The industry loss warranty (ILW) market started 2012 well with relatively strong trading activity as rates remained at 2011 levels driven by the huge catastrophic losses suffered over the course of last year. Despite this good start to the year, the ILW market has suffered in recent months and if there are no major catastrophe events over the remainder of the U.S. hurricane season, broker Aon Benfield estimates that the annual traded volume of ILWs will be significantly lower than initial market expectations.
This insight is taken from Aon Benfield Securities latest annual insurance-linked securities market report which they published recently and contains some commentary on the ILW market over the last year.
The main factor that appears to have impacted ILW volumes in 2012 appears to be retrocessional capacity and availability, according to Aon Benfield’s report. Despite the heavy losses from 2011 and also the impact of the RMS v11 risk model which impacted pricing, volumes of ILWs traded are generally proportional to the level of available supply in the retro markets, said Aon Benfield. In 2012 traditional retro capacity has remained consistent, with capital shortages being absorbed by new entrants.
As a result of this, Aon Benfield’s report says that towards the end of the second quarter of 2012, a year-on-year marked reduction in ILW buying appetite was apparent. Other factors which influenced the reduction in volume of ILWs are the relatively benign catastrophe loss environment in 2012, reduced ILW budgets due to the plentiful availability of competitively priced retro capacity and moderate increases on inwards reinsurance business.
The third quarter of 2012 has not seen the ILW market fare any better, with continuing growth of available capacity, particularly from collateralized players and a reduction in demand, meaning that ILW pricing declined.
This seems to be another tale of capital market sourced capacity having an impact on the reinsurance market and helping to keep pricing down on ILWs in a similar manner to the impact on traditional reinsurance pricing from capital market inflows that we’ve written about before. While capacity remains high, particularly in collateralized retro players, who Aon themselves said have been growing their share of the retro market, the ILW market may continue to suffer reduced volumes.
Aon Benfield note that without some sort of major event over the course of the rest of 2012, the ILW market will likely finish the year with much lower volumes than observers had predicted. This does present an opportunistic trading environment for protection buyers however, as prices have been kept down and Aon Benfield note that if we do see a major U.S. hurricane threat livecat ILW trading could be interesting.
Aon Benfield also note that international ILW trading has been relatively low as well, but they expect that volumes for risks such as European windstorm, Japan typhoon and Japan earthquakes will pick up again in the fourth quarter as buyers take advantage of attractive pricing.