ILS market reports record Q1 issuance

The insurance-linked securities (ILS) market saw record levels of growth in the first three months of 2018, according to two new reports on the market from Aon Securities and Willis Towers Watson.

Aon Securities’ Insurance-Linked Securities Q1 2018 Update points out that the first quarter of 2018 was marked by record issuance volumes, new entrants to the market, and strong support from investors. Aon said that the $3.58 billion of catastrophe bonds placed represented the highest ever first quarter issuance tally, and far exceeded the 2016 and 2017 first quarter issuance volumes, which were each approximately $2.2 billion.

Aon Securities said that as the ILS market digested the implications from 2017 loss-causing events, catastrophe bonds continued to demonstrate value both to sponsors and investors alike, and there remained strong demand for issuance on both sides.

The Aon Securities report said that: “Maturities for the quarter totalled $1.37 billion of property catastrophe bonds – which was not only easily replaced, but also significantly expanded, bringing the market to a new high of $29.0 billion of catastrophe bonds on-risk as at March 31, 2018, of which $27.3 billion were property transactions. In short, in Q1 the market remained strong, and we feel this momentum will carry into the second quarter and beyond.

“Repeat sponsors led Q1 in terms of issuance volume, with $2.28 billion in property catastrophe issuance, which alone exceeded the total first quarter 2017 issuance. Further, the market expanded into a previously unrepresented region in ILS – Latin America – through the International Bank for Reconstruction and Development CAR program issuances. Investor appetite remained healthy, as reflected in spread compression along with the repeated upsizing of transactions from initial guidance.”

According to Willis Towers Watson (WTW) in its own analysis of the first quarter of 2018, entitled 'ILS Market Update
April 2018 - Reloaded and ready' ILS expansion continues and investors have fully reloaded and are now putting capital to work in the lead-up to the crucial 6/1 Florida renewal date.

However WTW has some questions: “What was wrong with the thesis that investors would cut and run with cat losses and rising interest rates? Why did so many people outside of the immediate ILS space get this wrong for so long? The simple answer is that those making the arguments were ‘talking their books’ without regard to facts. A more charitable view is that they misunderstood some ILS basics.”

According to the WTW report investors were ready for headline news cat losses, pointing out that most end investors expect to take losses over time, especially from TV news type events and that the marketing of ILS fund investments and direct investments makes this risk and others crystal clear.

The report claimed that: “Perhaps some end investors are disappointed that the 2017 losses did not seem to at least create broad-based capacity constraints driving up pricing across the board. A bigger problem would have occurred and will occur when similar cat losses at an industry level come from a surprise source (e.g., an ice storm in Miami). Interestingly, the investors were so well prepared that many former investors, not currently active in the sector, looked at reengaging post-event.”

WTW said that an increase in risk-free interest rates may actually have helped ILS. Some reinsurers and pundits have told anyone who would listen that rising interest rates would cause ILS to disappear. However WTW said that this has proved wrong in two respects. First, most end investors make long-term and slow commitments to ILS and do not rapidly reallocate away based on short-term rate changes. In fact, this is not how they behave with changes in allocations to any asset class, not just ILS.

The WTW report added: “The cause of the changes in rates is really important. If you simplistically think of interest rates as having two components, a risk-free rate for the time value of money and a credit spread, it is only long-term changes in credit spreads that might cause some reallocation away from ILS. That is because a rising risk-free rate increases ILS collateral yields without changing the perceived risk of the highly rated stable value assets such as US Treasury money market funds that serve as typical assets. In contrast a prolonged, not just a cyclical, change in fundamental credit risk would potentially shift demand toward or away from ILS, albeit slowly.

“A bonus explanation for why the ILS market didn’t stall out in 2017 and is well primed for the future is that ILS distribution can sometimes work against the cartel-like behaviour of lead markets. The “syndication” in syndicated traditional reinsurance placements and the true syndication in a securities placement actually differ to some degree. In a traditional placement, the ability of the lead markets to either support or not support firm order terms as well as their implied renewal rights gives the lead markets enormous market power to increase rates and squeeze out competition. Fans of the traditional process say that lead markets have proven their value to insurers over the long term. This then justifies additional value paid to them. In particular, large reinsurers have (largely) demonstrated their ability and willingness to pay claims post event, which is fundamentally what reinsurance is about.”

The WTW report said that some had argued that ILS were untested and that their resilience over the cycle was overrated, but that recent events, however, have proved this line of thought wrong.

“On the contrary, ILS’s splendid behaviour at the January 1 renewal, in the face of reluctant reinsurers, proves the point: assuming a similar or better claims-paying ability, it is the rate-on-line that determines the competiveness of a reinsurer. By the way it operates, the ILS placement process is simply more efficient. In an ILS placement, the market speaks without the ability for one or two large players to dictate price or be in a position to hold up a deal. There are no Firm Order Terms but simply risk spreads where the forces of supply and demand meet. Generally speaking, new and old investors who match the market clearing rate can participate on equivalent terms, thus eliminating the supply constraining impact of renewal rights.”