A new report published by Conning & Company looks at the insurance-linked securities (ILS) market and concludes that as the market for risk transfer through alternative instruments such as ILS, catastrophe bonds, industry loss warranties (ILWs), sidecars and collateralized reinsurance becomes more mainstream the reinsurer business model itself is changing. Reinsurers are increasingly participating in the ILS space and Conning believes its share of global reinsurance capacity is set to grow.
Currently Conning estimates the size of the ILS market as approximately 15% of total property-catastrophe reinsurance capacity, equating to about $35 billion in market size. This alternative reinsurance capacity is made up of the instruments we regularly discuss here on Artemis, such as cat bonds, ILWs, collateralized reinsurance and sidecars.
As a sector, Conning says that the ILS space is attracting increased levels of participation from both reinsurers and investors and as the market grows and evolves, as a result of growing interest in it both as an asset class and source of risk transfer, it’s having an impact on the reinsurer business model.
The ILS space is evolving, finds Conning’s report, with new structuring methods adding flexibility to both the range of products on offer for issuers and the investment options, or ways to access the asset class, for investors. This is helping the market grow both in terms of interest from potential issuers and sponsors as well as the investor base whose ambitions in the space continue to be driven by attractive returns and the low correlations with other asset classes.
The evolution and maturation of the ILS space is increasingly attracting reinsurers to get involved as managers of third-party capital dedicated to underwriting risks using ILS tools and techniques. This is beginning to impact the reinsurer business model, with lines becoming blurred between capital sources and underwriting techniques and reinsurers increasingly acting as asset managers for external investors money.
“The insurance-linked securities market has become increasingly attractive to both investors and reinsurers,” commented Steve Webersen, Managing Director at Conning. “Investors are attracted to these non-correlated diversifying investments and the historical returns the asset class has delivered. Reinsurers, meanwhile, have recognized that this market is here to stay, and are extending their business models to establish relationships with ILS funds and develop their own internal capabilities. The market has expanded well beyond its cat bond beginnings, and further growth opportunities will include collateralized reinsurance and sidecar markets.”
Conning’s report looks at the various instruments and capital sources involved in the ILS market and the motivations of both issuers of and investors in these instruments and the asset class. The report also compares the ILS space with traditional reinsurance as an alternative source of risk transfer and says that whether friend or foe, the 15% contribution that ILS capacity makes to the reinsurance market is likely to be a percentage that grows.
The growing trend for reinsurers to develop internal ILS capabilities by establishing their own ILS funds, launching sidecars or building strategic relationships with an existing ILS market capacity source is something that Conning views as a shift in the reinsurer business model.
The report looks at how reinsurers are being affected by ILS as both a segment of the market they are increasingly feeling the need to become involved in as well as how ILS is becoming a more compelling alternative to traditional reinsurance cover. Conning believes that these trends will result in changes in pricing and also market cycles for reinsurers.
“We can see the impact that insurance-linked securities are having on the overall reinsurer business model,” said Stephan Christiansen, director of research at Conning. “Our assessment is that reinsurers are evolving to offer additional solutions to their clients while not losing business to the ILS market. We anticipate that as additional capital flows into the market, reinsurers and capital providers will experience pricing pressure. We also anticipate that insurance-linked securities will capture a growing share of reinsurance capacity.”
Conning sees the increasing amount of capital in the ILS space as a likely source of pricing pressure which will ultimately reduce the returns available. The report says that in recent years pricing fluctuation seems to have been dampened in the reinsurance market and Conning believes that the growth of alternative and ILS capital sources has a lot to do with this.
Conning says that it predicts convergence will continue between the ILS and traditional reinsurance markets and that this continuing convergence will come with healthy competition.
You can purchase a copy of the full report titled ‘2013: Insurance-Linked Securities – As Alternative Risk Transfer Goes Mainstream, the Reinsurer Business Model Is Changing’ from Conning via its website.