Rating of insurance-linked securities (ILS) transactions are essential if the ILS market wants to further expand its investor base beyond the current specialists who invest in the insurance and reinsurance linked asset class, according to A.M. Best.
Rating agency A.M. Best released the Best’s Insurance-Linked Securities & Structures Methodology (BILSM) earlier this year, following a period of feedback from the ILS industry.
The rating agency believes that ratings are going to be an essential part of the ILS markets future ability to expand and grow, with investors often preferring rated assets and certain transactions benefiting from having ratings applied.
“If the ILS market hopes to broaden its investor base beyond the current specialists who invest in this asset class, ratings are necessary. Less sophisticated investors would not have the expertise to understand the insurance risks in these transactions,” A.M. Best’s ILS rating team told Artemis.
As the ILS market seeks to expand its remit into new types of risks and geographies ratings may also prove vital. They can offer a way to give investors more confidence that a risk has been properly analysed, understood and well-structured.
A.M. Best explained; “In addition, new transactions that cover new exposures (such as cyber risks and operational risks) would probably also require ratings, at least at the outset, to give investors some comfort that another set of eyes have evaluated the transactions.”
Additionally there is a need for ratings to enable insurance or reinsurance companies to invest more meaningfully in the ILS asset class. Historically, re/insurers had been big investors in the ILS asset class, particularly in rated catastrophe bonds, but their participation in the sector has shrunk in recent years.
Whether the ILS markets shift away from having catastrophe bonds rated as frequently has contributed to this shift is not certain, but A.M. Best believes that more ratings on ILS transactions could result in more re/insurer participation in the sector.
“Insurers who want to invest in the ILS asset class can only do so if they are rated unless they want to incur the full capital charge associated with the asset,” the rating agencies ILS team told Artemis.
A.M. Best says that its new ILS rating criteria is not just for catastrophe bonds either, rather it believes the methodology is “flexible enough to rate all manners of ILS transactions.”
Ratings would also be attractive to some of the world’s largest investors, who will be forced by their own mandates to treat unrated ILS or catastrophe bonds a little differently to rated. There are some pension funds which can only invest in rated securitisations, for example. That could ultimately help to encourage more capital into the market.