ILS market has “meaningful growth opportunity” to $200bn by 2032: Jefferies

The catastrophe bond and insurance-linked securities (ILS) market has a “meaningful growth opportunity” ahead of it, with a near doubling of the ILS market to as much as $200 billion in capital possible by the year 2032, according to analysts at investment bank Jefferies.

The analysts say that the rebound in issuance and expansion of the catastrophe bond market is expected to broaden out to other ILS vehicles, such as collateralized reinsurance and sidecar opportunities, in 2025.

Believing that the ILS market has “runway to double the ~$100bn mkt by ’32.”

ILS investor appetite is expected to rebound near-term, thanks to the higher returns experienced since the more challenged period where catastrophe losses and soft market pricing and terms dented performance.

The analysts note that the growth expectations they have would be expected to cap pricing in both ILS and traditional reinsurance, which they see as benefiting primary insurers.

The Jefferies team explain, “Long term, we see broad ILS market growth, as (1) collateralization bid-ask spreads normalize, (2) insurer protection demand grows, (3) third party modeling of weather perils – including secondary perils – improves, (4) opportunities for expansion outside of N. America (which comprises >80% of market) increase, and (5) other LoBs, particularly cyber and flood, increase TAM.

“We could see the overall ILS market roughly double from $110bn currently, to $200bn by ’32. ILS non-correlation appeal should continue, particularly as traditional and ILS contracts tightened and should ’24 be a benign hurricane year.”

Growth of the ILS market will both cap reinsurance pricing and also offer more protection alternatives, benefiting the primary insurance market, the analysts highlight.

But they also note that, “Near term, we find the main limitation to growth to be supply, given ILS capital reticence after a challenging ’16-’22.

“Demand, however, is high, particularly while traditional reinsurers remain disciplined in capital allocation and in T&C, showing limited appetite for remote risk and essentially no appetite for attritional risk.”

The outcome of the US hurricane season and any other major catastrophe losses through year-end could hold back the growth potential of ILS, the analysts suggest.

But the Jefferies team state that, “Should the ’24 hurricane season (ends 11/30) prove to be benign despite early expectations, we anticipate a meaningful increase in the supply of collateralized reinsurance and sidecar capital in ’25 (both of which protect against less remote risk than CAT bonds and experienced weaker returns) as trapped capital from ’22 and prior is released, returns improve and investors look to capitalize on improving underlying property T&C and rates.”

The analysts believe that the fact large traditional reinsurance companies may be unwilling to budge on terms including attachment points and the inclusion of secondary perils will “offer a wider opening for ILS into 2025.”

Here it’s worth pointing out that it is our belief that ILS capital providers are also keen not to budge on these contract terms for the treaties and layers they are already allocated to.

But, we do know that some ILS capital managers are willing to provide some capacity lower down, albeit at similar exclusionary terms, while some appetite for aggregate structures also persists, although again at more stringent terms than would have been seen five years ago.

So this should not be seen as letting discipline slip in any way, but as the analysts state it does mean the field of opportunities is getting broader again and ILS capital will structure itself to respond to this, in some cases.

Other factors set to drive opportunity for the ILS market and help to feed its growth, especially into collateralized reinsurance and sidecars, include the facts that the primary market appetite does not yet appear satisfied, meaning more deployment opportunities, that traditional reinsurance capital raises still remain few and far between, that ILS continues to dominate much of the retrocession market and will likely continue to, that primary risks are becoming better priced which could drive interest in supporting quota share arrangements such as sidecars, that a second relatively clean year with attractive returns may buoy investor interest, and that trapped capital continues to be released which is effectively raising the deployable capital base of the ILS market.

“Looking beyond 2025, we see considerable growth potential for the ILS market. To-date, the ~$100bn ILS market has been largely concentrated in US property CAT. The complexity and nascency of the market may keep some investors away. However, continued third party modeling improvements and a growing capacity need in lines and risks such as cyber and flood should present long term growth opportunities,” Jefferies analyst team explains.

But adding that, “Ultimately, this asset class, like others, will need to offer attractive yields relative to credit spreads and expected insured losses, a low default history and manageable counterparty credit risk in order to continue to attract investments.”

Ultimately, growth of the ILS market is seen as positive for the primary insurance market, as it broadens the range of available risk transfer and risk capital options, and the cost of ILS capital tends to still be lower than that of traditional reinsurers, Jefferies believes.

But it’s also good for investors, as the relatively uncorrelated story continued to hold true.

“While this narrative was hurt in 2016-2022 due to repeated large CAT losses, we continue to believe that the value to investors of ILS will be measured over a longer period of time,” Jefferies analysts state. “Moreover, some of the low returns experienced in recent years can be and have been addressed through the structural market changes.”

We haven’t seen such a bullish outlook on ILS market growth for some time now, but with the groundwork of a reset reinsurance market in place, approaching two years of attractive track-record soon to be available (losses through the end of 2024 allowing), and investor interest high and rising, expansion is certainly on the cards.

To reach $200 billion by 2032, the ILS capital market would need to grow by roughly 82% over the intervening period.

While not impossible, that is still quite a big ask and we do expect traditional reinsurance firms to be more competitive than it seems Jefferies analysts are expecting. You only have to look back to the last significant softening of the reinsurance market to see where pricing and terms were relaxed first, which provides some insight into how things could pan out over the coming years if ILS capital does flow in more meaningfully again.