ILS market navigates stormy waters

After an uncertain start to the year due to severe natural catastrophe losses the insurance-linked securities (ILS) market might be returning to a more settled state, according to a number of reports in August 2019.

A report by S&P Global Ratings entitled Convergence Capital Will Remain Key For Reinsurers Despite Recent Losses suggests that alternative reinsurance or third-party capital is likely to remain ‘key’ in the global market as reinsurers grapple to stay competitive following large losses in the recent years.

Although the influx of convergence capital has fallen for the first time in a decade, reflecting two-and-a-half years of negative returns and trapped collateral from large natural catastrophes, the ratings agency said that it believes that despite these challenges new capital is entering the market—albeit at a slower rate.  New commitments have tended to favour ILS funds.

“It’s fair to say that the recent losses have put investors’ focus on seeking the best available returns,” the report says. “Indeed, the retrocession market has already hardened in 2019 and could further do so at the January 2020 renewals.”

However, the agency notes, investors have been cautious in entering the market or reloading.

“This is not surprising given it follows the two worst-performing years since the inception of the Eurekahedge ILS Advisers index. Despite a benign period of catastrophe-insured losses so far in 2019, this year also hasn’t started well for the index constituents.

“Further loss creep and mark-to-market catastrophe bond losses due to higher prices for new issuance have been the main culprits,” says the report.

Trapped collateral

According to a recent estimate by Aon about $15 billion of collateral is still trapped in contracts affected by losses from recent natural catastrophe events that could take another two years to settle, putting continued downward pressure on investors’ returns.

In 2019, several losses have continued to develop adversely across the whole industry, such as those from 2018’sTyphoon Jebi, which increased from an initial estimate of $3 billion to $7 billion to currently about $15 billion. During the April 1, 2019 Japanese renewals, reinsurance prices were up 15 percent to 25 percent, a somewhat subdued figure given the magnitude of the losses and the associated loss creep.

S&P notes that ongoing enhancements in models and adjustments in contract language (such as certain peril exclusions) are expected to encourage further growth once recent losses have been fully settled.

“Many third-party capital investors have made good returns over the long term, and the argument for investing in insurance risk to achieve portfolio diversification remains valid. For cedants, this means that there is capacity for the right risks at the right price,” it says.

Willis Re’s August ILS Market Update report says that the ILS market declined year on year in the second quarter of 2019, with just below $1.7 billion of non-life ILS capacity issued through 11 cat bonds, down from $6.2 billion and $4 billion in Q2 2017 and 2018, respectively.

That made the recent quarter the second-lowest second quarter for issuance by volume in the past eight years, except for 2016. The number of transactions declined less than total transaction value, according to the report.

As in the first quarter, US wind-focused deals dominated, including $650 million of pure coverage for the peril issued across three cat bonds, and $1.04 billion for peak multi-peril protection.

The US Federal Emergency Management Agency again reinsured the National Flood Insurance Program, through Floodsmart Re, which covers named storm-related US flood events with $300 million of capacity. In addition, four cat bonds were issued to provide more than $1.8 billion in cover for mortgage insurance risks.

Creeping losses

Reported loss creep continued to affect the ILS market but at a substantially reduced rate. At the end of Q2 2018, cat bond losses arising from 2017’shurricanesHarvey, Irma and Maria, California wildfires, and the Chiapas earthquake reached an estimated $755 million, roughly 3 percent of the $25.1 billion of widely distributed non-life cat bond capacity outstanding before hurricane Harvey.

A year later, the total 2017 loss under cat bonds reached slightly more than $1 billion, or 4.2 percent, reflecting nearly a quarter of a billion dollars of loss creep, and a year-on-year rise of about 40 percent.

According to Willis Re Securities, much of the market has recalibrated both models and its thinking to accommodate loss creep, and is closely watching the current wind season to set the tone for the year ahead.