Insurance-linked securities (ILS) investors remain very selective about opportunities to allocate capital still, with loss creep issues still fresh in the memory, as well continued fears of volatile loss experienced and trapped capital, AM Best has said.
While rating agency AM Best put out a forecast for third-party reinsurance capital, which is predominantly the capital deployed by the ILS market, to grow over the course of full-year 2022, it noted some continued nervousness among investors.
Interestingly, AM Best believes that the slow-down in ILS market growth and the investor churn that has been seen over the last few years, was actually indicative of what we’re now seeing in traditional reinsurance markets, where major players are pulling-back from natural catastrophe risks.
“Heightened natural catastrophe activity in 2017 and 2018 became a turning point for attitudes to risk,” the rating agency said. “Although the global reinsurance segment was well capitalized, the instability of financial results and inability of most players to meet their cost of capital put the level of investors’ risk tolerance to the test.
“This was more immediately evident in the insurance-linked securities (ILS) markets, which after a period of rapid expansion, plateaued and experienced a significant flight to quality when allocating capital.”
Which has driven some of the shrinking of cat exposure among reinsurance players, with only a few of the major companies still looking to grow their catastrophe books at this time.
Which AM Best said is now “consistent with what we are also seeing in the ILS markets.”
AM Best also notes some “mixed messaging” over expanding catastrophe bond issuance, and some signs of investors driving a small expansion in total alternative reinsurance capacity after a few years of stagnation.
But adds that, “The investor base remains extremely cautious and selective.”
Saying, “The significance of any expansion gets muddled by renewals and trapped capital.”
In addition, the rating agency said that retrocession capacity remains limited, which it sees as a key constraint for some traditional reinsurers.
Retro availability, or price, may actually be a driver for some of the catastrophe pull-back we’ve seen, as some companies just cannot take on as much exposure if they cannot maintain the large retro hedging programs they had in place before.
Despite the hardening of the reinsurance market, AM Best also noted that we aren’t seeing the same interest in new capital deployment from investors, on either the traditional or alternative sides of the market.
As a result, new reinsurance start-ups are few and far between, while some startup plans have changed, been delayed, or abandoned.
“Third-party capital, while typically is expected to react more swiftly to market conditions, seems subject to the same level of skepticism,” AM Best believes.
As a result of which, the market is dealing in provision of more restrictive covers, tighter terms and conditions.
“The volatility of recent claims remains the key issue,” AM Best said. “Issues with regard to trapped capital have not gone away completely. “Loss creep” remains well within the memory of investors.”
There is nothing wrong with a deal of caution, when it comes to capital deployment. In fact, the ILS market’s response to market hardening has so far been disciplined.
The catastrophe bond market evidenced this as well, where significant inflows in 2021 to some cat bond funds did not pressure pricing particularly and in fact pricing swiftly ticked up when that capital began to run lower after deployment.
While, at the same time, nobody raised significant sums to capitalise on the wave of new issuance seen through 2022.
We didn’t see significant ILS capital raises at the mid-year renewals either, with those capital raises revealed largely being very targeted, to take advantage of market dislocation and areas of reinsurance that capacity is a little scarce.
So, while caution remains and investors may be sceptical, there is continuing evidence of a recovery in sentiment, at least in some quarters of ILS.