Traditional reinsurance capital build-up more impactful to softening than ILS: AM Best

While the insurance-linked securities (ILS) market has been growing at a strong pace, thanks in the main to record levels of catastrophe bond issuance, rating agency AM Best believes that while this contributed to reinsurance market softening, the deployment of traditional capacity is still more impactful.

While reinsurance market participants cite the growth of insurance-linked securities capital as one driver of property catastrophe rate softening, the traditional market’s capacity to deploy has grown more on a dollar basis.

Recall that, AM Best and reinsurance broker Guy Carpenter estimated that third-party capital in reinsurance grew to $123 billion by the end of 2025 and it is projected to reach around $130 billion by the end of 2026.

In a new report, AM Best explains that, “The growth rate of the ILS market has exceeded the growth rate of traditional reinsurance dedicated capital. But the absolute dollar value increase in the traditional market still exceeds the ILS market growth by a wide margin.”

The rating agency explains that traditional reinsurers can leverage their capital bases to make capacity go even further, where most ILS capital matches risk dollar for dollar.

Of course, ILS managers have created infrastructure and utilise rated fronting partnerships to apply some leverage and make their capital go further as well.

But AM Best states, “While the abundant capacity in the ILS market contributes to the overall softening of the market, the deployment of traditional reinsurance capacity is still more impactful.”

It’s important to remember that fact, as when traditional reinsurers become more competitive it can accentuate the softening of reinsurance pricing far more rapidly than the steady build-up of ILS capital in the marketplace.

Record catastrophe bond issuance, as detailed in the Artemis quarterly cat bond market reports, has fuelled the growth of ILS capacity in the reinsurance market.

AM Best notes that catastrophe bond deals were regularly oversubscribed, following the course of many traditional reinsurance arrangements this year.

This came on the heels of three stellar years of ILS and reinsurance market returns, AM Best said, “which has left capacity providers flush with capital, perhaps even more than they can hope to deploy prudently.”

“By underwriting and restructuring reinsurance deals at the onset of the hard market in 2023, capacity providers positioned themselves so that no cat events in the past three years have been able to dent their large buildup of retained earnings,” explained Wai Tang, senior director, AM Best.

Abundant traditional reinsurance and ILS capital drove softening at the key mid-year reinsurance renewals, making market conditions increasingly buyer-friendly, the rating agency reports.

“The supply of capital was estimated to have surpassed demand by over 25%, driving further declines in reinsurance pricing,” added Matt Tuite, director, AM Best. “Capacity providers are finding market conditions attractive and are willing to accept lower prices to assume these risks.”

Catastrophe loss levels in 2026 have remained manageable, causing no dent to capacity on the traditional or capital markets side.

AM Best says one key question for the future and critical for the January 2027 reinsurance renewals is not whether buyer conditions remain favourable, rather it now is, “to what extent further pricing adjustments may occur, assuming catastrophe loss activity remains relatively benign through the balance of 2026.”

AM Best also highlights the exceptionally strong catastrophe bond issuance seen in the second-quarter of 2026, matching Artemis’ data point of US $11.3 billion of new issuance in the period.

“For perspective, the 2Q 2026 issuance was larger than total annual issuance for most of the history of the cat bond market, which demonstrates the rapid growth the market has experienced in recent years,” Tang commented.

Spreads are now tighter and collateral yields slightly down, resulting in lower returns for cat bond and ILS investment strategies than seen in recent years, AM Best highlights.

“The record high influx of capital has led to supply exceeding demand and a softening in the market and a compression in returns,” the rating agency explained in its report.

Adding that, “However, expected loss numbers for 144A Cat Bonds have increased compared to prior periods, which reflects higher exposure to loss. If losses rise, returns will compress further in 2026. At that point, investors may become more judicious in how they allocate capital in the market and may be more prone to focusing on specific risk profiles that are attractive to them.”

The decline spreads alongside slightly higher average expected loss numbers across cat bonds issued, has resulted in a decline in the cat bond multiple-at-market.

AM Best concluded, “Taken together, record cat bond issuance, record ILS capacity, and softer, though still positive, YTD returns reflect the same abundant-capital dynamic that has driven mid-year pricing lower across the reinsurance market. With attachment points facing renewed pressure and expected loss levels drifting upward, the trajectory into the January 2027 renewals will depend heavily on whether the remainder of the North Atlantic hurricane season stays benign.”