ILS may continue as primary source of new reinsurance capacity in 2024: Bloomberg

Insurance-linked securities (ILS) and alternative reinsurance capital structures may continue to be the primary source of new reinsurance capacity through 2024, according to analysts at Bloomberg Intelligence.

The analysts suggest that alternative reinsurance vehicles “compete with rated-reinsurers and thereby hurt pricing”, which we’d suggest is a bit of a generalisation.

If one were to look back at the last significant softening of the market, through the early to mid-2010’s, it was traditional reinsurers that drove a significant proportion of the price competition in the United States catastrophe reinsurance market in particular (the market had already softened well before what is know commonly known as the ILS capital ‘great reload’). Also, flows and capital entry from either alternative or traditional side will affect the price dynamic.

The analysts note the continued lack of new capital coming into traditional reinsurance companies, as well as the lack of new reinsurer start-ups.

Matthew Palazola, BI Senior Insurance Analyst, commented, “Total reinsurance capacity could continue to grow as historically high alternative-capital returns fuel further issuance and draw demand. Alternatives to rated reinsurer balance sheets can come in many forms, such as cat bonds, insurance linked securities (ILS) and sidecars. Alternative reinsurance capital dates back to the mid-1990s and has risen to about 16% of the market from 10% in 2014. Smoother capital-market transactions have made it easier for funding to enter the industry, which has limited price gains after large catastrophes.

“Despite major price increases in 2023-24, there was essentially no balance-sheet reinsurance capacity added aside from a capital raise at Everest. In prior strong markets, new companies were formed, such as the “classes” of 2001 and 2005.”

The smoothing of price gains is a positive for traditional re/insurers, as it helps them with more stability in their own reinsurance and retrocession purchases, it’s something the ILS market has always been known for.

Catastrophe bonds after their record year in 2023 are an area of focus, with the Bloomberg Intelligence analyst team saying, “Cat bonds could see further growth as higher pricing, along with increased money-market rates which hold the collateral, boosts yields and provide a greater expected return.

“Higher attachment points and retentions among primary carriers may boost interest in such securities.”

They believe that the combination of still comparably lower capacity in traditional reinsurance markets and higher prices could “entice capital inflows to the insurance-linked securities (ILS) market.”

Which we’re absolutely seeing today, but at the same time the demand for reinsurance has also risen significantly, which has soaked up all of the additional ILS capital that has flowed into the market so far, we believe.

More evidence of the rising demand for reinsurance limit was seen this morning, in our reports on the renewals of AXA and Zurich, both of which purchased more limit at January 2024, AXA significantly more.

The Bloomberg Intelligence analyst team also note that investor appetite may continue to be relatively cautious, due to the way an ILS structure allows cedents to extend maturities and trap in investor capital when losses threaten.

This is a continued issue for some, but the majority of ILS managers are finding ways to reduce their exposure to trapped capital, while some are now charging what are effectively extension spreads on collateralised reinsurance and retrocession arrangements, just like we see in catastrophe bonds.

Palazola added, “Expected returns on cat bonds — the coupon less expected loss (excluding money-market fund returns — appear to be at their highest since 2012. The current catastrophe-bond multiple, as measured by Artemis.bm, is at around 4.54x, 34% higher than 2022’s 3.38x and 144% better than 2017.

“Multiples compressed in the 2010s as capital entered both the ILS and traditional reinsurance market, creating a supply-demand imbalance and dampening pricing across reinsurance products. Coupon rates in 2023 averaged 8.9%, the highest since 2012, and expected losses fell to 1.8%, the lowest since 2014’s 1.6%.”

It’s early days in 2024 to compare developments in catastrophe bond pricing and multiples, as the mix of deals available remains a little small so far.

But, we can look at the year-on-year quarterly comparison we can see that Q1 2024’s price multiple is only slightly lower than Q1 2023’s, so far.

At this stage of the year, Bloomberg Intelligence’s thesis that alternative and ILS capital may be the biggest driver of fresh reinsurance capacity this year, looks a relatively safe bet.

We’re still not seeing an Class of start-ups come to market and those still in the works do not look likely to move the dial, or unbalance the market particularly.

The question over whether pricing is affected really depends on whether demand continues to rise at the mid-year renewals and if that remains sufficient to soak up fresh capital, which is really how the January renewals seem to have turned out.

The competitive nature of reinsurers and ILS managers will be the other key dynamic to watch, alongside market discipline and the occurrence of any major cat loss events.

Which all makes for a fascinating year ahead, where the ILS market does have a strong chance of significant growth, as long as discipline is maintained and as a result investor returns are sustained.