Insurance-linked securities (ILS) remain an attractive and diversifying asset class, and with returns now expected to be higher following 2017 catastrophe events and the subsequent impact on reinsurance industry pricing, Mercer’s Robert Howie suggests investors should look to the space in 2018.
“With expected returns now higher, we believe existing investors should consider increasing their allocations (with sensible diversification limits), and those not currently invested should consider or reconsider the asset class,” said Howie, a principal in the Hedge Fund Boutique of Mercer’s wealth business, as part of Mercer’s March, 2018 Research Perspectives report.
Howie notes that the combined impacts of hurricanes Harvey, Irma and Maria, the Mexico earthquakes and the Northern and Southern California wildfires, is likely to drive an insurance and reinsurance industry loss of more than $100 billion, a slice of which will be borne by the ILS investor base.
Rates in the global reinsurance industry had been declining for some time, which in turn meant lower returns from ILS business, although, it’s worth noting that during this softening cycle the ILS arena did continue to expand as investors remained attracted to the uncorrelated, diversified returns the marketplace offers.
But nevertheless, returns continued to fall in the reinsurance and ILS arena, at least until the devastating impacts of third and fourth-quarter 2017 catastrophe events led to a reversal of the softening trend, and ultimately positive rate movements.
Comparing recent events to 2006, when hurricanes Katrina, Rita and Wilma removed a substantial volume of capital from the re/insurance industry resulting in dramatic price hikes, Howie explained that now, “the insurance and reinsurance industries are still well-capitalized after HIM, and many more investors are willing and able to deploy capital into ILS. This will moderate the increases in premiums.”
Rate increases were evident at the key January 1st, 2018 renewals season, albeit reportedly lower than many had hoped for, with premiums up by 0% – 10%, with the largest increases being seen in loss-affected lines and retrocession.
“As we move through 2018 and new cat bonds are issued and we pass other reinsurance renewal dates, the true impact on premiums will become clearer. January 1 premium increases have not been uniform, and ILS managers expect this pattern to continue, meaning certain areas and individual cases offer significant opportunities,” said Howie.
The response of the ILS arena to 2017 events, what’s been described as its first real test, has been noted across the industry in the aftermath of the disasters and since the January renewals season.
Overall, the ILS sector responded well to events and ultimately showed the broader risk transfer world that not only is it here to stay, but that it’s a viable and valuable component of the insurance and reinsurance arena.
Howie explained that as well as 2017 events providing a loss experience to the ILS community, it also exposed investors to the trapped collateral issue, and although this varies from fund-to-fund, “has been fairly minimal for most ILS portfolios.”
“On the back of HIM, many managers believed opportunities would arise and launched post-event funds and/or reopened existing funds that had previously closed to new investment. We believe topping up investments after losses is key to successful investing in ILS and continue to encourage investors to consider this,” continued Howie.
It’s clear from the response and reaction of the ILS sponsor and investor base to 2017 events that the marketplace has become increasingly sophisticated and mature, consistently looking to expand its remit and take advantage of opportunities in the reinsurance industry.
Howie underlined the importance in topping up investments post-loss, calling on those in the space to consider increasing their allocations, and those outside the space to look at entering the market, while return potentials are higher.
However, with competition set to rise once again the ability to deploy capital and find the risks to match it with may become more limited throughout the year, making allocations not always as easy as investors might like.
In fact a number of ILS managers have shuttered their funds already in 2018 and we expect to see more of this as the year progresses.
With returns in the ILS space expected to be higher in 2018, it will be interesting to see if the sector continues to grow its share of the overall reinsurance market pie, particularly with first-quarter 2018 catastrophe bond issuance poised to break records, as shown by the Artemis Deal Directory.
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