ILS panellists see bright future for alternative risk transfer as pandemic fuels growth

The insurance-linked securities (ILS) sector remains stable and primed to play a larger role in covering emerging risks such as climate change and cybersecurity on the back of its surging growth over the last 12 months, according to panellists at Munich Re’s Annual ILS/ART Roundtable at the Monte Carlo Rendez-Vous.

In a wide ranging discussion which touched on growing investor interest in the sector, and how ILS can address so-called secondary perils facing the industry, as well as divergence between the traditional industry and alternative risk transfer (ART) assets, panellists said that overall, the market entered the final quarter of 2021 in a healthy position

Munich Re chief underwriter and head of corporate underwriting Stefan Golling said the market was overall in a strong position, with capacity remaining steady and more discipline in pricing emerging in a similar way to the mainstream reinsurance markets.

However, he added, the sector needed to look beyond covering only natural catastrophes to begin to address issues such as cyber risk which are proving challenging for the re/insurance industry as a whole.

Not only nat cat

“Overall the ILS/ART market is very stable. When it comes to capacity we see a steady, slight growth, no drop back but on the other hand not a flood of new capacity.

“We see a disciplined market in the alternative markets as we have seen on the reinsurance side, maybe some segments are a bit more optimistic or aggressive, especially on the cat bond side,” Golling said.

“There we have seen slight differences to the traditional market. Of course we see new topics are important within ILS, especially environment, social and corporate governance factors, as in reinsurance.

“ILS is not only about nat cat. When I think about the ILS and ART market, we mainly still talk about nat cat, but what is the ILS market’s response to new risks, with topics such as cyber?” he asked.

“When we look back to the start of the ILS market it was a shortage of capacity for North Atlantic hurricane exposure, and in the next couple of years we will have a shortage of capacity for cyber exposure.

“It would be extremely good if we could find answers and if this is something that the ILS and ART markets can develop a risk appetite for in the near future.”

Trends

Cory Anger, managing director of Guy Carpenter Securities, said that the pandemic had accelerated trends previously under way, with more capital flowing into the cat bond markets which she attributed to the consistency of the sector relative to listed reinsurers.

Excluding events in 2017 and 2018 which trapped capital in certain vehicles, most maturities from this year had rolled over back into other ILS assets which, she said, was helping to support the market in a turbulent economic environment.

“That high maturity cycle has kept a very functioning market in the cat bond market,” Anger said.

“The third biggest theme is that ILS capital takes a faster view of where rates need to be. That can be a positive and a negative, and we have definitely seen that in 2020 and 2021 where they have been willing to deploy their capital at attractive rate on lines.

“However, we saw back in March and April 2020, when everyone was starting to react to the impact of COVID-19, and how it impacted the insurance industry, that they moved much more quickly in the pricing they needed.

“The high maturities plus the fact that, at least in the cat bond sleeve, the ILS market has been attractive in pricing, we have seen significant growth this year and a number of new sponsors in new segments, be it public sector, corporate, or re/insurers.”

Spread of returns

Stephan Ruoff, head of ILS/reinsurance at Schroder Secquaero, said that the ART market had split into two distinct segments over the past year, with catastrophe bonds proving more popular with investors than private market transactions.

“There has been an interesting phenomenon over the last 12 months of a bifurcation of the ILS market. On one hand, we have seen the cat bond space really thriving, and with that we have seen spreads coming down to some extent,” he said.

“That stands in contrast to the private market side where we have seen probably the opposite, where still inflows have been slow despite the fact that we have seen inflows increasing in line with the wider reinsurance and risk transfer markets.

“What is really remarkable about the last 12 months is that the capital base of the ILS space is close to $100 billion, which was its highest a few years ago, and that’s despite all the events that we have seen. The activity from an investor’s perspective has definitely increased.

Ruoff added that investors were becoming increasingly discerning about how to pick specific assets to add to their portfolio, with conversations with managers moving beyond the underlying risks to a more granular level.

“Investors are looking not just at the risk, they look at the manager quality, the disclosure of origination, etc, so it’s been fascinating to see how an asset class can mature in a relatively short time frame.”

Andrew Ritchie, founder of independent research firm Autonomous Research, highlighted how spreads on ILS assets had moved in equal and opposite fashion to the cost of equity for listed reinsurers, which he attributed to investor frustration with the inconsistent returns of the traditional sector over the past five years.

“My observation over the last 12 months has been a dramatic spread between expected returns in parts of the ILS market, particularly cat bonds, and expected returns or the cost of equity that the market is demanding of listed reinsurers,” Ritchie said.

“By my calculations, since 2019 newly-issued cat bond yields are now down around 200 basis points, while the implied cost of equity judging by price-to-book ratios of listed reinsurers is up about 200 basis points.”

While he acknowledged that some of the gap stemmed from broader macroeconomic trends impacting debt and equity markets, Ritchie added that investor concern over the industry’s ability to get to grips with secondary perils such as wildfires, flooding, climate change or cybersecurity had prompted a rethink on where to invest capital.

“Those are clearly impacting the lower part of the capital structure of listed reinsurers, whereas the cat bond market is sailing on regardless, given they are not affected by returns at that level of frequency,” he said.

“But there is a disconnect, and I’m not sure how that works out, between the listed reinsurance sector and the apparently very low cat bond new issue yields.

“This is the first time that the dividend yield of listed reinsurers is higher than the average cat bond new issue yield,” he concluded.