As reinsurance rates have declined over the last two years, particularly across the core catastrophe exposed lines of business, where insurance-linked securities (ILS) have seen the most growth, some long-standing third-party investors have chosen to pull-back.
For these investors, some of whom have been in the ILS market for ten years or even more, the rapid decline in rates has made it more difficult to maintain the size of their allocations to the space.
Many investors maintain a smaller allocation, preferring to keep a foothold in ILS and reinsurance despite the lower rates, while some others have pulled out completely.
The reason for the pull-back is partly one of perception. If you’ve been averaging an 8%+ return on your investments in ILS and that near-halves in the space of two or three years, you might find it more difficult to encourage your board or trustees that it’s the right asset class for you at this point in time.
Still, the ILS market continues to grow and new investors enter the sector all the time for whom the current returns are still acceptable, particularly given the diversification and low-correlation benefits, plus what is available in other markets.
It’s testament to the attractiveness of ILS, even at the current lower returns, that new institutional investors continue to go through the effort of gaining a level of education about the asset class and make their first allocations to it at this time.
But what of the investors who do pull-back, or those that like the asset class conceptually but for whom the current level of return is just not sufficient to coax an initial allocation out of?
Some of these investors are setting up arrangements or agreements with ILS managers and reinsurance firms, to guarantee them a level of access to opportunities in the event that pricing moves after a major catastrophe event.
One of the ILS investment managers that has offered these “options” to reinvest to investors is reported to be RenaissanceRe. According to analysts at Keefe, Bruyette and Woods the reinsurer has discussed that some capital providers have maintained “options” to reinvest should catastrophe reinsurance pricing rebound.
That suggests that there are investors who find ILS and reinsurance so attractive, at a higher rate of return, that they are willing to sign agreements to guarantee capital inflows, under the right circumstances.
After a quick poll of a number of other investors and managers in the ILS space, it transpires that this kind of arrangement is considered a good way to guarantee key investors access to investment opportunities, if or when the market turns.
For large investors that have been sidelined due to reduced returns this is a good way to guarantee access to a preferred asset manager if rates do bounce back. That is an important consideration, as there may be opportunities post-event, but they may not be as easily able to get access to their preferred ILS managers strategies if other investors are also seeking to upsize allocations to the space.
KBW’s analysts see the existence of “options” to reinvest in ILS as a negative for the reinsurance sector. The analysts explain that the ability of ILS managers to call on new capital inflows, as and when market conditions allow, is a threat to the very rate rises that certain investors may be seeking.
Effectively, the ability to quickly and easily recapitalise or grow capital under management, at ILS managers and third-party reinsurance capital units, could act as “a cap to post-event rate increases” the analysts say.
Alongside the investors that are believed to be waiting on the sidelines, of which there are without doubt a number, this optioned capital could quickly take the peaks off any post-event rise in catastrophe reinsurance rates.
That would shrink the window of opportunity for both traditional reinsurance firms and ILS players to capitalise on rate increases, making it even more important to be able to re-enter the sector at the right time.
Hence these “options” to reinvest are a sensible way for large investors to as near as guarantee their ability to deploy a fixed amount of capacity, within certain parameters which likely govern any official agreement.
It’s an interesting dynamic that current market conditions have dictated.
Some investors don’t find current conditions conducive to allocate, while at the same time being willing to guarantee capital or perhaps even pay (note, we don’t know the terms of any options to reinvest) for the ability to allocate when rates, or investment opportunities, meet their return appetite.
The effect of this is to increase the capital on the sidelines. And results in an expectation that the pricing cycle will not bounce back for long, making it even more important for investors attracted to ILS to build relationships with investment managers now in order to be able to take advantage of opportunities that appear in future.
Positively it means whether capital is sidelined by its own choice, or because market conditions won’t allow its deployment easily, investors can work with ILS managers to build a strategy for deployment when the time is right.