ILS capacity recovering in sidecars, ILW’s, collateralized reinsurance: AM Best

Capacity is increasing across the range of private insurance-linked securities (ILS) products, as fund managers and reinsurers have benefited from new inflows to structures and investors look to access the strong reinsurance market returns that are available, rating agency AM Best has said.

But a single year of stellar returns, such as was seen across catastrophe bond and ILS strategies in 2023, is not seen as enough to drive a significant wave of new capital into the sector, AM Best believes.

As we reported last week, the latest data from AM Best and reinsurance broker Guy Carpenter estimates that alternative capital in reinsurance, so ILS, cat bonds and other third-party capitalised structures, could reach as high as $110 billion by the end of this year.

It’s not particularly significant growth for the market, but understandable as those managing strategies seek to more closely match capital to the opportunity as a desire to sustain returns remains a key consideration for those raising money in the space.

AM best does note a trend towards more nimble capital deployment in ILS, something that has been an increasing feature of the market over the last few years.

As standing up new reinsurers, or even sidecars, could often mean raising capital that would be locked in for a defined period, managers have become more adept at offering strategies that those same investors can get into to maximise the current market opportunity, while making it easier to get out again as well.

AM Best says, “In some cases, opportunistic investors who dipped into the ILS market in 2023 because of the record return potential have exited the market in 2024 based on the premise that the 2023 returns will not be repeated this year.

“ILS managers have built efficient platforms to facilitate this type of more nimble cat risk trading by investors. Whereas in past years institutional ILS investors may have followed an approach to ILS investing more akin to “set-and-forget,” quick-moving cat risk trading may become more prevalent in the ILS market.”

These strategies still aren’t as nimble as investors will be familiar with in other asset classes, but they are attractive to some investors that might have backed a start-up or sidecar in the past.

It’s going to be interesting to see how that trend develops, as managers look to provide greater optionality and flexibility to the ILS fund investor base going forwards.

But, while more speculative capital is all good and well, the ILS market does still largely focus on attracting committed investors that see the benefit of allocating capital across market cycles.

Evidence of this is seen in the catastrophe bond market, where after a record 2023 of issuance 2024 saw new records fall by the half-year.

The size of the cat bond market, measured in risk-capital outstanding, is up by more 5% since the end of 2023.

AM Best explained, “Capacity growth for the ILS market is modest and, except for the more remote layers of risk, appears to mostly match demand rather than exceed it. One year of great returns is probably not enough to draw in material amounts of new capacity that would significantly soften the market. Retained earnings led to some capacity growth, but not all of the 2023 earnings were redeployed into new deals—some investors chose to redeem profits instead.”

Capacity from maturing deals being recycled into new transactions, alongside the cash earnings from catastrophe bond coupons, have been a driver of growth this year, alongside some fresh capital raised.

But there are signs of capital entering across a broader spectrum of ILS deals than just cat bonds now, which AM Best details in its latest report on the market.

One area is reinsurance sidecars, where we’ve seen both larger deals in 2024, as well as a broadening out of the risks being covered.

AM Best noted, “Sidecar capacity is estimated to be between USD 6 billion and USD 8 billion and may well have shifted to the higher end of that range, as capacity providers find those deals more attractive given underlying improvements in rate adequacy.”

The industry-loss warranty (ILW) market has also seen more activity this year, although a good deal of this has been in hedging activity for some of the larger ILS fund managers.

On ILW’s AM Best said, “Industry loss warranty (ILW) capacity is estimated to be between USD 5 billion and
USD 7 billion.

“ILW capacity going into the mid-year renewals may have been slightly higher than in other recent renewal periods and that capacity was quickly used to hedge against an Atlantic hurricane season that is forecast to be very active.”

The rating agency also sees an improving outlook on the collateralized reinsurance side, which also includes retrocessional arrangements.

“Collateralized reinsurance capacity is estimated at approximately USD 46 billion to USD 50 billion. Capacity growth in this segment had lagged that of cat bonds. However, as fundraising begins to rebound from the sluggish pace of the past two years, capacity growth could speed up,” AM Best explained.

That is how the rating agency gets to the $105 billion to $110 billion market estimate for 2024.

Depending on how the rest of the hurricane season progresses, there is every chance that with little in the way of losses we could see a higher level of alternative and ILS capital in the reinsurance market by year-end, we believe.

Commenting on how the end of year could pan-out, AM Best said, “Capacity providers are highly motivated to maintain discipline because the poor returns of recent years are still fresh in their minds. Any material softening is more likely to begin with the traditional reinsurers that are working with a larger (and leveraged) capital base and have more flexibility to use their retained earnings to further expand that base.

“ILS managers, in contrast, may not be able to retain earnings to deploy into new deals because they may need to return money to investors at contract expiry.”