ILS “poised for strong market growth” on returns & diversification: Aon

Elevated, near-record returns and still-evident asset class diversification benefits, leave insurance-linked securities (ILS) and alternative capital in reinsurance poised for strong growth, according to Aon’s Reinsurance Solutions.

A supply-demand imbalance that became evident in the catastrophe bond market in 2022, alongside the reaction to increased catastrophe activity over the last five years, has “pushed the bond market into a higher total return environment, with material increases in overall pricing, accompanied by higher collateral returns,” Aon explains.

Adding, “We anticipate Insurance-Linked Securities (ILS) investors to take advantage of attractive returns and diversification opportunities presented by the ILS market in 2023, driving further growth and delivering valuable capacity for re/insurers.”

Across the alternative capital and ILS market through 2022, Aon has “observed investor preference for cat bonds, as the liquidity and structure of the instrument continues to be favored, resulting in an increase in capital allocated to the cat bond market, overall,” the broker said.

On rising risk spreads, the broker continued to say, “Margins in ILS have increased significantly during 2022. Some of the increased margins observed in 2022 are directly attributable to Hurricane Ian and the material rise in collateral yields.”

While on the diversification benefit of catastrophe bonds and ILS, “Global equity, fixed income and credit markets struggled during 2022 and investors benefited from the lack of correlation between ILS and other asset classes.”

However, on the opposite side of the trade to the ILS investor-base Aon said that, “From an ILS sponsors’ perspective, the increasing prices seen in traditional reinsurance and retrocession markets is increasing the demand for ILS capacity.

“We are now in a market where demand for ILS capacity exceeds supply, and while this has resulted in higher overall pricing and tighter terms and conditions, regular sponsors of cat bonds and other ILS products have been appreciative for this alternative source of capital, having developed stronger relationships with ILS investors.”

All of which leads Aon to be very constructive on the catastrophe bond market, but also positive on other alternative capital and ILS reinsurance solutions.

“ILS capital has become an essential source of capacity for insurers, and an important component of reinsurance purchasing strategy,” Aon’s Reinsurance Solutions commented.

Forecasting that, “We expect demand for all forms of alternative capital to remain elevated throughout 2023 as insurers and reinsurers look to mitigate both macro-economic and reinsurance market challenges.”

In the past, higher margins and the diversification benefits of ILS, compared to other asset classes, have been drivers of “meaningful market growth and could be a net positive for new and existing sponsors,” Aon continued.

Concluding that, “This is likely to occur once the markets better understand Ian loss development, inflationary trends, interest rates and the overall geopolitical uncertainties that have pervaded the broader financial markets in 2022.

“The overall theme remains that diversification is playing out well compared to prior ‘bull run’ of the broader financial markets. The investment case for ILS remains strong, and will be further bolstered by reinsurance and retrocessional rate increases sustained at year-end 2022.”