Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Industry-loss warranty (ILW) market softens YoY as capacity rises


Following conversations with a number of market sources, it seems that the market for industry-loss warranty (ILW) protection has softened year-on-year, following on the heels of the catastrophe bond market as capacity turns its attention to ILW’s in the run up to the renewals.

inflow-capital-money-investJust the other day we explained that indicative pricing for industry-loss warranties (ILW’s) has jumped higher year-on-year, but it turns out this is just broker pricing sheets catching up to more realistic pricing levels after many had been indicating rates that were far too low a year ago.

That caused a number of contacts in the ILW capacity providing and broking market to reach out, to provide some colour on where pricing actually sits in 2021.

It’s clear that the ILW market has softened in 2021, with pricing for many ILW’s exposed to Florida wind and other US peril ILW contracts now coming in below the firm-order terms seen a year ago.

The market for typically retrocessional reinsurance protection structured in industry loss warranty (ILW) form has been one of the areas that saw a contraction of available capacity and then hardening over the last few years.

A year ago, rates had hardened considerably, as capacity was dented after losses and the impacts of the pandemic on capital markets appetite.

But in 2021, there is now what one source called a glut of capacity looking at industry loss warranty (ILW) opportunities, in some cases because they are deemed to offer a better return than industry-loss triggered catastrophe bonds at this time.

A year ago, in 2020 there was less available capacity for ILW’s in the run up to the mid-year reinsurance renewals, even though some traditional reinsurers turned their attention to the market.

In 2021 capacity has built higher and a number of markets have increased their appetite for ILW’s, we’re told, while on the protection buying side demand remains relatively high, we understand.

The reason more capacity providers and capital sources are looking to ILW’s are varied, but two main reasons seem to have driven the elevated appetite to write ILW’s at this time.

First, because they are considered to be less exposed to the potential longer-tail loss creep that has been evident in the Florida market in the past, due to their named peril and industry loss focus, plus the way losses are reported, they are often considered likely to settle before some of the cedents finalise their ultimate net losses after an event.

Secondly and perhaps at this time more important due to the proximity of the mid-year renewals, spread tightening in the catastrophe bond issuance market, where multiples-at-market are now sitting just below levels seen in 2019, has also driven more capacity (from ILS funds and investors) to look to ILW’s, resulting in price tightening there as well.

Cat bond pricing has been tightening all through 2021, with significant investor interest driven by the more predictable and named peril nature of the cat bond market, as well as the continuing value investors derive from the low correlation and attractive returns on offer.

Now, that softening of rates in the cat bond market has actually driven some ILS investors to look to ILW’s instead, finding that on a comparable basis, such as expected loss levels, the returns of an ILW contract may, in some cases, be a little better right now.

As a result, actual market cleared ILW pricing looks down year-on-year, in many cases.

When it comes to Florida and US perils we’re told the majority of ILW’s transacted around this renewal season, or after it, could clear at lower pricing compared to a year ago.

So the ILW market is the subject of additional interest from capital and capacity providers, as they seek greater predictability in loss development and look to benefit from returns deemed a little better than recent cat bonds, it seems.

One source said a Florida wind ILW with a $50bn industry trigger could price as much as 20% below where some firm order terms sat a year ago.

We expect the softening of ILW capacity could drive some additional demand as well, especially from start-up reinsurers and ILS funds looking to hedge their mid-year renewal books against major storms, or aggregate US all natural peril events.

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