There is every chance that the insurance-linked securities (ILS) market continues to experience a flight to quality, when it comes to where investor allocations are made and this could accelerate in the wake of the Covid-19 pandemic, as there is now another factor against which investors can measure ILS fund managers.
We’d suggest this doesn’t just mean the larger incumbents will benefit though, as there remains room for innovation, differentiated business models and new structures, for the deployment of investor capital into the ILS space.
But immediately it could hurt some players that find themselves more exposed to certain property related claims from the pandemic, particularly for smaller players that may have a more concentrated exposure to any claims that leak through.
A flight to quality in ILS and collateralised reinsurance has been underway, to a degree, for over a year now, as some investors shifted allocations to different fund managers following the major catastrophe losses experienced from the 2017 and 2018 underwriting years.
A shake-out, in terms of investor allocations to ILS and collateralised reinsurance vehicles, was always going to happen in the wake of major losses such as those seen in recent years.
However, it hasn’t been particularly significant in the overall market and in fact may have been better characterised as new inflows flying to more established ILS fund managers, while newer players that had faced significant losses have in some cases struggled a bit.
In fact, it’s understood that the redemptions seen after 2017 and 2018’s loss years were not particularly significant, compared to the size of the market. But they did affect its spread across players, to a degree.
S&P Global Ratings explained recently that in reinsurance in general, “Third-party capital inflows were already slowing in 2019, because of investors’ concerns regarding issues such as model credibility, risk selection/underwriting, loss reporting, reserve setting, and the potential impact of climate change on the frequency and severity of natural catastrophes. The resulting flight to quality made investors more selective, and this trend is likely to continue post-pandemic.”
How S&P saw this develop was in a reallocation within the ILS market and this is something it now expects could continue and even accelerate, where ILS fund managers have found themselves more exposed to pandemic related claims.
“Investors already preferred well-established sponsors or managers with better track records and modeling capabilities, clearer underwriting strategies, and stronger reserving practices and governance,” S&P explained.
Adding, “If losses from the pandemic creep into contracts where the pandemic risk was not modeled, we expect investors to scrutinize individual fund performance and diversification even more closely.”
Of the ILS fund managers allocating capital to collateralised reinsurance and retrocession, a good number are going to find themselves facing some exposure, or uncertainty related to potential exposure, due to the Covid-19 pandemic.
In the main, these are going to be related to contracts where pandemic risk was not adequately excluded, or where wordings are unclear and lead to uncertainty.
This may not always translate into losses and in many cases ILS fund managers say that their ‘potential’ exposure to the pandemic is very limited. But uncertainty could drive a chance of collateral being held or trapped, which could also factor into investor decisions on who to stay with and who to allocate with going forwards.
S&P further said, “Some investors may leave the market for other opportunities, or to free up cash following the COVID-19 pandemic, and we could see an increase in trapped collateral in the short term.”
Which suggests that the pandemic and the impending potential for some ILS funds and collateralised reinsurance structures to face trapped collateral as this year progresses and moves into the next, could all drive a further acceleration of any flight to quality that is ongoing still in ILS.
Of course, the pandemic has also helped to drive the firming of reinsurance rates much further than had originally been anticipated this year, making now a very attractive time to enter the ILS investment market as well.
Which means there are increasing numbers of institutional and qualified investors analysing the ILS market at this time, which may lead to elevated inflow levels in time.
It will therefore be an interesting test to see where these inflows emerge.
S&P said, “Investors will be seeking to achieve their higher target returns. If successful, this could be an incentive for investors that have been waiting on the sidelines to come in and increase ILS capacity at future renewals.”
Clearly, the larger and more established ILS fund managers likely have the infrastructure and connections to ensure inflows can be profitably deployed, meaning they will always tend to benefit most from periods when capital is flowing into the ILS market.
But there’s nothing to say an innovative start-up or smaller ILS fund manager can’t benefit just as much and in some cases large investors may value the opportunity to be a bigger fish in a smaller pond, helping to grow a business with expansion potential.
Innovation is perhaps going to be the key level for ILS fund managers to unlock inflows in years to come, as investors gain an increasing understanding of the ILS market and look to innovation as a differentiator.
Hence, launching a new ILS fund management venture with an angle, or differentiator, could right now be a very positive attribute for those seeking to attract a greater share of the funding that we now expect to come over the coming year.
The uncertainty related to claims from the pandemic is unlikely to last too much beyond the end of this year (second peaks or waves allowing), at which point most contracts that are in some way affected will have either been identified or in some number of cases perhaps even loss notified.
Meaning collateral will be held, or requested to be held, and ILS fund managers will have greater certainty to move forwards with.
As the playing field then levels out, the catastrophes of prior years move further into history and the ILS market continues to advance forwards, it will then be interesting to see how allocations flow and whether the flight to quality continues apace, or a greater redistribution of ILS capital emerges as the sector returns to growth.
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