The book Barbarians at the Gate came out in 1990 describing the $30 billion KKR leveraged buyout (LBO) of RJR Nabisco. The book almost as much as the LBO itself sent a message that the age of the transformative LBO had arrived. It remains with us today.
Q2 2017 may play a similar role in the growth and influence of insurance-linked securities (ILS) capital. Have the investors successfully stormed the gates without any shots being fired?
Not only did ILS issuance itself break records, but also broader ILS AUM grew. Both did so into stiff headwinds from all directions. First, there was an ever softer market causing various analysts to assert that many traditional reinsurers now fail to cover their costs of capital. Second, government yields in Europe and Japan remained negative, depressing yields on collateral. Finally, Brexit and potential U.S. tax changes have increased investment uncertainty.
Of course, the penetration is far from complete. ILS still has a long way to go both to make a difference in property catastrophe (cat) in the middle market in peak zones as well as to have substantial impact in nonpeak zones. Further, areas beyond property cat see some limited influence from ILS, but by no means is ILS in the driver’s seat. Even in property cat it is possible that certain types of cat events will create differentiation among underwriters, traditional, ILS and otherwise, potentially shifting the balance.
Still, it seems perhaps more likely that this does represent a critical juncture. We very well may look back and see Q2 2017 as the death knell of the traditional property cat reinsurance model. As we have suggested as recently as last quarter, many reinsurers have and will successfully partner with ILS capital as well as technology to benefit their customers and shareholders, now that standing still seems fruitless.
We also saw a return to the underwritten deal as a way for cedants to access the broadest and most efficient liquid capacity. A few larger ILS investors fought tooth and nail to prevent these syndicated deals and more generally squeeze out smaller investors, keep more for themselves and foist higher rates on ceding companies.
Sometimes they succeeded but more often than not, at least in H1 2017, they failed. Wellinformed intermediaries helped cedants resist the temptation of the “riskless” private deal and save money through syndication. Of course it is only “riskless” until the capacity disappears at a future renewal or until the cedant’s competitors have a lower cost structure achieved with broad placement.
After the typically slow Q3, the civil war among investors will return as brokers and cedants bring 1/1s to the market. Our expectation is that Q4 volume will be muted relative to Q2 but by no means quiet. ILS activity remains high. 2017 will be a record year and 2018 may bring more of the same.
To read Willis Towers Watson Securities Q2 2017 ILS Market Report in full, click here.