Varied April renewal outcomes for ILS funds, as Covid-19 bites

The April reinsurance renewals saw significant rate increases that offered a chance for insurance-linked securities (ILS) funds to create a much higher returning book of Japanese catastrophe risk for their portfolios, but the results appear to have been uneven.

While loss-hit Japanese catastrophe reinsurance towers exposed to wind and flood saw price increases of as high as 50% and loss-free increases of up to 35%, not everyone was able to take advantage of this, as new capital constraints saw some ILS funds having to pull-back a little in Japan.

Reinsurance broker Willis Re explained today that overall insurance-linked securities (ILS) capacity was down a little at the April 1st renewals, particularly for Japanese risks.

This even though ILS capacity came through 2019 relatively unscathed, in terms of availability, with only “modest reductions in insurance-linked securities (ILS) capacity” seen during the past year, Willis Re CEO James Kent explained today.

But the reason for some ILS funds showing a lesser appetite for Japanese catastrophe risks at these renewals was not prior year losses and trapped collateral, the drivers of ILS capacity reductions of the last few years.

Instead it was the early impacts of the Covid-19 coronavirus pandemic, which has driven some investors to seek redemptions from ILS funds and caused the market to readjust accordingly around these renewals.

The April renewal negotiations were already well underway before the coronavirus outbreak reached pandemic proportions and it is only within the last two to three weeks that some redemption requests have been received, as more generalist investors sought to liquidate ILS positions and sell-off catastrophe bonds in search of cash.

The reason for this is a flight to cash at a time when most other asset classes seems to be declining, in terms of value, but ILS and catastrophe bonds have held up due to the fact they are relatively uncorrelated to broader financial market factors.

With the ILS market viewed as a source of cash therefore, by multi-strategy funds and generalist investors whose portfolios have been decimated by declines in equities and elsewhere, the redemption requests are therefore unsurprising.

“There were examples of some ILS funds reducing their offered capacity at April 1 with the message that there had been recent redemptions by investor,” Willis Re CEO Kent said this morning.

But this wasn’t the case across the market and responding to cedents needs, “For the most part, traditional reinsurers were able to offer increased capacity along with some ILS funds,” according to Kent.

So, while redemption requests have caused some ILS fund managers to reduce available capital for the Japanese risks at the renewal, it certainly wasn’t evenly experienced and some ILS fund managers have increased their commitment to the cedents in the Japanese market.

Those ILS funds that could upsize their deployment to Japanese renewals will likely have benefited from the improved rate environment and their portfolios have elevated return potential as a result.

We’re told that on U.S. nationwide accounts (some of which also renewed) the effect of largely pending redemptions, as most are for the mid-year at the earliest where funds are invested in private ILS and collateralised reinsurance, was less apparent.

Given the less liquid nature of private ILS and collateralised reinsurance, compared to catastrophe bonds, any redemption requests to them can take time to be realised.

But once the requests come in, the ILS fund managers will work to allocate capital in the best way possible to enable the redemptions at the appropriate time, meaning less ILS capacity being made available for Japanese renewals by some does not immediately equal capital returned to investors.

Rather it can just be a reflection of the planning for that capital return beginning, as ILS fund managers work out where their capacity is best deployed in the meantime.

The effects of redemptions are not being evenly seen, as it does seem that some of the larger ILS funds have more of the kind of investors that might be seeking liquidity at this time.

If you’re a smaller ILS fund, then it’s possible your capital comes from fewer sources, more of which may be longer-term in nature. Where as, if you’re a $5 billion plus ILS fund manager there is an increased chance that you count multi-strategy investors and more generalist allocators within your investor-base, making your exposure to the types of investors that would be seeking cash at this time perhaps greater.

However, even among the larger ILS fund managers the experience won’t have been even, as it does depend on strategic targeting of investors and the mix within the investor-base.

All of which drove the varied April reinsurance renewal for ILS funds, which may well be repeated at June/July as long as the broader financial market uncertainty related to the coronavirus outbreak continues and there are redemption requests still to serve.