Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Terms & risk access as important as rates in determining ILS returns


Terms and conditions associated with reinsurance, retrocession and insurance-linked securities (ILS) renewals, as well as the way you access the risk, are said to have been equally as important as rates at the recent renewal in determining the actual risk adjusted returns achievable.

terms-conditions-ils-reinsurancePricing and rates has of course been a major talking point at the just-passed January 2019 reinsurance renewal (aren’t they always).

But as we’ve explained before, the outcome of a renewal is never evenly experienced across the market and some have underwritten portfolios that they expect will deliver satisfactory returns over the year ahead.

Everyone focuses on rates and pricing in reinsurance and the broad reporting of industry rate trends doesn’t really help anyone, as it often overlooks the nuances and differences between accounts as well as the influence of relationships.

Take one catastrophe reinsurance program layer and two reinsurance markets, both of which sign on the renewal at the same pricing level, but one gets favourable terms as it’s been a partner to the ceding company for more than a decade and provides broader support across its business.

In some cases the risk adjusted returns both reinsurance markets receive could be very different, thanks to the favourable terms that one market can secure over the other.

These differences do not shine through in the reinsurance broker reports that bundle all rates into a single metric designed to show the direction of the market. But this isn’t always true and in 2019 it seems the nuances related to renewal signings really matter.

This recent January 2019 reinsurance renewal has seen this dynamic in spades, our sources tell us.

While some markets, both traditional reinsurance and ILS fund or collateralised, have been disappointed by the outcome of the renewals, others say they are happy with the risk adjusted returns of the portfolios they have created, but put this largely down to their relationships and the way they access the same risks.

Yes, the majority of ILS markets would have appreciated a higher response in pricing to the losses of the last two years, but the outcome of the renewal is still seen as positive by most and it is the terms & conditions secured that appear set to make all the difference in 2019.

Improved terms and conditions can benefit ILS funds and investors by enhancing the risk-return profile of a specific transaction, making it a more attractive investment even if the rate-on-line improvement has not been as significant as hoped for.

As a result, terms are considered almost as important as rates, something expected to become increasingly true as the market price cycle continues to remain flat thanks to the ongoing interest from capital markets players.

As well as the terms, there is also the mechanism by which a reinsurance contract signing is accessed. With ILS investment managers constantly seeking the most efficient and direct way to access risks, these efforts can increase the margin of a piece of business considerably, hence can be almost as important as rate-on-line as well.

These two factors, the ability to negotiate preferential terms and conditions, or to access the underwritten risks more directly and efficiently, are set to become significant differentiators for ILS investment managers, as they are qualities that investors are beginning to actively seek out.

As we explained recently, the impact of the catastrophe events of recent years is driving something of a flight to quality in the ILS world, as some of the longer-term investors look to identify whether their money is currently deployed in the right place.

It’s not that their appetite for investing in ILS and reinsurance has been dampened significantly, more that they want to ensure their allocations are made to the managers that can secure them the best possible risk adjusted returns over the longer-term.

As the ILS market moves forwards from the last two years of losses, managers will find a focus on differentiation through these factors benefits them and enhance their ability to attract new investors.

Alongside access to preferential terms and the routes used to access business, other areas of the ILS investment teams operations are also likely to provide opportunities for differentiation through this year and beyond, with the operational structure, access to rated paper, ability to secure larger lines, and ability to model and underwrite complex deals, all set to provide opportunities to stand-out from the crowd.

After the period of losses and the resulting fall-out ILS investment teams now have the perfect opportunity to impress the investor community at large with their prowess in sourcing, originating and structuring deals, while negotiating the most favourable terms.

The proof will be in the risk adjusted returns they offer to their investors over time, as well as in how they promote their business models more generally and the differentiating factors they have.

Being a following market or relying on a small number of specific sources of risk increasingly seems like a less viable strategy for an ILS fund manager to follow.

This does mean size is important, as securing favourable terms and access to business is unlikely to come easy to ILS managers with very low levels of assets under management.

But it’s not impossible to be smaller and still be able to differentiate yourself, so this shouldn’t deter anyone from starting up in the sector.

While underwriters across reinsurance and insurance-linked securities (ILS) are cautiously optimistic about the chances of better rate increases at the April and mid-year renewals, it seems their focus and time would be as well targeted at how they can enhance returns even if rates-on-line don’t rise significantly.

With the number of new ILS initiatives in the works rising all the time, it seems likely any increase in rate will be met by an increase in new capital inflows into the reinsurance sector.

Hence it may be better not to rely on (or put all your hopes on) rate increases, but instead to concentrate on where your ILS business practices and structure can positively influence risk adjusted returns instead.

In this reinsurance world of a flatter, less responsive to loss, market price cycle, it is encouraging that ILS managers are finding ways to differentiate themselves and enhance their returns.

It’s important to note that terms may themselves become flatter in years to come, especially if electronic trading of risks finally becomes the standard. There may be less room for preferential treatment in that case, heightening the need for margin-focused origination and capital efficiency once again.

But overall the ability to differentiate and enhance returns is only going to become more important, we believe, leading to significant investment in building out platforms and structures, or partnerships, that support these goals.

Also read: The renewal wasn’t flat (or down) for everyone.

Read all of our reinsurance renewal coverage here.

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