Willis sees ILS growth through innovation

With the 2017 losses slowly fading in the rear view mirror, the insurance-linked securities (ILS) market is roaring through the first half of 2018, according the latest ILS market update from Willis Towers Watson (WTW), Growth through innovation.

The company claims that cat bond issuance is at or near record levels, and that non-life ILS assets under management (AUM) continue to grow, and asks where might the road lead.

According to WTW, before getting to the possible answers it makes sense to consider what is driving the market’s continued success.

The report states that: “The first obvious answer is that ceding insurers and reinsurers want to have more risk transfer options at a better cost, and ILS delivers.

“Second, end investors are largely sold on the portfolio diversification benefits of ILS and want to increase their allocations, with investments linked to natural catastrophe (nat cat) reinsurance still their primary focus. There are some less obvious factors too.

“Some research analysts have said the lack of a big price bump on the back of the 2017 losses makes the idea of a property cat reinsurer relying solely on equity without some access to ILS capital essentially untenable. This has caused a race to create even more partnerships with ILS capital to stay competitive.

“In addition insurance, as well as reinsurance, is starting to become a growth area for ILS. Investors are trying to grow AUM and realise this offers a lot of potential, especially if the investors can manage some risks beyond nat cat. In response, some insurers and corporate risk managers are now trying to position to play offence or defence to this trend.”

WTW says that it continues to see innovation in the structure in which risk is converted to investible form as well as an effort to offer more risks and ILS structures reflecting the diversity in investors and in risk transfer needs. One example is the continued growth in ILS backing quota share-type arrangements on a semi-permanent basis. Sources of risk have ranged from insurance portfolios to reinsurance portfolios, to facilities arranged by intermediaries for the benefit of their customers.

WTW claims that while purely tactical sidecars may have not disappeared entirely, they have played next to no role in providing capacity following the 2017 losses. New relationships with ILS complement rather than fully replace the relationships protection buyers have long held with insurers and reinsurers. The near future may also continue to see more ILS penetration in insurance. For now, this will be in partnership with traditional insurers providing fronting paper for, or sharing risk with, an ILS-backed investment vehicle.

However, as has started in the reinsurance space, WTW says that some investors may ultimately source their own paper to transact without insurance partners. In this area, the next year or two will continue to see experimentation and growth, with any dramatic impacts on industry structure such as have previously been seen in the reinsurance space apparently still a few years off.

“A final trend to watch is continued expansion beyond nat cat risk. This is a trend with promise and peril. It can help make a wide range of insurance more available and affordable and help cover the protection gap.

“On the other hand, nat cat risk still has some advantages in modelling and diversification. The good news is that the expansion so far is mindful of and has addressed these differences vis-à-vis nat cat in various ways. If successful, an ILS market much larger than would be possible on nat cat alone seems likely,” the report concludes.