ILS investors willing to take on more risk, if the price is right: Peel Hunt

Insurance-linked securities (ILS) investors appear ready and willing to take on more peak peril severity catastrophe risk, if the price is right, leading analysts at Peel Hunt to suggest the ILS market is primed for growth.

Investors are looking for evidence that reinsurance is now rate-adequate, and that is what now needs to be proven out for the ILS market’s inflows to become more meaningful into property catastrophe risks, Peel Hunt’s analyst team state.

The analysts note that it is not just insurers and reinsurers that have adjusted their risk appetites of late, moving away from secondary perils being one example of this.

The ILS market and its investors have been doing the same, as has been evidenced by the shift up the risk tower, the tightening of underwriting terms, the reduction in exposure to aggregate deals and much clearer definitions of covered perils.

But still, total ILS assets under management have remained relatively flat for now five years or more, held back by the loss activity experienced, the rotation out of ILS by some investors, the cycling in of others but on a smaller scale, and of course trapped capital, which has been a drag on the sector’s deployable ILS assets since 2017.

Investor appetite is still more subdued for collateralised reinsurance and retrocession, as we explained last week.

But money is flowing into the ILS market, especially into catastrophe bonds, while inflows to other alternative reinsurance capital vehicles is continuing to grow and some collateralised ILS funds are reporting recent successes as well.

With spreads still much higher in the catastrophe bond market, despite recent softening and multiples-at-market of expected loss remaining above five times year-to-date so far, Peel Hunt’s analyst team believes this shows the motivation of investors to achieve and sustain higher returns in order to allocate to catastrophe risks.

“ILS investors are willing to take on more (peak) severity catastrophe risk at the right price,” the analysts explained.

Further saying that, “We believe that once ILS investors see evidence that property catastrophe reinsurance is rate adequate and delivers attractive IRRs, investors will start to put capital to work more broadly in property catastrophe reinsurance again.”

The analysts note that this will be a positive for the market, helping to reduce undersupply in property cat capacity.

It’s critical to note the balance in the market, with capital still under-supplied, but exposure growing, meaning the reinsurance market does have room for more catastrophe risk capital to enter than it did before, without it driving a significant softening of rates.

On ILS investor inflows to the market, Peel Hunt’s analyst team states, “This would be welcome, as the demand/supply imbalance for property catastrophe risks is restricting growth in a market that is underinsured.”

At renewals some reinsurance programs have been oversubscribed, but this is more down to quality of cedent and risks, than a market-wide feature, with many cedents still struggling to secure the catastrophe reinsurance capacity they needed.

While the market’s balance and dynamic remains in this state, rates should hold and it’s possible ILS investors get the chance to see it evidenced that IRR’s are attractive once again in catastrophe reinsurance risk.

What happens then, if inflows become more meaningful, remains to be seen.

But investors will be looking for disciplined capital raising and for managers of their capital to be pushing for pricing baselines to be set, or we could very quickly see money starting to withdraw, perhaps just as fast as it entered.

While ILS investors are exhibiting a growing appetite for risk and we’re seeing more new investors examining and looking to learn about the ILS market now, than perhaps at anytime in the last decade, the desire for adequate returns will not go away.

As a result, we suspect capital raises and deployments will have to be more measured. As those seen to raise fast and deploy at low pricing may not find their strategies win them the long-term investor-backing they seek.