much more rapid settlement and reducing the need for long-term collateral trapping.

But of course, ILWs and other index or parametric triggered products did face their share of losses from the recent catastrophe years. But given their nature, the investors allocating to strategies that are focused on these products may have found they had clarity over the scale of losses much more quickly than the broader collateralised reinsurance funds were able to provide.

Industry sources told us that the types of products requested by buyers has been expanding alongside the sophistication of what can be provided, in the way of index and parametric risk transfer tools.

That bodes well for investors, as it should mean a growing supply of investment opportunities related to ILWs and other structures in the years to come.

This also provides opportunities to ILS-focused investment fund managers like Neuberger Berman themselves, or others such as Bermuda based Mercury Capital, for who the ILW and index triggers remain a mainstay of their investment strategies.

In addition, the depth of deal flow in the ILS space continues to grow, as new counterparties emerge and transactions between ILS funds remain a key component of this, as ILWs offer valuable hedging capacity for these collateralised markets.

Neuberger’s DiFiore further said, “Investors may gain from ILS strategies as they seek diversification to address late cycle concerns. Following the experiences in 2017-18 investors now have additional real world (not modelled) basis for comparing strategies. In particular, we are seeing growing demands for transparency in exposure and valuation, price and term discipline, and thoughtful portfolio diversification.”

That all sounds positive for the future of this niche within the ILS market and suggests that for ILWs and parametrics, the best days may still be to come.

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