Another year of large catastrophe losses in 2020 could signal the return of opportunistic capital to the insurance-linked securities (ILS) market, as short-term investors look to exploit a hardening rate environment.
This is according to industry experts speaking at the ILS Bermuda Beyond Convergence event in London this week, who discussed the pricing outlook during a panel on recent developments in the ILS market.
Des Potter, Managing Director at GC Securities, said that it was “naive” to expect rate increases across the whole market next year, even after the challenges posed by large catastrophe losses and some reductions in capacity.
“We’re great as an industry at over-simplifying the complex business we operate within,” he told attendees at the event.
“We’re always talking about hard markets and cycles … But you can’t generalize across the market. Because within the market different parts of the market there are very, very different supply/demand dynamics, and this is going to play out at January 1.”
The losses in 2017 and 2018 also created an environment where everyone was waiting for rates to shoot up in 2019 so they could “double down” on their investments, he added.
But while the market has hardened, rates have not risen to the extent that many players had been anticipating.
Brent Slade, President of Lodgepine Capital Management, suggested that the muted pricing environment could be due to a transition from opportunistic capital to longer-term investors that has occurred over the last 10 to 15 years.
“It’s been private equity or special opportunity hedge fund type capital that’s led to the cyclicality of the business as far as capital flows, and the cycle management and rate cycles,” he said.
The turn to longer-term investors has overall been positive for the market, Slade argued, as their interests are more aligned with the longer-term ILS return periods, but it has also had a dampening effect on the rate environment.
“I like to get away from that from the hardening discussion about the rate environment because I think that’s led to some of the problem of cyclicality in this market,” he remarked.
However, the panellists acknowledged that this dynamic could be disrupted if next year turns out to be another active period for large catastrophe losses.
Brad Adderley, Partner at Appleby and moderator of the ILS Bermuda panel, asked the speakers to consider how the market would react to another year of $100 billion losses.
In response, Potter suggested that there would be serious questions raised about the credibility of the modelling and understanding of risk in the market, as well around price adequacy and the effects of climate change.
“In that scenario, rates will go up,” he said. “Long-term permanent capital will be very cautious about coming in. And what you will see is a queue of short-term opportunistic capital. You’ll see a repeat of 2005 and 2006 where the hedge funds are waiting on the side, wringing their hands looking for these 20 plus return opportunities.”
An influx of opportunistic capital could therefore signal a return to hard market cyclicality, but to the detriment of investor quality, and with the credibility of the industry seriously undermined.
In addition to potential losses next year, another unknown that could have a significant impact on the rate environment is the response of rated carriers to the slowdown in ILS capital deployment.
Potter noted that carriers could easily influence pricing by moving in to occupy any gaps that have been created by ILS not supporting certain types of business.
“If they decide they want to increase their market share and exposure in certain areas which they’ve given up to ILS, that’ll put a cap on rates,” he said.
Regular readers will be aware that we’ve already reported that some opportunistic capital had already returned, in particular in the retrocession market in advance of the January 2020 renewals.
Should the rate increases experienced this January persist in the retro space, it may not take much in the way of fresh losses to drive more of this more speculative capital into the sector at renewals later this year.