Outflow trend over for collateralized reinsurance funds and sidecars: Fitch

Fitch Ratings believes that the trend of net outflows that has been seen across insurance-linked securities (ILS) funds and structures that allocated capital directly to private reinsurance and retrocession arrangements is now over, with assets now deemed more stable, suggesting a chance of more consistent growth is ahead.

But, at the same time the rating agency is warning that investor appetite for catastrophe bonds may increase margin pressure for the reinsurance sector, at the higher-layers of programs at least, something that could also cascade further down the risk tower if the collateralized side of the ILS fund market experiences strong inflows.

The same factors that drove last year’s strong expansion for the catastrophe bond market have also ultimately driven the stabilisation of collateralized reinsurance and retro focused ILS funds and structures, it seems.

These were, for the cat bond market, the “absence of large loss events, strong pricing, and a strong investment return on collateral pools,” Fitch explained.

In addition, Fitch also added that, “Concerns due to poor performance over the past five years, and the poor reliability of catastrophe models, have increasingly faded over 2023,” which is another factor that is expected to increasingly benefit the private ILS side of the marketplace.

On how these factors will influence the cat bond market and ultimately reinsurance going forwards, Fitch said, “We believe this will continue in 2024 despite tighter cat bond pricing, which will exercise increasing margin pressure, particularly on upper layers of property cat protection.”

These very same statements now look like they will apply to the private ILS and collateralized reinsurance sides of the marketplace, as conditions appear set to help ILS managers grow their strategies there as well.

“Within the alternative capital space, collateralised reinsurance programmes and sidecars stabilised assets under management in 2023, putting an end to a trend of net outflows that started in 2019,” Fitch said.

Adding, “We believe these forms of alternative capital deployment, similarly to cat bonds, also benefitted from a favourable claims development and strong collateral returns.”

It’s all positive commentary, from an ILS market point of view, but Fitch’s message underlying this is that capital flows are stabilising prices in reinsurance and private ILS flows could tip that over towards a more moderating trend at lower-layers in risk towers, as we’ve seen happen in catastrophe bonds and the higher-layers over recent months.

As we wrote this morning, there are already forecasts for pricing power to diminish in property catastrophe reinsurance at the mid-year renewal season.

The ILS and reinsurance market is now at an intriguing inflection point, where the balancing act between satisfying the appetite being shown by capital providers and sustaining reinsurance pricing at levels sufficient to generate returns over the longer-term, could be extremely fine.

Increasingly, ILS managers are moving forwards with an expectation of the investor churn that has been seen slowing or halting entirely, while new investors are showing rising interest in the asset class still.

On the back of strong to record returns of 2023, the private ILS fund and sidecar market looks poised to benefit from a wave of investor interest, but those investors will be hoping the opportunity does not diminish too far, in terms of the returns that are available.

With early forecasts for the 2024 hurricane season suggesting a year with significant levels of activity is possible, it might be deemed foolish to depress pricing of catastrophe reinsurance covering that peril too far, or too soon.

That said, it’s not just down to ILS managers to control flows and match the capital to the opportunity, to protect their return targets.

It’s also down to traditional reinsurance firms not to depress pricing through excessively competitive behaviour at renewals, as we saw back in the early 2010’s when major reinsurers bulked up on cat heavy US reinsurance, forcing the softening that was seen over that period, which was then exacerbated just prior to a loss-heavy hurricane year in 2017.

Memories can be short in this industry, but we hope not that short.